What You Can - And Can't - Learn from Warren Buffett

I am a complete sucker for investment books. My wife accuses me of owning several thousand books that have essentially the same title, usually some variant of Value Investing, valuation, or intrinsic value, or securities analysis. Of course, I have every Buffett or Munger book known to man as well as everything about or by Benjamin Graham.

Vahan Janjigian, a fellow CFA, is executive director of Forbes Investment Advisory Institute and publishes a number of newsletters with Forbes. He also has a blog and serves on the investment committee of a large RIA. Dr. Janjigian's book is a gingerly attempt to criticize some of Buffett's mistaken investments, and controversial points of view. I think the book is more successful with the latter than the former.

Janjigian admires Buffett's discipline and capital allocation methodologies. He admires Buffett's ability to manage executive talent. His last sentence in the book summarizes his viewpoint,

Based on the evidence, it is certainly fair to conclude that WB is one of the greatest investors-if not the greatest investor-of all time.

So where are Buffett's mistakes? Janjigian criticizes Buffett's views on taxation, especially those on estate taxes. I agree with Janjigian that there is an irony if not an artificiality or phoniness about urging the continuity of high estate taxes and concomitantly avoiding the situation through setting up trusts and foundations. Evidence of avoiding income taxes is evident throughout Berkshire's life, as the company and Buffett have always used the IRS Tax Code to their advantage. There is clearly nothing wrong with that but similarly, it is somewhat disingenuous to urge higher taxes after a career of avoiding them.

Like any investor, Buffett has made some mistakes. This is not a perfect game, but rather one where investors should attempt to understand the downside risks in making an investment. The outcomes can be highly uncertain, the future always is hazy and usually, initial assumptions are plain wrong, either on the optimistic or the pessimistic side of expectations.

Janjigian addresses the Buffett diversification versus concentration question. Buffett believes that if you can't invest enough money to have some say in how the company's capital is to be deployed, you are better off diversifying your portfolio.

This is simply not true. Most Buffetteers and wannabes certainly attempt to focus their portfolios. Warren Buffett does not say not to diversify, in fact, for the average investor who is not inclined to do sufficient due diligence, diversification is a salvation. For many professional portfolios, the great bulk of the portfolio is indexed. However, in cases where one has specialized knowledge or skills, satellite investments outside the cord index are made and should add performance. Diversification is a protection against ignorance. If one is able to do due diligence, and select successful businesses at reasonable valuations, diversification will not serve you other than to reduce volatility and an unfortunate corollary, reduce returns.

Janjigian does a decent job in discussing attributes of diversification in a non-mathematical approach to statistical correlation. This is one of the strongest elements in this book.

Much of the rest of the book is, in my view, completely obvious. Buffett buys stocks cheap, not cheap stocks. Successful investors must be able to distinguish between great companies and great stocks. Janjigian has an amazing grasp of the obvious and adds little insight into valuation of growth stocks. There are far better sources than this book for this element.

He addresses the fact that value works over the long run but growth or rather momentum can work over the short run. Buffett never trashes growth but views it as a partner in helping undervalued stocks recover when growth becomes temporarily disrupted. Other than Buffett's famous comments about lemmings, he has never discussed momentum investing per se, at least to my knowledge.

Janjigian makes some dangerous statements about PIPE stocks indicating that Warren Buffett has been successful in buying special issue "Private Investment in Public Equity" holdings such as Salomon Brothers or US Airways (LCC). True, these had special terms that a large buyer can extract but it is misleading to believe that what some brokers present as PIPEs will offer the average investor better returns. Most PIPE offerings are made in very small cap, highly risky businesses. He does suggest that the best access to such investments is through a hedge fund or through Berkie itself.

He makes the point that unless you have access to Buffett-like resources, it is better to think of yourself as a stock buyer rather than a business buyer.

The argument that managements will rarely listen to outside advice is humbling for both institutional and retail investors. However, retail investors and small institutional investors can be very successful in motivating and organizing larger investors to add pressure to a board. The principle of thinking long term as an owner of a business rather than a punter of stocks is an important part of any real value investor's credo.

