How does an Efficient Market explain Buffett?

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Re: How does an Efficient Market explain Buffett?

Post by knpstr »

EDIT: See last post on previous page before this post

Buffett on this subject:

"To invest successfully, you need not understand beta, efficient markets, modern portfolio theory, option pricing or emerging markets. You may, in fact, be better off knowing nothing of these. That, of course, is not the prevailing view at most business schools, whose finance curriculum tends to be dominated by such subjects. In our view, though, investment students need only two well-taught courses - How to Value a Business, and How to Think About Market Prices." - 1996 Letter
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Re: How does an Efficient Market explain Buffett?

Post by VictoriaF »

knpstr wrote: For Victoria
People need heroes, but I prefer to look for heroes in more socially rewarding pursuits than investing.
Like say, instead of creating a dynastic family of wealth they choose instead to give virtually all their wealth to charity?
How active are hedge fund managers in charity?
knpstr wrote:-business savvy confused with the investment savvy (e.g., Buffett)
This statement again... seriously? :oops:
However, it is ironic that in Security Analysis there is a quote that says something to the extent of: "investment is most successful when it is most businesslike" Investing is a business and business is investing.
The quoted statement is silly, in my opinion.
knpstr wrote:EDIT:
Looking at your list, dumb luck and reckless speculation are the same, no?
Success in "reckless speculation" requires luck, but it is not necessarily dumb. Soros's breaking of the Bank of England took a good deal of intelligence, as well as luck.

"Dumb luck" implies less decision making intelligence and much lower risk. An example is buying Microsoft shares in its early days.

Victoria
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Re: How does an Efficient Market explain Buffett?

Post by nisiprius »

In 'The Way of All Flesh,' written c. 1880 by Samuel Butler wrote:...if I had my way I would have a speculation master attached to every school. The boys would be encouraged to read the Money Market Review, the Railway News, and all the best financial papers, and should establish a stock exchange amongst themselves in which pence should stand as pounds. Then let them see how this making haste to get rich moneys out in actual practice. There might be a prize awarded by the head-master to the most prudent dealer, and the boys who lost their money time after time should be dismissed. Of course if any boy proved to have a genius for speculation and made money—well and good, let him speculate by all means.

If Universities were not the worst teachers in the world I should like to see professorships of speculation established at Oxford and Cambridge. When I reflect, however, that the only things worth doing which Oxford and Cambridge can do well are cooking, cricket, rowing and games, of which there is no professorship, I fear that the establishment of a professorial chair would end in teaching young men neither how to speculate, nor how not to speculate, but would simply turn them out as bad speculators.

I heard of one case in which a father actually carried my idea into practice. He wanted his son to learn how little confidence was to be placed in glowing prospectuses and flaming articles, and found him five hundred pounds which he was to invest according to his lights. The father expected he would lose the money; but it did not turn out so in practice, for the boy took so much pains and played so cautiously that the money kept growing and growing till the father took it away again, increment and all—as he was pleased to say, in self defence.
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Re: How does an Efficient Market explain Buffett?

Post by Boglegrappler »

Is Buffett achieving higher returns by simply taking more risk?

Certainly in his earlier years that was the case. He never leveraged up, but he often said that diversification was silly, and guaranteed average returns. So he was concentrated in his investments.

I"ve made this point before. You can get a sense of Buffetts stock picking prowess by using google finance or some similar graphing program and compare for the past 30-40 years the appreciation in his public investments (AXP, WFC, WMT, KO, etc.) to the S&P 500. He's made some mistakes over time, but his record is one that, in the aggregate, is far better than throwing darts.
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Re: How does an Efficient Market explain Buffett?

Post by knpstr »

VictoriaF wrote:
knpstr wrote: For Victoria
People need heroes, but I prefer to look for heroes in more socially rewarding pursuits than investing.
Like say, instead of creating a dynastic family of wealth they choose instead to give virtually all their wealth to charity?
How active are hedge fund managers in charity? I included Buffett's charitable donation of tens of billions to demonstrate his career in investing was still socially rewarding, in response to your holier than thou position.
knpstr wrote:-business savvy confused with the investment savvy (e.g., Buffett)
This statement again... seriously? :oops:
However, it is ironic that in Security Analysis there is a quote that says something to the extent of: "investment is most successful when it is most businesslike" Investing is a business and business is investing.
The quoted statement is silly, in my opinion. Fair enough
knpstr wrote:EDIT:
Looking at your list, dumb luck and reckless speculation are the same, no?
Success in "reckless speculation" requires luck, but it is not necessarily dumb. Soros's breaking of the Bank of England took a good deal of intelligence, as well as luck.

"Dumb luck" implies less decision making intelligence and much lower risk. An example is buying Microsoft shares in its early days.

Victoria
If someone gave you an explanation why they bought MSFT in the early days, could it not be considered "reckless speculation"? Also dumb luck carries lower risk?? Weird definitions
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Re: How does an Efficient Market explain Buffett?

Post by knpstr »

Boglegrappler wrote:
Is Buffett achieving higher returns by simply taking more risk?

Certainly in his earlier years that was the case. He never leveraged up, but he often said that diversification was silly, and guaranteed average returns. So he was concentrated in his investments.

I"ve made this point before. You can get a sense of Buffetts stock picking prowess by using google finance or some similar graphing program and compare for the past 30-40 years the appreciation in his public investments (AXP, WFC, WMT, KO, etc.) to the S&P 500. He's made some mistakes over time, but his record is one that, in the aggregate, is far better than throwing darts.
I'm almost certain Buffett would say he took less risk. Again, the problem comes to defining risk.
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Re: How does an Efficient Market explain Buffett?

