Seth Klarman in Barron’s 1999 article on Warren Buffett
H/T Brattle Street
At the root of value investing is the belief, first espoused by Benjamin Graham, that the market is a voting machine and not a weighing machine. Thus an in-vestor must have more confidence in his or her own opinion than in the combined weight of all other opinions. This borders on arrogance, the necessary arrogance that is required to make investment de-cisions. This arrogance must be tem-pered with extreme caution, giving due respect to the opinions of others, many of whom are very intelligent and hard working. Their sale of shares to you at a seeming bargain price may be the result of ignorance. emotion or various institu-tional constraints, or it may be that the apparent bargain is in fact flawed, that it is actually fairly priced or even overval-ued and that the sellers know more than you do.
This Is a serious risk, but one that can be mitigated first by extensive fundamental analysis and second by knowing not only that something is bar-gain-priced but, as best you can, also why it is so. (You never know for certain why sellers are getting out but you may be able to reasonably surmise a ratio-nale.) This is the position in which in-vestors should, over and over, want to put themselves (and an astonishingly dif-ferent type of consideration than the great majority of today’s investors are bothering to make).
Now consider mega-growth-fund manager Buffett. Warren, who has been racking up year after year of great per-formance buying and holding the shares of expensive but steadily rising growth companies. Buff has consistently been and remains bullish, since that is what got him where he is today. High stock prices have long since ceased to worry Buff, who is nothing if not flexible. And what choice does he really have, any-way? The fundamentals are excellent as far as the eye can see, so share prices should be high. His portfolio companies are among America’s greatest, they are in sync with the times and they beat an. awn. quarter. There is apparently nothing in the great demographic roller coaster to Interrupt the steady cash inflows into the stock market.
Almost no one, in fact, can’ even imagine a reason why these large, well-liked companies won’t con-tinue to command the greatest share of investor demand. At the end of the Hall of Greater Fools is a mirror. Buff, unaware of en-tering the building, actually thinks of himself as a prudent investor. After all, he owns no junk. only the shares of great businesses. And the market’s constant vindication of his judgment only rein-forces his conviction and self-image. Ob-viously, selling his best performers to dabble in anything else would be wildly speculative and he has convinced himself that he is a risk-averse investor, even a “value” investor.
Buying and holding, us-ing inflows to add to positions, is his watchword. Occasionally, one of Buffs shooting stars falls to earth; fortunately, his compa-triots at other mutual funds probably owned it in about the same proportion. Then he does what you should always do when a stock disappoints and plunges in price: He blows it out. You can’t, after all, trust a company that is incapable of mas-saging earnings into a steady growth pat- tern; why, the same thing might happen again. And he knows all his compadres are thinking the same thing and blowing it out, too. Buffett has a lot of company. His stocks are going up, not necessarily because they should but because they do. That no one can think of why they wouldn’t is taken as evidence that they wth rise further.
Lost An of Contrary Thinking Lost in Buffs world is the art of con-trary thinking. Ignored, out-of-print titles about the madness of crowds (not to men-tion the importance of a margin of safety) suggest that the majority cannot be right in the long run. Being very early and be-ing wrong look exactly the same 99% of the time, and early in Buffs line of work means unemployed. Anyway, it Is Buffs to be full invested.