I have had former business partners who "played" stocks rather than owned businesses and who were looking for trends rather than valuation rationales for stocks. I have had investee company managements who have indicated that I should just sell the stock if I didn't like what they are doing. If the business has a strong moat that is not being defended, get rid of the management but hang onto the business. His advice is ill conceived at best in this topic.

Swinging for the fat pitch is Warren Buffett's approach. Warren Buffett does not suffer from analysis paralysis and he believes that some of Warren Buffett's recent deals have had inadequate due diligence. Sometimes the obvious should not take very long!

Warren Buffett readily admits to being "dead wrong." Salomon was a mistake that took an extraordinary amount of work to escape. Gen Re was much worse with poor judgment on Warren Buffett's part re underwriting discipline and the derivatives book of GenRe securities. NetJets capital intensity does not seem to fit the usual Buffett textbook. Pier One had no moat. These were all mistakes. He actually misses the most egregious errors that I recall, namely Dexter Shoe, which gave away 1.6% of BRK, or about $3.5 Billion in value for what is now a tiny fragment of H.H. Brown Shoe Group, another BRK subsidiary Dexter, which Buffett calls his worst mistake. He doesn't even address this.

There have been others. Warren Buffett was the largest investor in Handy and Harman, the silver processor and refiner. Unfortunately, it was also an auto parts supplier and metal bender. Buffett's endless fascination with silver attracted him to H&H. H&H ultimately merged into WHX, which went chapter 11 in 2003. Berky had escaped H&H many years before this ignominious end.

He dislikes Warren Buffett's views about corporate governance. It is incorrect to say that Buffett opposes employee stock options. He faulted the accounting, as well as the low hurdles that most company's managements clear to get them. In many cases, the only requirement for managements to achieve is respiration, and there are even cases where compensation continues into the after-life!

The composition of Warren Buffett's board has been controversial in the past. It certainly was not independent since historically, Warren and Charlie, Susan and Howard Buffett; Malcolm Chace and Walter Scott were old business cronies; Ron Olson was a partner in Munger's old firm. However, Janjigian missed the most obvious point, Buffett for most of the time that he was involved in BRK owned over half the stock. It was absolutely iron clad clear that management's interests were aligned with shareholders. Unlike most public corporations, management owned most of the stock. The role of the board is not to protect minority shareholder interests but rather to ensure that shareholders' interests are protected. He misses this point.

The key takeaways after each chapter provide an excellent summary of each chapter. The final chapter, "Conclusion" successfully highlights the important points.

The bottom line is :If you are looking for advice to imitate Warren Buffett's investment style, then this is not the best source of information. If you are looking for a comprehensive list of Warren Buffett's mistakes in judgment, this is incomplete. If you are looking for views on taxation contra to those of Warren Buffett, read Steve Forbes rather than Vahan Janjigian's book.

Dr. Janjigian has attempted to provide an antidote to the usual glorious heaping of praise that most Buffett books (and CNBC coverage) provide. The reality is that nobody walks on water (or parts the sea depending on your point of view.) Even great investors frankly screw up royally. However, the incidence in the case of Buffett is remarkably low; the damage is a scratch or fender bender rather than a complete wreck. All of us should be so fortunate, or disciplined!

Even Buffett Isn't Perfect, by Vahan Jahigian (2008: Penguin Books, 256 pp. hardcover, $24.95)

Comments

[Charlie Stromeyer Jr]

Thanks for this helpful review, Rick. Do you happen to know if it is true as someone once told me that Warren Buffett has had a total of 99% winners and thus 1% losers among all his equity investments over his entire career?

[Carl Martin]

RICK KONRAD, You have a really clear way of thinking and expressing, on top of a very sharp mind.

[User 229494]

I think buffett's greatest mistake has been his failure to recognise globalisation and emerging markets (yes I know but Posco and China Petro)...these are exceptions that just underline the point that if WB had used his ability to look at companies beyond the US border, his outperformance would have been manifold of the current levels

[andydee]

Rick,

Well written, fair review.