Post by VictoriaF »

knpstr wrote:
VictoriaF wrote:
knpstr wrote: For Victoria
People need heroes, but I prefer to look for heroes in more socially rewarding pursuits than investing.
Like say, instead of creating a dynastic family of wealth they choose instead to give virtually all their wealth to charity?
How active are hedge fund managers in charity? I included Buffett's charitable donation of tens of billions to demonstrate his career in investing was still socially rewarding, in response to your holier than thou position.
You are getting personal, which is against Forum's rules.
knpstr wrote:
knpstr wrote:
knpstr wrote:-business savvy confused with the investment savvy (e.g., Buffett)
This statement again... seriously? :oops:
However, it is ironic that in Security Analysis there is a quote that says something to the extent of: "investment is most successful when it is most businesslike" Investing is a business and business is investing.
The quoted statement is silly, in my opinion. Fair enough
knpstr wrote:EDIT:
Looking at your list, dumb luck and reckless speculation are the same, no?
Success in "reckless speculation" requires luck, but it is not necessarily dumb. Soros's breaking of the Bank of England took a good deal of intelligence, as well as luck.

"Dumb luck" implies less decision making intelligence and much lower risk. An example is buying Microsoft shares in its early days.

Victoria
If someone gave you an explanation why they bought MSFT in the early days, could it not be considered "reckless speculation"? Also dumb luck carries lower risk?? Weird definitions
Buying Microsoft in its early days with a small portion of one's assets is a dumb luck.
Going against the Bank of England with all one's assets is a reckless speculation.

Victoria
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Re: How does an Efficient Market explain Buffett?

Post by knpstr »

My apologies I didn't mean to personally offend you.

You didn't mention they only used a small portion of one's assets the first time. Very interesting perspective you have though.

I would say "reckless speculation" and "dumb speculation". If it requires luck to be successful, as you said, I consider it speculation either way, personally.
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Re: How does an Efficient Market explain Buffett?

Post by robert88 »

knpstr wrote:
robert88 wrote: standard deviation is a good proxy for risk, as long as you remember it's only a proxy. Beta isn't the same as share price volatility.
Oh, I may have a fundamental misunderstanding of beta.

I thought beta viewed the risk of the issue as the given stock's volatility (variation in share price) as compared to the volatility of the market (beta=1).
So not simply volatility alone, but it's volatility against the market's volatility.

Is this wrong?
Beta is the coefficient on the independent variable in a linear regression with the asset return the dependent variable and the difference in the monthly return on the stock market and the risk free asset(usually short term treasuries) the independent variable in CAPM. In multi-factor models, you run a multi-linear regression. I think Fama found that the actual beta of individual stocks tended to be highly unstable, so he tried to smooth it out with some more additional processing(beta buckets?) Others can give a better explanation than I can.
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Re: How does an Efficient Market explain Buffett?

Post by knpstr »

robert88 wrote: Beta is the coefficient on the independent variable in a linear regression with the asset return the dependent variable and the difference in the monthly return on the stock market and the risk free asset(usually short term treasuries) the independent variable in CAPM. In multi-factor models, you run a multi-linear regression. I think Fama found that the actual beta of individual stocks tended to be highly unstable, so he tried to smooth it out with some more additional processing(beta buckets?) Others can give a better explanation than I can.
Good grief... that DOES sound risky!

Next ignoring the problems with CAPM, for now... (slowly getting more and more tangled in an academic nightmare)

Wikipedia:
In finance, the beta (β) of an investment is a measure of the risk arising from exposure to general market movements as opposed to idiosyncratic factors.

Wikipedia, again:
Interpretations of Beta:
β < 0 Asset generally moves in the opposite direction as compared to the index
β = 0 Movement of the asset is uncorrelated with the movement of the benchmark
0 < β < 1 Movement of the asset is generally in the same direction as, but less than the movement of the benchmark
β = 1 Movement of the asset is generally in the same direction as, and about the same amount as the movement of the benchmark
β > 1 Movement of the asset is generally in the same direction as, but more than the movement of the benchmark

Trying to not get too far off discussion with a thread on betas, Buffett/Munger would say that the above has nothing to do with valuing a business nor assessing the risk of the business (for business, read: stock)
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Re: How does an Efficient Market explain Buffett?

Post by protagonist »

knpstr wrote:
I would say "reckless speculation" and "dumb speculation". If it requires luck to be successful, as you said, I consider it speculation either way, personally.
Any investing with risk involved requires luck to be successful. In fact, even the wisest investing is probably mostly luck. It's not chess. Who knows what hand we will be dealt?
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Re: How does an Efficient Market explain Buffett?

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protagonist wrote:
knpstr wrote:
I would say "reckless speculation" and "dumb speculation". If it requires luck to be successful, as you said, I consider it speculation either way, personally.
Any investing with risk involved requires luck to be successful. In fact, even the wisest investing is probably mostly luck. It's not chess. Who knows what hand we will be dealt?
I guess technically you're correct. However, in investing you choose the cards in your hand, it isn't random chance. Also, if you don't like any of the cards, you don't have to play, if you want all of the cards, you can have them all too.

For example,
1) If you buy a bond, from a AAA rated company things could turn south and they default. If you buy the stock of a business that is valued at say $50B at a market price of $30B it could go bankrupt if some unforeseeable circumstance happens. You need to be "lucky" that these unfortunate events don't happen. (if you want to phrase luck into this decision)

2.) But these scenarios are different from say buying a junk bond or buying a stock of a company valued at $50B at a market price of $200B because it has dot com in it's name. You need to be lucky to make a gain.

3.) And different from buying a lottery ticket or roulette at a casino. You need to be lucky to make a gain.

Simplistic examples, but I think you can see the difference.

#1 hoping for no "bad" luck, don't need good luck, though it is still welcome. (investment)
#2, #3 requires "good" luck (speculation)

if anytime there is risk involved, luck is at play, then we're all lucky more than we can ever imagine already. Risk of choking while eating, driving/riding in cars, lightning strikes... etc all carry risk.
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Re: How does an Efficient Market explain Buffett?

Post by protagonist »

knpstr wrote:
I guess technically you're correct. However, in investing you choose the cards in your hand,
I see it more like Texas Hold-'em on steroids. You choose your strategy, how much you want to bet, and how much risk you want to take. The cards are being dealt daily, often face-down, over the course of your investing lifetime. You are constantly faced with the same decision....whether to hold, whether to fold, whether to increase your bet, etc. when the hand changes. You never know what the next card will be and it is not always turned over- often it is face down. But unlike poker, you can't even accurately estimate probabilities for the long haul because all you have to go on is a very limited amount of past data and an infinite pool of possibilities as history unfolds.

