Buffett And Munger… Shock Value! by Aswath Damodaran, Musings On Markets
Berkshire Hathaway is having its annual meeting and the financial press is falling all over itself reporting what the sage from Omaha has to say about investing. Let me say at the outset that I have expressed my admiration for what Warren Buffet does well - the fact that he has a core philosophy that he does not deviate from and his instinct for going against the grain. Over time, he and Charlie Munger, who has operated at his right hand for decades, also say things for shock value to indicate how separated they are from both academics and other portfolio managers. Here is a listing of quotes and my responses to them.
Mr. Buffett: “There is so much that’s false and nutty in modern investing practice and modern investment banking, that if you just reduced the nonsense, that’s a goal you should reasonably hope for.”
I agree entirely. There is much that is done in portfolio management and corporate finance that does not pass the common sense test. Layering complexity on stupid ideas - that leverage always increases value, that securitization can make you a more valuable company - do not make them any less stupid.
Mr. Buffett said he was once asked by a student from the University of Chicago, a hub of modern portfolio theory, “What are we learning that’s most wrong?” To which Charlie Munger quipped, “How do you handle that in one session?”
My question to Mr. Buffett would be a simple one: What exactly is your understanding of Modern Portfolio Theory? I would wager that he would come back with Markowtiz portfolios and the CAPM. If you define modern as circa 1964, he would be right. If not, he has a lot of catching up to do.
Mr. Buffett on the efficient market hypothesis, the idea that all information is instantly priced into the market: “There’s this holy writ, the efficient market theory. How do you teach your students everything is priced properly? What do you do for the rest of the hour?”
Mr. Buffett probably does not realize this but the efficient market hypothesis is really a warning to those portfolio managers who try to trade on information - earnings announcements and acquisitions, for instance - and day traders. To be honest, 99% of investors would be saved a lot of money, if they followed the suggestions of efficient market theorists. Let's face reality. If you define an efficient market as one where investors cannot easily take advantage of market imperfections, markets are efficient to most investors on most assets most of the time... One reason that Mr. Buffett continues to generate excess returns is that he is able to strike inside deals with managers... Do you think you or I would have been able to get the deal he got from Goldman?
Mr. Buffett on complex calculations used to value purchases: “If you need to use a computer or a calculator to make the calculation, you shouldn’t buy it.”
Spoken like a Luddite... How about an abacus, Mr. Buffett? Maybe a slide rule?
Mr. Buffett on the use of higher-order math in finance: “The more symbols they could work into their writing the more they were revered.”
Actually, I do share Mr. Buffett's concern that common sense is sometimes overwhelmed by mathematics. However, the people who are most revered in finance - Harry Markowtiz, Merton Miller and Gene Fama- are surprisingly down to earth in explaining their ideas.
Mr. Munger on the same theme: “Some of the worst business decisions I’ve ever seen are those with future projections and discounts back. It seems like the higher mathematics with more false precision should help you but it doesn’t. They teach that in business schools because, well, they’ve got to do something. ”
What would Mr. Munger do instead? Look backwards and discount forward? What part of forecasting does he think is pointless? And does he not agree with the proposition that a dollar today is worth than a dollar in year? If not, he should be sentenced to spend a year in a high inflation economy (say Zimbabwe)...
Mr. Buffett adds: “If you stand up in front of a business class and say a bird in the hand is worth two in the bush, you won’t get tenure…. Higher mathematics my be dangerous and lead you down pathways that are better left untrod.”
Depends upon your chances of getting the birds in the bush, right? If you feel that you have a 60% chance of getting the birds in the bush, is it not worth the trade off? No wait. Talking about probabilities probably is higher mathematics and I should not do it... My bad...
Mr. Buffett on the persistence of bad ideas in finance: “The famous physicist Max Planck was talking about the resistance of the human mind, even the bright human mind, to new ideas…. And he said science advances one funeral at a time, and I think there’s a lot of truth to that and it’s certainly been true in finance.”
It is true. In any discipline, for every three ideas you come up with, only one will move forward. But the solution to this is not to stop having new ideas but to churn out more..