FOOL ON THE HILL
What Have You Done for Me Lately?

By Dale Wettlaufer (TMF Ralegh)
April 15, 1999

When looking at companies like Coca-Cola, Gillette, or Berkshire Hathaway, some people wonder why they're flat or down year-over year. Assuming that those wondering about these things don't have a problem computing compound returns over multiple year time periods, it bears a look at some useful data that indicates why outperformance over multi-year periods doesn't need to be totally linear. Outperformance over multi-year periods also doesn't need to be comprised of outperformance each year; nor does the outperformance need to be placid and lacking in volatility.

In fact, super-normal returns generated by world-class companies or world-class investors frequently show periods of underperformance over short periods of time, sometimes by significant margins. Fund manager Robert Hagstrom details in his recent effort (and best effort on investing, in my opinion), The Warren Buffett Portfolio, the short-term and long-term track records of some excellent investors:

"In 1986, V. Eugene Shanan, a Columbia University Business School alumnus and portfolio manager at U.S. Trust, wrote a follow-up article to Buffett's "The Superinvestors of Graham-and-Doddsville." In his piece, titled "Are Short-Term Performance and Value Investing Mutually Exclusive?" Shahan took on the same question we are now asking: How appropriate is it to measure a money manager's skill on the basis of short-term performance?

"He noted that, with the exception of Buffett himself, many of the people Buffett described as "Superinvestors" -- undeniably skilled, undeniably successful -- faced periods of short-term underperformance. In a money-management version of the tortoise and the hare, Shahan commented, "It may be another of life's ironies that investors principally concerned with short-term performance may well achieve it, but at the expense of long-term results. The outstanding records of the Superinvestors of Graham-and-Doddsville were compiled with apparent indifference to short-term performance." In today's mutual fund performance derby, he pointed out, many of the Superinvestors of Graham-and-Doddsville would have been overlooked." (The Waren Buffet Portfolio, p. 68)

Let's look at some of the track records of these investors, all of whom consider themselves "value" investors in the sense that, whether they are buying growth or assets or whatever, they consider all investing to be value investing. These are John Maynard Keynes, Warren Buffett, Charlie Munger, Bill Ruane, and Lou Simpson:

*Table 4.1 The Superinvestors of Graham-and-Doddsville


         Number of years   Number of Years of   Underperformance years as
         of performance     Underperformance    a % of all years measured
Keynes        18                   6                     33
Buffett       13                   0                      0
Munger        14                   5                     36
Ruane         27                  10                     37
Simpson       17                   4                     24

Let's look at the "dog" of the group, Bill Ruane.

*Table 3.4 Sequoia Fund Inc.
                         Annual Percentage Change
                       Sequoia Fund (%)   S&P 500 (%)
1971                       13.5           14.3
1972                        3.7           18.9
1973                      -24.0          -14.8
1974                      -15.7          -26.4
1975                       60.5           37.2
1976                       72.3           23.6
1977                       19.9           -7.4
1978                       23.9            6.4
1979                       12.1           18.2
1980                       12.6           32.3
1981                       21.5           -5.0
1982                       31.2           21.4
1983                       27.3           22.4
1984                       18.5            6.1
1985                       28.0           31.6
1986                       13.3           18.6
1987                        7.4            5.2
1988                       11.1           16.5
1989                       27.9           31.6
1990                       -3.8           -3.1
1991                       40.0           30.3
1992                        9.4            7.6
1993                       10.8           10.0
1994                        3.3            1.4
1995                       41.4           37.5
1996                       21.7           22.9
1997                       42.3           33.4

Average return             19.6           16.4
Standard deviation         20.6           16.4
Compound annual return     17.9           13.7

[$1 at inception becomes $85.94 at end of 1997 in Sequoia and $32.24 in S&P 500]


Now let's look at the track record of another Superinvestor of Graham-and-Doddsville:

*Table 3.3 Charles Munger Partnership
           Annual Percentage Change
                 Partnership (%)    S&P 500 (%)

1962                   30.1         -7.6
1963                   71.7         20.6
1964                   49.7         18.7
1965                    8.4         14.2
1966                   12.4        -15.8
1967                   56.2         19.0
1968                   40.4          7.7
1969                   28.3        -11.6
1970                   -0.1          8.7
1971                   25.4          9.8
1972                    8.3         18.2
1973                  -31.9        -13.1
1974                  -31.5        -23.1
1975                   73.2         44.4

Average return         24.3          6.4
Standard deviation     33.0         18.5
[Compound annual return 19.8         4.9]
[$1 at inception becomes $12.57 in Munger Partnership and $1.96 in S&P 500]

(*All tables from chapters 3 and 4, The Warren Buffett Portfolio)

The data in brackets are mine. I think this very clearly shows that an analysis of "what have you done for me lately" without looking ahead is unproductive at best and a reinforcement of a poor investment worldview at worst. Super companies and super investors do not necessarily put together multi-year outperformance that is made up of outperformance in each individual year.

Whether you can outperform each year is a less useful a yardstick than whether you can outperform over a number of years. Furthermore, glaring underperformance in some years is not free-standing evidence of poor investing acumen. So if someone presents you with 365-day or 730-day evidence that Coca-Cola, Warren Buffett, David Dreman, or Garrett Van Wagoner haven't done anything lately and that they therefore have lost their touch, you'll have to look at other evidence to see what they can do for you in the future.