But that is semantics. At the bottom of it, knpstr, I think you and I agree. (smile)

(I could be wrong about Texas Hold-'em. I don't know how to play.)
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Re: How does an Efficient Market explain Buffett?

Post by knpstr »

protagonist wrote:
knpstr wrote:
I guess technically you're correct. However, in investing you choose the cards in your hand,
I see it more like Texas Hold-'em on steroids. You choose your strategy, how much you want to bet, and how much risk you want to take. The cards are being dealt daily, often face-down, over the course of your investing lifetime. You are constantly faced with the same decision....whether to hold, whether to fold, whether to increase your bet, etc. when the hand changes. You never know what the next card will be and it is not always turned over- often it is face down. But unlike poker, you can't even accurately estimate probabilities for the long haul because all you have to go on is a very limited amount of past data and an infinite pool of possibilities as history unfolds.

But that is semantics. At the bottom of it, knpstr, I think you and I agree. (smile)

(I could be wrong about Texas Hold-'em. I don't know how to play.)
I don't agree with the poker analogy at all. (and that didn't sound like hold-em, haha)
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Re: How does an Efficient Market explain Buffett?

Post by Caduceus »

I think this discussion is a little abstract. If you really want to formulate an opinion about whether Buffett's success is due to skill or luck, I recommend reading his annual reports (collected handily in Letters to Corporate America), Carol Loomis' articles on his early career, and Roger Lowenstein's and Alice Schroeder's biographies of the man, and also Ben Graham's Intelligent Investor, and Security Analysis.

You might come to the conclusion that, yes, it was some skill but a lot of luck and the product of being born into a particular moment in American financial history. (I don't think it's an accident that Buffett appeared on the world stage at such a specific moment.) Or you might decide that he is a particularly gifted practitioner of the craft of value investing. But this is not something you can decide without immersing yourself into his world.

To understand if an efficient market can make room for someone like Buffett, perhaps we should dig into questions like: Why did Buffett buy Dempster Mills? Why did his investments in Hochschild, Kohn and Co. fail? Was his minority investment in the Washington Post typical of other minority shareholders in the same company? Can the precepts of value investing be sustained against the backdrop of semi-strong efficient markets?

If you follow the letters from their inception to the present, I think you will see the evolution of a very formidable mind. So, regardless of whether he was lucky or not, there will be a great deal to learn. The one thing I wish his biographers had gone more deeply into was the world that he was living in; individuals are products of their time, no matter how singular they are, and their stories aren't just internal histories.
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Re: How does an Efficient Market explain Buffett?

Post by Phineas J. Whoopee »

knpstr wrote:...
I think it is obvious that a "market" only exists where a buyer/seller agree on a price, but that price can be "wrong". The seller may not have proper understanding of all the information.
...
Which is to say you personally take issue with one or the other of the parties', or perhaps both's, analysis regarding the perfect or near-perfect price, an eventuality I thoroughly accounted for in my post you're responding to.
knpstr wrote:...
The main issue that those such as Buffett, Munger, etc have with the EMH is this:
"The weak form says all information that is already public is already incorporated into the market price (which must be at least nearly true)"
...
It's up to you, I think, to demonstrate that the most eager seller and the most eager buyer both consistently ignore public information, or that the pair of them do not set the market price. If it's or, not and, the contention doesn't hold water.

With respect to your point that Buffett's reported pink sheets successes were impossible or else markets aren't informationally efficient, I think you have to demonstrate the information he extracted by visiting, interviewing, and I will go so far as to say intimidating management was, at that time, in any reasonable sense of the word, public.

More generally, you seem to be attacking the contention that Buffett (and Munger and whoever you like) can't possibly have been more successful than the average investor over their own investing lifetimes. Nobody in this thread, that I know of, has suggested such. The dispersion of potential outcomes over several decades is a point frequently made here at bogleheads.org.

With what are you so vigorously, and ably, disagreeing?

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Re: How does an Efficient Market explain Buffett?

Post by knpstr »

Phineas J. Whoopee wrote: It's up to you, I think, to demonstrate that the most eager seller and the most eager buyer both consistently ignore public information, or that the pair of them do not set the market price. If it's or, not and, the contention doesn't hold water. Only one party needs be "out of the loop" in any given transaction for the advantage of a "inefficiency" to take place. However, in certain circumstances (booms/busts) the entire market seems to swing to an "inefficient" moment.

With respect to your point that Buffett's reported pink sheets successes were impossible or else markets aren't informationally efficient, I think you have to demonstrate the information he extracted by visiting, interviewing, and I will go so far as to say intimidating management was, at that time, in any reasonable sense of the word, public. Surely the things he saw in Moody's Manual to give him the inclination to talk with these companies were made known to the public. For example, Sanborn Maps, held a market value of stocks that in total were greater than the company was selling for on the stock market. This was public information.

More generally, you seem to be attacking the contention that Buffett (and Munger and whoever you like) can't possibly have been more successful than the average investor over their own investing lifetimes. Nobody in this thread, that I know of, has suggested such. The dispersion of potential outcomes over several decades is a point frequently made here at bogleheads.org.

With what are you so vigorously, and ably, disagreeing?Obviously people can be more successful than the market average, Buffett has shown it can be done. The suggested explanation of Buffett (here) has been that it was all luck, or the other prominent idea that he was just a "businessman", not an "investor". As noted earlier by me, Buffett racked up the equivalent of $1.5M by the time he was 26, before the partnerships even happened, he wasn't taking over businesses at this point. It's like it is seen that him being a value investor is the equivalent of "reading" sheep guts for guidance.


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Re: How does an Efficient Market explain Buffett?

Post by Phineas J. Whoopee »

Wouldn't the party "out of the loop," as you put it, be trading in a securities market? And wouldn't they, if they placed a market order, buy from the most eager seller or sell to the most eager buyer? Brokers have a duty, not always fully carried out, to obtain best execution for their customers' orders.