My question: I have a couple of Buffett books, (Lowenstein's, "The W.B. Way", "Buffetology"... "Of Permanent Value") and "Security Analysis" - but would like to round out my collection with a couple on Charlie Munger, and more of your favorite Buffet books - do you have any recommendations?

[Rick Konrad]

I appreciate everyone's comments. The success ratios for WB I suspect are well below 99%, my guess would be much closer to about 70%.

This truly is a fascinating business where mediocrity of 50% (random success) can be achieved by a blind-folded ape. Sadly, many professional portfolios cannot achieve even mediocrity. What differentiates great managers is not only the frequency of success but the size and scale of that success.

This is by its nature, a very humbling business where great managers have batting averages of .550 to .600. WB has a higher batting average but is truly a power hitter.

I think the comments about globalization and emerging markets are fair comment for WB and for many value managers. Familiarity and comfort with US GAAP accounting is part of the rationale. IASB principles have only come together in the last five years or so...standardization has helped a great deal. An even more important aspect of avoiding emerging markets relates to significant differences in corporate governance practice.

However, look to the record of Templeton who pioneered the practice of going global. Jean-Marie Eveillard is another champion of global value investing that I respect. Interestingly, though he currently has a bit of an aversion to U.S. stocks, Eveillard's largest position in the States is Berkshire Hathaway.

Thank you again for your kind comments!

[Umm, yeah]

I enjoyed your article, thanks!

[Rick Konrad]

Andydee...there are several Buffett books that I like. Robert Hagstrom's "Warren Buffett Way" provides some interesting case studies into the "why" of many Berkshire investments.

Charlie Munger's clarity of thinking is renowned. One of the best ways to access his wisdom and wit (in that order) is "Poor Charlies' Almanac," a title that WB bestowed on this book and of course Charlie hates. It includes many snippets of quotes from his writings and speeches.

Finally, a couple of other books I would recommend on investment thinking that lean heavily on Buffett and Munger. Peter Bevelin, a fellow Berkie shareholder and a brilliant thinker ( well, at least PB is a brilliant thinker) has written "Seeking Wisdom." Peter uses quotations from many authors to improve one's way of thinking. For example, on the topic of being wrong," A man should never be ashamed to own that he has been in the wrong, which is but saying , in other words, that he is wiser today than he was yesterday." Unfortunately, what most of us do is what Buffett describes, "What the human being is best of doing, is interpreting all new information so that their prior conclusions remain intact."

Another useful book in this regard is Lawrence Cunningham's "How to Think Like Benjamin Graham and Invest Like Warren Buffett." This is again a fairly enjoyable read. Cunningham is not a practitioner, but rather a teacher and professor. He admires these great investors "for their independence of thought, their utter and profound common sense, which led to their remarkable success."

I think you will find all of these books very helpful additions to your investment library.


On Jul 21 10:45 AM andydee wrote:

> Rick,
>
> Well written, fair review.
>
> My question: I have a couple of Buffett books, (Lowenstein's, "The
> W.B. Way", "Buffetology&... "Of Permanent Value") and "Security
> Analysis" - but would like to round out my collection with a couple
> on Charlie Munger, and more of your favorite Buffet books - do you
> have any recommendations?

[Charlie Stromeyer Jr]

Here is the best (academic) analysis of Buffett's portfolio from 1976-2006 and this paper shows on page 28 that Buffett's gain-to-loss ratio (which measures the ratio of positive returns to negative returns) is 66.77 compared with just 8.32 for the S&P 500:

papers.ssrn.com/sol3/p...

Also, this paper finds that large cap growth stocks have been the number one choice for Buffett during the period.

[Rick Konrad]

An excellent point. Contrary to what most people believe, WB, the consummate value investor made most of his returns in large cap growth stocks. As the research paper indicates:

"Although beating the market in all but four years can statistically happen due to chance, incorporating the magnitude by which the portfolio beats the market makes a luck explanation extremely unlikely even after taking into account ex-post selection bias"

The frequency of the great picks versus turkey picks has little to do with the end results; rather, it is the magnitude and scale of the victories that has made shareholders wealthy.

