Wednesday, January 25, 2012

Why We Give Buffett A Hard Time on Credit Bubble Stocks

Consider the following 2x2 matrix of possibilities:

Buffett is either right or wrong about an investment, and we either agree or disagree with him (and act accordingly). Note that "Buffett" can be a shorthand or placeholder for conventional wisdom in general.

Buffett is right Buffett is wrong
We agree Make no money Lose money
We disagree Lose money Make money!!

If Buffett is right and we agree, we make "no money" in the economic sense, i.e. no abnormal returns, because it is conventional wisdom and therefore priced in to the market. 

If we agree with a wrong idea, or disagree with a correct idea, we will obviously lose money in those cases.

Our only way to make (significant, abnormal) money is to focus on areas where we are right and Buffett is wrong. That is, we need the Buffetts of the world - conventional wisdom - to create opportunities for us, either through indifference or actively making a mistake.

So, no wonder I focus my thoughts and research on areas where the market exhibits groupthink that I think is incorrect! That is the quadrant of opportunity!

[Afterthought: you could have a "fifth quadrant," with cases where Buffett is indifferent and we are right, which would also be profitable.]


Mark said...

I love your blog but I think it might be a stretch to say that Buffett represents conventional wisdom.

CP said...

I think he is as conventional as it gets. That's why he's a media darling (plus, his girlfriend owned a newspaper).

Did you know he doesn't think that demographics are important? If he lives long enough, I could see him running the company into the ground buying building products and homebuilders in the face of an aging population.

Mark said...

Buffett is a hypocrite at times and there’s definitely a love-fest for him in the media. I can’t argue with that. Perhaps his general outlook is somewhat conventional but the timing of when he invests and what he invests in is not always conventional.

With regard to demographics, I suspect he’d say demographics are unimportant relative to the importance of the competitive advantage of a specific company and the price of the specific company.

I also sense that he believes he has to be a bit of a cheerleader because of his stature(when he says things like: “Look at what the stock market did over the last 100 years despite two world-wars, 9/11, huge inflation in the 70’s, etc. etc. Nobody is luckier than an American born today, etc.”) but he’s very worried about government deficits. Is he perhaps too much in the reversion-to-the-mean-this-is-a-normal-post-war-recovery camp? Yes but that doesn’t make him the very embodiment of conventional wisdom.

His building materials investments were done a long time ago low prices. While he thinks housing is going to turn, I don’t think he’d invest in homebuilders (commodity business, diseconomies of scale, capital intensive). He invested in the best manufactured housing company at what he thought might be the bottom of the cycle for that industry but he wouldn’t call that a good investment.

He’s had to change his game over the years because he’s so big. There are maybe a few hundred assets in the world that can move the needle for him, so he’s had to focus on certainty of return, sustainably high ROE type things, and accept lower returns. If he was still young with a small amount of assets, he wouldn’t own KO, PG, KFT, WFC, etc. and he wouldn’t have bought Burlington Northern. (If he was managing $1 million he’d be putting on the types of trades you’re doing in solar). I think if lived long enough he would eventually pay huge dividends and occasionally make well-timed buybacks. Just my 2 cents. Maybe I’m wrong.

(I’m only sensitive on this topic because I’m surrounded by people that chronically underperform and yet they bash Buffett all the time because it makes them feel smart).

CP said...

I think that the timing of when he invests is only unconventional in the sense that he always buys the dips.

Have you read this post of mine?:

O'bama gushed about Buffett during the SOTU, more evidence...

He may not be investing "further" in building products and homebuilders, but a decision to continue owning is the same as a decision to invest. One of Buffett's major flaws, by the way, is that he does not sell.

I agree that he would be totally different if he was small.

How long have you been reading the blog? I'm always surprised what gets people to comment. It's usually something contentious but not usually the trade idea posts.

Saj Karsan said...

I, too, would argue that Buffett is conventional wisdom. "Conventional wisdom" had people shunning stocks in the early 1980's, buying tech stocks in the late 1990's, buying houses in the early 2000's and buying gold and other commodities today (judging from their prices and all the attention they garner). Buffett did none of those, and in some cases did the opposite!

As a result, you would actually make money by betting with Buffett, unlike what is proposed in your 2x2. Here's a link to a paper showing how investing alongside BRK (after its investments became public, so no inside info required) would have beaten the market by 10%+ per year from 1976 to 2008

Saj Karsan said...

Buffett ISN'T conventional wisdom that is

CP said...

One other thing, guys.

There are three categories of my blog posts that receive tons of comments: criticism of precious metals, criticism of Buffett, and any mention of Apple.