I explained market mechanics for precisely this reason - to counter the idea that Jane Doe will agree to sell IBM for $15.71 per share to Jane Dow. They aren't negotiating directly with each other, so neither can mislead their counterparty. They participate in an orderly and regulated market.
knpstr wrote:
Phineas J. Whoopee wrote:...
With what are you so vigorously, and ably, disagreeing?
Obviously people can be more successful than the market average, Buffett has shown it can be done. The suggested explanation of Buffett (here) has been that it was all luck, or the other prominent idea that he was just a "businessman", not an "investor". As noted earlier by me, Buffett racked up the equivalent of $1.5M by the time he was 26, before the partnerships even happened, he wasn't taking over businesses at this point. ...
(Attribution fixed.)

Somebody here may have said that, but it isn't anything near a universal opinion, and there is no dogma we swear fealty to.

If anyone wants to prove Buffett did better than chance, it is up to them to refute the null hypothesis, that he didn't. Such proofs are mathematical, not rhetorical.
knpstr wrote:... It's like it is seen that him being a value investor is the equivalent of "reading" sheep guts for guidance.
(Attribution fixed.)

Arguments in favor of value investing appear here all the time.

PJW
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Re: How does an Efficient Market explain Buffett?

Post by knpstr »

Phineas J. Whoopee wrote:Wouldn't the party "out of the loop," as you put it, be trading in a securities market? And wouldn't they, if they placed a market order, buy from the most eager seller or sell to the most eager buyer? Brokers have a duty, not always fully carried out, to obtain best execution for their customers' orders.

I explained market mechanics for precisely this reason - to counter the idea that Jane Doe will agree to sell IBM for $15.71 per share to Jane Dow. They aren't negotiating directly with each other, so neither fools the other. They participate in an orderly and regulated market.
EDIT:
I guess the best way to say what I mean to say below is that: Jane Doe isn't getting fooled by Jane Dow. Jane Doe is fooling herself. and being "inefficient" all on her own,

A few issues...
1.) In a simplified example: if a market order is placed by the seller, a buyer can put in a limit order at their given price. Market order accepts the best price available, limit order accepts stated price
2.) Humans can agreeably sell at a "bad" price. Just because the market was efficient at making the transaction happen it doesn't mean that the transaction happened at a "informational efficient" price. (think boom/bust) Just because internet stocks were soaring people were willing to buy at almost any price, however they weren't taking in all the public information available and seeing that some of the dot com companies were shams... so an inefficient price occurred in the market. During the run up the seller made out like a bandit, the buyer went to slaughter. These phenomena happen because of human emotion, not human logic/rationality...this is the fundamental flaw of EMH. It assumes that humans act in a rational and logical manner.

Basically the fundamental difference in EMH and value investing is:
EMH: Humans are always rational/logical in their investment decisions
Value Investing: Humans can get "caught up" emotionally in investing and are willing to buy/sell at what logically and rationally would be considered "wrong" prices at times.

This ability to shut out emotion is what makes investing so difficult. It is very easy to doubt and second guess oneself. It is incidentally one reason Buffett/Munger say it isn't for everyone, that type of temperament is rare.
Phineas J. Whoopee wrote:...
Somebody here may have said that, but it isn't anything near a universal opinion, and there is no dogma we swear fealty to.

If anyone wants to prove Buffett did better than chance, it is up to them to refute the null hypothesis, that he didn't. Such proofs are mathematical, not rhetorical.
That's where that Munger quote comes in saying how at first some EMH guy was saying berkshire was a 2-sigma event, then 3-sigma,... to 6-sigma event. Now, sure they can be a 6-sigma event... but as I said earlier, what is more probable? An outlier to the extent of 6-sigma or simply EMH is flawed? Being a 6-sigma event means it is a 99.99966% likely he knows what he's doing and 0.00034% likely he is just getting lucky. (best to be rational/logical in placing your bet on which side you take)
Phineas J. Whoopee wrote:... It's like it is seen that him being a value investor is the equivalent of "reading" sheep guts for guidance.
(Attribution fixed)

Arguments in favor of value investing appear

PJW[/quote]

By here I meant opinions in this thread, not the forum as a whole.
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Re: How does an Efficient Market explain Buffett?

Post by protagonist »

knpstr wrote: Being a 6-sigma event means it is a 99.99966% likely he knows what he's doing and 0.00034% likely he is just getting lucky

0.00034% is about one in 300,000.

In a field of what I would guess would amount to millions of investors, that at least one would fall within this range would be highly probable. Besides which, he pulled the number "six sigma", I imagine, out of thin air.

I'm not making an argument for EMH. As I implied multiple times, arguing about EMH is like arguing about how many angels fit on the head of a pin. I'm just saying.....
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Re: How does an Efficient Market explain Buffett?

Post by knpstr »

protagonist wrote: 0.00034% is about one in 300,000.

In a field of what I would guess would amount to millions of investors, that at least one would fall within this range would be highly probable. Besides which, he pulled the number "six sigma", I imagine, out of thin air.

I'm not making an argument for EMH. As I implied multiple times, arguing about EMH is like arguing about how many angels fit on the head of a pin. I'm just saying.....
Fair enough, I can understand just trying to speak for both sides.

With odds of 99.99966% (knows what he's doing) vs 0.00034% (luck) the rational and logical choice is to say he knows what he is doing. Also lets not forget that broadly speaking low p/e stocks outperform high p/e stocks, so I as I have said maybe 5 times this thread EMH is found flawed long before we even get to people with results like Buffett. It is just so easy to go to Buffett because his record is so convincing, yet some choose to believe it is still "luck" despite the odds. That alone should demonstrate the flaw in EMH. Public information suggests that there is a 99.99966% chance it skill not luck, yet people still claim it is luck. This is exactly what I meant when I said "Jane Doe fools herself" in the above post. I mean even at 2 sigma probabilistically speaking it is still silly to bet it is luck vs skill. Most people will (should) accept a wager with 95% chance of success.