TY for your comments!

[gordo]

For any of you who want to learn from Warren Buffet, I suggest you read the annual reports of Berkshire...

[Randy Fay]

Been a fan of WB for a little while. Grown to appreciate his way of thinking. I was kinda the opposite back in 1999 when investing in say Commerce One. As a slightly humourous aside, my buddy sent me a fake email just yesterday. I didn't know it was fake because he did a pretty good job of disguising himself. Later in morning I called him up and said "You'll NEVER guess who emailed me." To which he replied "Warren Buffett?" I am still laughing about it.

[goldenhinde]

With regards to estate tax, Buffett has a perspective most other don't. I cannot describe it - or the source of it but to say that Bill Gates and Bill Gates Sr. are of like mind. I suppose it would be obvious that they have a sense of duty which is stronger within them about the "need" or moral imperative to give back.

Not all wealthy think this way. No surprise there. No all of anyone thinks one way.

I would argue that estate taxes as applied to a closely held business are uneconomic and make no sense. Few businesses can recapitalize themselves at 55% of their net worth - even over 14 years as the federal estate tax allows.

If your money is tied up in a business the estate tax ought to be minimal - say 10%. so amend SEC 6166 - fine.

It is interesting to note that our sense of obligation to others here is nothing compared to the sense of obligation embedded in Asian or Middle Eastern culture. It is simplistic to say that our selfishness has caught up with us. It is also simplistic to dismiss the value that is generated by having a culture in which citizens felt honor in giving back to their communities and countries - rather than foolishish.

It is not entirely clear - other than from a more middle class perspective - that Buffett has it wrong.

[Charlie Stromeyer Jr]

goldenhinde, like Warren Buffett, I also support some kind of estate tax and Barack Obama, but I realize that individuals such as Buffett and I can economically afford such views.

Another good reason NOT to read Vahan Janjigian's book above: It was endorsed by the CNBC fool Larry Kudlow. Also, I prefer academic papers over books because the papers are less biased (and thus more accurate) and the papers are usually shorter than books.

Disclosure: I have contributed my own money to Obama for America.

[JoefromCranston]

Rick,

I believe your reference to yourself and a CFA charterholder is incorrect. You have violated Standard VII(B). The CFA and Chartered Financial Analyst designations must always be used
as adjectives, never as nouns or common names.

"Vahan Janjigian, a fellow CFA, is executive director of Forbes..."

Information on proper use of the designation can be found on the CFA Institute website at:
cfainstitute.org/memse....

Thank You,

Joe

[notsosmart]

maybe l.kudlow could print & sell "goldilocks"... bookmarks for the above named books.

[John Egan]

Larry Kudlow is such a gas-bag. Like the hypochondriac that has 'I told you I was sick!' on his tombstone, Kudlow will eventually find his Goldilocks economy. (As one commentator said on CNN this morning 'If I live to be two hundred!') ... I would probably watch Kudlow if he ever had guests on that actually argued an opposite opinion. And, if he learned to shut up for two minutes so the listeners could hear what the guests actually had to say. Even Chris Matthews (who admits in his books that he can't help talking over his guests) will allow them to say their piece sometimes....

Anyway... nice to see an article that points out that Warren does not sit on the right hand of God....

jegan ;-)

[Kunst]

"...there is an irony if not an artificiality or phoniness about urging the continuity of high estate taxes and concomitantly avoiding the situation through setting up trusts and foundations."

Buffett has it right. It is unhealthy for society as well as the families involved for great wealth to pass down from one generation to the next. Money being power, this creates a form of aristocracy that is completely contrary to American ideals.

I have no problem with Sam Walton, Warren Buffett, Bill Gates, or anyone else legally acquiring as much wealth as possible. I have a huge problem with the next generation inheriting billions of dollars they did nothing to earn. Every person ought to start on an equal footing. There are enough advantages to having wealthy parents just in terms of education and opportunity.

Buffett and Gates have done the right thing, as Carnegie and others have done in the past. Instead of producing several generations of idle rich, they point that money toward making the world a better place as they see it.