I'm not familiar with the man Munger is referring to in his quote. He just said: a guy that came up with EMH and won the nobel prize said that Berkshire can be explained as a 6-sigma event (after starting out as 2-sigma and revising upward).

I absolutely agree with you about the topic.
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Re: How does an Efficient Market explain Buffett?

Post by Phineas J. Whoopee »

Mathematics.

Null hypothesis.

Not rhetoric.

Math, and please show your work.

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Re: How does an Efficient Market explain Buffett?

Post by VictoriaF »

knpstr wrote:I'm not familiar with the man Munger is referring to in his quote. He just said: a guy that came up with EMH and won the nobel prize said that Berkshire can be explained as a 6-sigma event (after starting out as 2-sigma and revising upward).
If you have a very large number of data points, a few of them will land at 6-sigma and beyond. That's the nature of the distribution. If you don't know a priori which investors will end up in the tails, you should not celebrate a posteriori those who were brought there by the vagarities of the distribution, also known as luck.

The "guy" is Eugene Fama.

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Re: How does an Efficient Market explain Buffett?

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VictoriaF wrote:
knpstr wrote:I'm not familiar with the man Munger is referring to in his quote. He just said: a guy that came up with EMH and won the nobel prize said that Berkshire can be explained as a 6-sigma event (after starting out as 2-sigma and revising upward).
If you have a very large number of data points, a few of them will land at 6-sigma and beyond. That's the nature of the distribution. If you don't know a priori which investors will end up in the tails, you should not celebrate a posteriori those who were brought there by the vagarities of the distribution, also known as luck.

The "guy" is Eugene Fama.

Victoria
Thanks Victoria! Phineas J Whoopee, apparently I'm going off of Fama's math on the six sigma calculation, I just read the quote.

...Meanwhile, waiting on the EMH proof, that doesn't get a good faith pass either.

Also, it is true that the vagaries of a distribution could land any given investor, at any given time at a six sigma level. The even more improbable event happens when it's the same guy "beating the odds" every year, not just a random year or two in his career. I mean for EMH to be true, this can't happen. Over the long run, no one should stand out, individually speaking, while it says there could[will] be stand outs in any given year.
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Re: How does an Efficient Market explain Buffett?

Post by Phineas J. Whoopee »

knpstr wrote:...
...Meanwhile, waiting on the EMH proof, that doesn't get a good faith pass either.
...
(Internal ellipsis original.)

You're the one making the specific claim, that Buffett's investment results falsify the Efficient Market Hypothesis, which, as merely a hypothesis, hasn't been claimed as true in the first place (by anybody who knows what they're talking about), therefore the burden of proof rests with you and with nobody else.

Math, please, to refute the null hypothesis that Buffett's results are part of the expected distribution.

Not rhetoric.

Math to refute the null hypothesis.

And please show your work.

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Re: How does an Efficient Market explain Buffett?

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Phineas J. Whoopee wrote:You're the one making the specific claim, therefore the burden of proof rests with you and nobody else.
PJW
I prefer to read the best of what both sides have already figured out... as well as use common sense, since I have a day job and cannot put the resources for the grunt work in for a further examination (incidentally same reason why I choose to invest in index funds). It isn't feasible for one to "work everything out" on there own.

It appears this discussion has reached it's culmination since I am just asked the same questions repeatedly, while at the same being ignored of my question to see the proof of EMH, which itself needs to be proven, which common sense defies, and numerous "exceptions" have been demonstrated.

However, I will leave you with one last quote:

However, Jack Bogle's position on Fama and EMH is pretty clear: "I have a philosophical disagreement."
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Re: How does an Efficient Market explain Buffett?

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Re: How does an Efficient Market explain Buffett?

Post by printer »

Is there an authoritative, precise statement of the efficient market hypothesis that makes testable predictions?

Here is wikipedia's definition:

In finance, the efficient-market hypothesis (EMH) asserts that financial markets are "informationally efficient". In consequence of this, one cannot consistently achieve returns in excess of average market returns on a risk-adjusted basis, given the information available at the time the investment is made.

This is testable only if one defines what "consistently" means.

Investopedia:

DEFINITION of 'Informationally Efficient Market'

A theory, which moves beyond the definition of the efficient market hypothesis, that states that new information about any given firm is known with certainty, and is immediately priced into that company's stock.

What does "priced into" mean, exactly - what is the testable prediction that is made here?
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Re: How does an Efficient Market explain Buffett?

Post by Trader Joe »

Warren Buffett is an outliner - the greatest investor in human history.
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Re: How does an Efficient Market explain Buffett?

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printer wrote:Is there an authoritative, precise statement of the efficient market hypothesis that makes testable predictions?
...
Aye, there's the rub. Although the weak form can hardly help but to be mostly true, given the structure of capital markets, and the semi-strong can hardly help but to be true after only a few milliseconds, and the strong can hardly help but to be true if there's illegal trading (and if there isn't how come so many have recently been convicted of doing it), nobody I know of has been able to propose a test which could definitively falsify it.

It remains at best a hypothesis, and hasn't risen to the level of a theory.

Eppur si muove.

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Re: How does an Efficient Market explain Buffett?

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printer wrote: What does "priced into" mean, exactly - what is the testable prediction that is made here?
It means that the stock price has been adjusted up/down (bought/sold) to accommodate the new information.
Phineas J. Whoopee wrote:... nobody I know of has been able to propose a test which could definitively falsify it.
Wikipedia:
Argument from ignorance: It asserts that a proposition is true because it has not yet been proven false.
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Re: How does an Efficient Market explain Buffett?

Post by printer »

knpstr wrote:
printer wrote: What does "priced into" mean, exactly - what is the testable prediction that is made here?
It means that the stock price has been adjusted up/down (bought/sold) to accommodate the new information.
What is the testable prediction?
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Re: How does an Efficient Market explain Buffett?

Post by Phineas J. Whoopee »

knpstr wrote:...
Phineas J. Whoopee wrote:... nobody I know of has been able to propose a test which could definitively falsify it.
Wikipedia:
Argument from ignorance: It asserts that a proposition is true because it has not yet been proven false.
Phineas J. Whoopee wrote:...
It remains at best a hypothesis, and hasn't risen to the level of a theory.
...
I never claimed the EMH was true. You claimed it was false and failed to demonstrate it.

I have no problem with posters pointing out errors I make, or even positions in which I am wrong. You, madam or sir, are simply misrepresenting my words.

Stop it.

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Re: How does an Efficient Market explain Buffett?

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printer wrote:
What is the testable prediction?
Phineas J. Whoopee wrote:[
I never claimed the EMH was true. You claimed it was false and failed to demonstrate it.
Again, from what I've gathered and read about the EMH it seems fairly agreed upon that it cannot be tested. So asking for testable predictions and tests for it being false is a bit much to ask.
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Re: How does an Efficient Market explain Buffett?

Post by printer »

knpstr wrote: Again, from what I've gathered and read about the EMH it seems fairly agreed upon that it cannot be tested. So asking for testable predictions and tests for it being false is a bit much to ask.
Here's a paper that gives what it says is a concise definition of EMH, and examines testable predictions: [url]http://www.e-m-h.org%2FBeecheyGruenVickery2000.pdf&ei=kOu9VMfADuS1sAT0qoHoDg&usg=AFQjCNEc-pXFt0z5cMMGZfejUV0WbRZwVw&bvm=bv.83829542,d.cWc[/url]

Interestingly enough, Fama is there. From wikipedia http://en.wikipedia.org/wiki/Eugene_Fama
Fama (1991) also stresses that market efficiency per se is not testable and can only be tested jointly with some model of equilibrium, i.e. an asset-pricing model.
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Re: How does an Efficient Market explain Buffett?

Post by VictoriaF »

knpstr wrote:
VictoriaF wrote:
knpstr wrote:I'm not familiar with the man Munger is referring to in his quote. He just said: a guy that came up with EMH and won the nobel prize said that Berkshire can be explained as a 6-sigma event (after starting out as 2-sigma and revising upward).
If you have a very large number of data points, a few of them will land at 6-sigma and beyond. That's the nature of the distribution. If you don't know a priori which investors will end up in the tails, you should not celebrate a posteriori those who were brought there by the vagarities of the distribution, also known as luck.

Victoria
Also, it is true that the vagaries of a distribution could land any given investor, at any given time at a six sigma level. The even more improbable event happens when it's the same guy "beating the odds" every year, not just a random year or two in his career. I mean for EMH to be true, this can't happen. Over the long run, no one should stand out, individually speaking, while it says there could[will] be stand outs in any given year.
You are double counting. Even if Buffett's overall performance is in the tail, he did not have repeated 6-sigma performance every year.

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Re: How does an Efficient Market explain Buffett?

Post by knpstr »

VictoriaF wrote:
knpstr wrote:
VictoriaF wrote:
knpstr wrote:I'm not familiar with the man Munger is referring to in his quote. He just said: a guy that came up with EMH and won the nobel prize said that Berkshire can be explained as a 6-sigma event (after starting out as 2-sigma and revising upward).
If you have a very large number of data points, a few of them will land at 6-sigma and beyond. That's the nature of the distribution. If you don't know a priori which investors will end up in the tails, you should not celebrate a posteriori those who were brought there by the vagarities of the distribution, also known as luck.

Victoria
Also, it is true that the vagaries of a distribution could land any given investor, at any given time at a six sigma level. The even more improbable event happens when it's the same guy "beating the odds" every year, not just a random year or two in his career. I mean for EMH to be true, this can't happen. Over the long run, no one should stand out, individually speaking, while it says there could[will] be stand outs in any given year.
You are double counting. Even if Buffett's overall performance is in the tail, he did not have repeated 6-sigma performance every year.

Victoria
Fair enough, I'm not the one that established he had a "6-sigma performance" in the first place. The crux of the matter is:
1. EMH states one cannot outperform the market average over time, due to them being informationally efficient.
2. Buffett is a person outperforming the market average over time.

Fama may want to disqualify Buffett's performance by saying "he's a businessman, not an investor", but we know from his early record that's not true. One may want to dismiss his record as luck, and one is free to hold that opinion... however logic and rationale suggest otherwise. One may want to claim he "went around the rule" by dealing in issues that are "not closely followed", this idea alone goes against the notion that financial markets are efficient. The objections to empirical evidence of the hypothesis being incorrect have been brought up, discussed and brought up again ad nauseam.

I think if one wants to create an ongoing debate, create an idea that sounds good to people, describes some of reality but extends beyond into the theoretical and is neither provable nor disprovable in it's entirety. There are many "debates" structured in such a manner, not just this one. In the absence of the ability to scientifically test such statements, some people find it wise to follow the empirical evidence as it is the best we have available, while other people choose to believe in what they deem a good idea. This has been demonstrated not only here, but in countless topics structured in a similar manner throughout time.
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Re: How does an Efficient Market explain Buffett?

Post by Fallible »

knpstr wrote:
VictoriaF wrote:
knpstr wrote:
VictoriaF wrote:
knpstr wrote:I'm not familiar with the man Munger is referring to in his quote. He just said: a guy that came up with EMH and won the nobel prize said that Berkshire can be explained as a 6-sigma event (after starting out as 2-sigma and revising upward).
If you have a very large number of data points, a few of them will land at 6-sigma and beyond. That's the nature of the distribution. If you don't know a priori which investors will end up in the tails, you should not celebrate a posteriori those who were brought there by the vagarities of the distribution, also known as luck.

Victoria
Also, it is true that the vagaries of a distribution could land any given investor, at any given time at a six sigma level. The even more improbable event happens when it's the same guy "beating the odds" every year, not just a random year or two in his career. I mean for EMH to be true, this can't happen. Over the long run, no one should stand out, individually speaking, while it says there could[will] be stand outs in any given year.
You are double counting. Even if Buffett's overall performance is in the tail, he did not have repeated 6-sigma performance every year.

Victoria
Fair enough, I'm not the one that established he had a "6-sigma performance" in the first place. The crux of the matter is:
1. EMH states one cannot outperform the market average over time, due to them being informationally efficient.
2. Buffett is a person outperforming the market average over time.