Inherited wealth is corrosive, to those who receive it and to society as a whole.

[Rhett]

Why the hell are Warren Buffet and Bill Gates extending the bulk of their charitable largesse overseas instead of here in the good ole USA where they made their fortunes. There is plenty of need here but unfortunately, not as much publicity as in "saving the savages" around the world.

[Punit Kumar]

I think Vahan Jahijian is an idiot, he is trying to stir up controversy where nothing of any substance exists. Yes, there is some problems with his views on Estate Taxes. WB is arguing it one way, but doing things around estate taxes. But WB has long said that none of his money will go to his children and it is actually true. After his death none of his money will be going to his children. So, this is less of a controversial view than laid out in this book.

As for investment success, one of the best thing about WB is his ability to realize businesses with stretegic advantage over their competitors (economic moats) and then making large bets on those businesses.

[User 233007]

Many of Warren Buffet's best value fundamental investing principles are discussed on bullishbankers.com

[blah-blah]

Jim Rogers is a complete clown

Great article BTW

[Kunst]

Why the hell are Warren Buffet and Bill Gates extending the bulk of their charitable largesse overseas instead of here in the good ole USA where they made their fortunes. There is plenty of need here but unfortunately, not as much publicity as in "saving the savages" around the world.

-- Who says the savages are overseas? I think you just proved the opposite. BTW, do you think only Americans buy Microsoft products?

[The FItzman]

Kudlow, like Rush Limbaugh, is a paid winbag to fool the uneducating into believing the BS coming from the administration - like how good they would be for the economy and the markets. we've seen how 8 years of that BS has worked out.

wrt buffet: he and his investments don't seem to understand the realities of a future in which worldwide oil supply won't keep up with worldwide oil demand. if so, he wouldn't own all the exposure to the consumer that he does with his housing related investments etc. he did buy some COP awhile back, but has had little follow up that i know of in that regard. meanwhile, berkshire is down, what, close to 20% year to date?

i contacted both buffet and gates 6 months or so ago in an attempt to get their chartible foundations to attack the energy issue, as i made a fairly logical argument as to how the rest of their charitible endeavors would ultimately fail if the energy issue is allowed to crack the US and world economy. neither responded. i noticed this week gates put $500 million (!!!) toward an "anti-smoking&quo... campaign. now, imagine if that amount of money would have been turned over to T. Boone Pickens and was allowed to educate, inform, and fund American energy policy. it's clear to me that gates and buffet just don't see what is currently happened to our economy, currency, and security due to oil. sure buffet bet on the brazilian currency and made money, but, for someone who professes to love america so much (which i am sure he does) and care so much about his children (which i am sure he does) and has alot of integrity (which i am sure he does), how else does one explain his lack of effort when it comes to the "oil problem" other than to simply say "he just doesn't get it". let's hope he WILL get it soon, and put his and his buddy Gates' large foundation finanances at work to DO something about it ala Pickens.

[The FItzman]

oops! "uneducating"... should have been "uneducated" (duh)
when will i ever learn to re-read my comments before posting?

[Ames Tiedeman]

Very well written. Thanks.

[Ashish S]

"Evidence of avoiding income taxes is evident throughout Berkshire's life, as the company and Buffett have always used the IRS Tax Code to their advantage. There is clearly nothing wrong with that but similarly, it is somewhat disingenuous to urge higher taxes after a career of avoiding them."

>> I disagree. If tax is 20% and someone believes that the govt should raise taxes to 30% to pay for more social services, that doesn't mean that person needs to pay extra tax himself. There is nothing hypocritical about using the existing rules to benefit yourself while believing that the rules should be changed.

[ValueHunter]

Fitz, maybe WB doesn't give money in the U.S. for the same reason that I don't give money to drug addicts on the street.

[Charlie Stromeyer Jr]

The Fitzman, you make a great point about the energy problems facing America.

Disclosure: I endorse Pickens plan, and would like to purchase shares of Berkshire but am wary about the prospects for insurance companies in the current environment.