Fama may want to disqualify Buffett's performance by saying "he's a businessman, not an investor", but we know from his early record that's not true. One may want to dismiss his record as luck, and one is free to hold that opinion... however logic and rationale suggest otherwise. One may want to claim he "went around the rule" by dealing in issues that are "not closely followed", this idea alone goes against the notion that financial markets are efficient. The objections to empirical evidence of the hypothesis being incorrect have been brought up, discussed and brought up again ad nauseam.
...
As I said earlier, Buffett is more than the sum of his parts. That's what genius is. You can possibly explain one of his remarkable feats, but rarely all of it and even if all of it, there's the next remarkable one and the next and the next.
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Re: How does an Efficient Market explain Buffett?

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Hmm, but what kind of information exactly is being incorporated would depend on who the marginal investors as a group are, no? Let's say that the Deepwater Horizon crisis in 2010 caused BP's share prices to plunge. Over seconds, minutes, days, and months, the "market" digests this information and this information is "incorporated" into the share price. Does it make a difference who the marginal investors are? If they are long-term value investors who are willing to buy at any price below $40, that represents one kind of valuation estimate. But momentum traders might decide that regardless of the fundamentals, BP's price is going to trend down because of some triangles and candlesticks and beautiful squigglys. Then you throw in John Does and Jane Does who just know what the price should be because, well, they're just awesome that way.

So what kind of information efficiency exactly is being priced into the market? It seems that the decision to buy or sell might not convey a commitment about value but simply about movement. And even commitments about value might be strategic rather than fundamental in nature. Maybe an institution is switching into similar but non substantially identical positions for tax reasons. So its purchase conveys only the limited belief that "BP's share price will not fluctuate too much in the next 31 days" rather than "BP is fairly valued at $37.9384"

if we attempt to test Buffett's outperformance, is the relevant data set the universe of all money managers, only value investors who hail from the village of Graham and Doddsvile, all money managers, whether American or not who have invested the bulk of their capital in U.S.-domiciled assets, or what? Does investment management skill follow a normal distribution?
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Re: How does an Efficient Market explain Buffett?

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Caduceus wrote:Hmm, but what kind of information exactly is being incorporated would depend on who the marginal investors as a group are, no? Let's say that the Deepwater Horizon crisis in 2010 caused BP's share prices to plunge. Over seconds, minutes, days, and months, the "market" digests this information and this information is "incorporated" into the share price. Does it make a difference who the marginal investors are? If they are long-term value investors who are willing to buy at any price below $40, that represents one kind of valuation estimate. But momentum traders might decide that regardless of the fundamentals, BP's price is going to trend down because of some triangles and candlesticks and beautiful squigglys. Then you throw in John Does and Jane Does who just know what the price should be because, well, they're just awesome that way.

So what kind of information efficiency exactly is being priced into the market? It seems that the decision to buy or sell might not convey a commitment about value but simply about movement. And even commitments about value might be strategic rather than fundamental in nature. Maybe an institution is switching into similar but non substantially identical positions for tax reasons. So its purchase conveys only the limited belief that "BP's share price will not fluctuate too much in the next 31 days" rather than "BP is fairly valued at $37.9384"

if we attempt to test Buffett's outperformance, is the relevant data set the universe of all money managers, only value investors who hail from the village of Graham and Doddsvile, all money managers, whether American or not who have invested the bulk of their capital in U.S.-domiciled assets, or what? Does investment management skill follow a normal distribution?
Well said! The "availability" of information does not mean that it will/must be "priced in" to the market price rationally or logically by investors, a resounding oversight in EMH.

Also, as Buffett says it isn't wise to think there is a concrete value of a business (and therefore stock price). However, one can come up with a value range that he/she can be reasonably sure of through careful analysis. Say for example it is determined that BP is reasonable at a price of $37-$41. Then the investor can look to see what the share price is in the market (as compared to the independently appraised price the investor came up with) and will buy BP if the share price is say $25 but not buying it at say $36.

This is Graham's "margin of safety" concept and is said to be vital to be successful. Buying well below a "fair price" will give you some room for error. These opportunities can be difficult to find, and that is also why Buffett said it is wise to "load up" when you find such a situation.
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Re: How does an Efficient Market explain Buffett?

Post by Caduceus »

I actually wasn't making an argument in question format. I was really asking questions!

Regardless of whether the EMH is or is not theoretically sound, the question is if investors should behave as if the markets are efficient for the most part. I incline toward the view that they should. Very few people will be able to exploit market inefficiencies with any degree of regularity.
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Re: How does an Efficient Market explain Buffett?

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Caduceus wrote:I actually wasn't making an argument in question format. I was really asking questions!

Regardless of whether the EMH is or is not theoretically sound, the question is if investors should behave as if the markets are efficient for the most part. I incline toward the view that they should. Very few people will be able to exploit market inefficiencies with any degree of regularity.
I agree. Buffett, has recommended that the "average investor" buy a vanguard index fund and contribute monthly, never watching the market/market news. He offers this advice because to do what he does is not only VERY time consuming, but the majority of people will sabotage themselves with emotional decisions as well.

That's the "temptation" of the EMH, but the difference of the markets being "reasonably efficient" and being "efficient" (in emh terms) is large and that difference is how Buffett does what he does.
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Re: How does an Efficient Market explain Buffett?

Post by Fallible »

knpstr wrote:
Caduceus wrote:I actually wasn't making an argument in question format. I was really asking questions!

Regardless of whether the EMH is or is not theoretically sound, the question is if investors should behave as if the markets are efficient for the most part. I incline toward the view that they should. Very few people will be able to exploit market inefficiencies with any degree of regularity.
I agree. Buffett, has recommended that the "average investor" buy a vanguard index fund and contribute monthly, never watching the market/market news. He offers this advice because to do what he does is not only VERY time consuming, but the majority of people will sabotage themselves with emotional decisions as well.

That's the "temptation" of the EMH, but the difference of the markets being "reasonably efficient" and being "efficient" (in emh terms) is large and that difference is how Buffett does what he does.
I think this is now all back where it started - the "difference is how Buffett does what he does."
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Re: How does an Efficient Market explain Buffett?

Post by knpstr »

Fallible wrote:
knpstr wrote:
Caduceus wrote:I actually wasn't making an argument in question format. I was really asking questions!

Regardless of whether the EMH is or is not theoretically sound, the question is if investors should behave as if the markets are efficient for the most part. I incline toward the view that they should. Very few people will be able to exploit market inefficiencies with any degree of regularity.
I agree. Buffett, has recommended that the "average investor" buy a vanguard index fund and contribute monthly, never watching the market/market news. He offers this advice because to do what he does is not only VERY time consuming, but the majority of people will sabotage themselves with emotional decisions as well.

That's the "temptation" of the EMH, but the difference of the markets being "reasonably efficient" and being "efficient" (in emh terms) is large and that difference is how Buffett does what he does.
I think this is now all back where it started - the "difference is how Buffett does what he does."
As Buffett/Munger say, what they do seems so simple when they say it, that people don't believe they're getting the whole story... however it requires a tremendous amount of work and equanimity to gyrations of the market so its extremely difficult to stay on top of over long periods.
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Re: How does an Efficient Market explain Buffett?

Post by VictoriaF »

Fallible wrote:As I said earlier, Buffett is more than the sum of his parts. That's what genius is. You can possibly explain one of his remarkable feats, but rarely all of it and even if all of it, there's the next remarkable one and the next and the next.
Hi Fallible,

I don't consider Warren Buffett a genius. He is a very successful investor, he is a very rich man, he is a charitable man, but he is not a genius. Leonardo da Vinci was a genius. Shakespeare was a genius. Einstein was a genius. Turing was a genius. Buffett is not in that league.

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Re: How does an Efficient Market explain Buffett?

Post by Fallible »

VictoriaF wrote:
Fallible wrote:As I said earlier, Buffett is more than the sum of his parts. That's what genius is. You can possibly explain one of his remarkable feats, but rarely all of it and even if all of it, there's the next remarkable one and the next and the next.
Hi Fallible,

I don't consider Warren Buffett a genius. He is a very successful investor, he is a very rich man, he is a charitable man, but he is not a genius. Leonardo da Vinci was a genius. Shakespeare was a genius. Einstein was a genius. Turing was a genius. Buffett is not in that league.

Victoria
Hi Victoria,

First, I would add Ada Lovelace to your list, having read The Innovators.

But why isn't Buffett a genius? In his field, of course, as are those you list, except it should probably be fields for Leonardo.

Fallible
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Re: How does an Efficient Market explain Buffett?

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Re: How does an Efficient Market explain Buffett?

Post by knpstr »

Fallible wrote:
Hi Victoria,

First, I would add Ada Lovelace to your list, having read The Innovators.

But why isn't Buffett a genius? In his field, of course, as are those you list, except it should probably be fields for Leonardo.

Fallible
Genius usually applies to those that are exceptionally intelligent or creative. Buffett has said, one of the great things about investing is that your intelligience level doesn't matter that much (so long as the obvious exceptions). Investing isn't a game where the guy with 160 IQ beats the guy with 140 IQ.

I agree with Victoria, that he shouldn't be considered a genius.
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Re: How does an Efficient Market explain Buffett?

Post by Caduceus »

the "difference is how Buffett does what he does."
Private business owners do it every day. Let' say you are the owner of a small but profitable snack store, and that you have a contract with the local university that you have the right to be the sole provider of snacks on campus (or university-owned grounds) for the next 10 years, subject to certain terms and conditions. Say you have $250,000 in cash in the bank because you're a scaredy-cat Boglehead and want to be safe, and only $50,000 of total liabilities. You own your property, which is worth 1 million dollars. If someone offered to let you buy the business for $500,000, would you jump at it? What about $700,000? Or 1 million? 1.5 m?

You might think about it as a raider - someone who gets control of the entire business, and immediately liquidates it for a profit. (Actually, some PE firms have done this in the past.) Or you might value the business as a going-concern, and ask yourself what level of cash flows you think are safe.

Valuation is not a precise art, but occasionally, investors in the market offer a marginal price that defies fundamentals and gives you an extreme probability of being right - which is to say that no sane owner of the entire enterprise would ever sell fractional interests at those prices. Not everyone is thinking like a business owner. Some people want to make money in 7 seconds. Others in two years. Others don't mind losing money but just absolutely want to own it for shizz and giggles.

But to know this, you have to be a genius at accounting, which isn't easy, because companies have an incentive to dress up their numbers. It might not be fraud, but it sure does look prettier than it should. Can you do foreign currency translations like Buffett can? Can you reconcile LIFO and FIFO in your sleep? Most importantly, can you identify the sorts of challenges / risks to a business that don't show up in its balance sheets?

And then you have to compare this to the likely returns on passive investing in stocks, which may also offer an equally good return with no company-specific risks. Maybe the university moves its student housing to another part of campus and no one wants to walk to your place and they all end up calling in pizza. Maybe the CEO of your company ends up accidentally saying something stupid and homophobic and no one wants to buy your chicken fingers anymore. So you take on these risks.

So what's a good price that would induce you to leave the safety of an index? This might be difficult, and almost everyone probably shouldn't try it. But it isn't voodoo. And it's not about math either, which really misses the point. Again, I'd really recommend reading Buffett's annual reports over many decades. The collective animus seems a little misplaced.

I index. But the fact that I have to say this suggests that there's a form of GroupThink going on that's making me feel like going into the closet all over again. I'm a straight-out Indexer, but i'm not a Buffett-phobe either.
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nisiprius
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Re: How does an Efficient Market explain Buffett?

Post by nisiprius »

Fallible wrote:...But why isn't Buffett a genius?...
Why isn't Ken Heebner a genius?

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Answer: Because it's not 2006. (Blue: CGM Focus, Ken Heebner's fund; Orange, genius-free Vanguard Total Stock Market Index Fund).

Source: Morningstar
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It's not so easy to tell the difference between luck and genius.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
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