Warren Buffett Isn't a Stock Picker?

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"Buffett buys control of companies. He is not a stock picker."
-- Dan Solin

Wait, what? Come again?

The preceding is a comment from investment writer Dan Solin responding to a reader of his recent post "Foolish Advice From the Motley Fool." The advice that he's referring to came from yours truly.

Now let's get something straight right up front here: I actually agree on the big picture with Solin. He directs the masses toward investing in low-cost index funds, and that's the right place for them to be. For the great majority of people out there that are saving for retirement or hoping to put children through college, index funds are a great way to capture the market's returns without getting burned by half-baked stock picks or scalped by high fees.

But it's the "why" of Solin's fervor for index funds -- and, more specifically, his use of some Warren Buffett quotes to back his position -- where we differ. Originally, I chided Solin for misconstruing Warren Buffett's advice regarding investments in low-cost index funds. In his follow-up, he fired back with some Buffett quips that he thinks back up his position, but I think he's still a bit off target.

Warren the stock picker
Solin implies that Buffett would agree with the efficient markets theory and concede that it's not worth trying to beat the market because all news and other information is already priced into stocks.

In reality, Buffett scoffs at that idea. In a possibly apocryphal quote, Buffett cracks, "I'd be a bum on the street with a tin cup if the markets were always efficient." While the veracity of those particular words might be questionable, anyone that's read Buffett's article "The Superinvestors of Graham-and-Doddsville" could easily picture that coming out of his mouth.

And Buffett certainly hasn't just talked the talk when it comes to beating the market. Though Solin asserted that Buffett is not actually a stock picker, his long career strongly suggests otherwise. Buffett began his career at Graham-Newman, a highly successful money management company and left to found his own market-crushing investment partnership. And during his long run at the head of Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) , Buffett has made his investors very significant amounts of money through his stock picking -- and that's whether we're talking about classic wins like picking up American Express (NYSE: AXP  ) in the wake of the Allied Crude Vegetable Oil scandal or more recently sinking a significant amount of capital into Goldman Sachs (NYSE: GS  ) right in the middle of the financial crisis.

Solin is correct in noting that Buffett buys control of entire companies, but that's simply something that he's increasingly done as Berkshire has grown in size. When you're throwing around hundreds of billions of dollars, it becomes a little tougher to move the needle without buying entire companies. But to characterize Buffett's career as such would be like saying that Lenny Dykstra was an options trader. Sure, Nails had a (ill-advised) foray into trading and other business ventures after his baseball career was over, but it was baseball that made him a great.

What Buffett really thinks
Buffett doesn't think markets are efficient and he's spent his entire career backing that up. He does, however, think that index funds are great for a wide swath of investors. Why? Because, as he points out in the "Gotrocks" parable in his 2005 letter to Berkshire shareholders, the cost of frenetic trading activity and mutual fund and other advisory fees can easily get out of hand and slash the returns that investors are actually pocketing. In the end, he sees it as better to simply own the entire market and pay little in fees.

What Fools think
As I noted above (and in my original article), for most people index funds are a great way to go. But at The Motley Fool I don't write for most people. My barber has never heard of The Fool, my dentist doesn't care about what I'm writing, and even my wife has to be cajoled to ever read my articles. I would recommend that these folks do anything but invest in index funds no more than I'd recommend a couch potato try to run a marathon.

The folks I write for see tickers when they walk down grocery aisles and know that "SEC filings" aren't college football schedules. They aren't in it for the "thrill of the chase" as Solin puts it -- they're investing time and effort to find companies that the market has mispriced below their true worth.

And interestingly, I have a sneaking suspicion that beneath his tough efficient markets exterior, Solin may actually be a bit Foolish himself. After all, though he quickly dismisses my use of valuation metrics in identifying potential outperforming stocks ("It is incorporated into the price of these (and all other) stocks, making the current price a fair price."), he notes that in his index fund advisory business he constructs portfolios with "a tilt toward small and value" in following the findings of Fama and French. Call me crazy, but I'm not sure that there's another way to determine "value" other than looking for value-like, um, valuations. So, like I said, maybe there's not as much of a gap between us after all.

Investor, know thyself
So, should you be trying to pick individual stocks? The answer lies in, as Benjamin Graham puts it in The Intelligent Investor, "the amount of intelligent effort the investor is willing and able to bring to bear on his task."

In my original article I quipped that many folks would rather "watch a Dharma and Greg rerun, reorganize their closet, or go to the dentist" than do the research required to invest in individual stocks. I meant this not to be demeaning to index fund investors, but rather highlight that most people don't find investment research particularly engaging. The index fund route is perfect for this group -- they can easily capture market returns, avoid massive fees, and get back to the more rewarding aspects of their lives (yes, even if that is Dharma and Greg).

But for those of us willing to invest time in research and diligence, well, let's just say I don't see a perfectly efficient market getting in our way.

You've heard my piece, now I want to hear what you think. Head down to the comments section and sound off!

American Express and Berkshire Hathaway are Motley Fool Inside Value choices. Berkshire Hathaway is a Motley Fool Stock Advisor selection. The Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Fool contributor Matt Koppenheffer owns shares of Berkshire Hathaway, but does not own shares of any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool's disclosure policy thinks Dan Solin could have been a bit more creative with the "Foolish Advice" line. We've heard that one just a few times before.

Read/Post Comments (14) | Recommend This Article (14)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 22, 2010, at 2:09 PM, mrwizard555 wrote:

    the market is efficient at pricing in all available information quickly. the inefficiencies everbody like to point out, come from what investors actually do with that information. mostly around the return horizon.

    an investor who thinks XYZ will go up 5% in the next quarter and ABC will only do 4%, will often pick XYZ, even if the long term ABC prospects trample XYZ. the market is now, plus or minus about a microsecond. information gets priced in is a couple seconds at best. valuation for time period T> that, takes a little longer.

  • Report this Comment On December 22, 2010, at 5:46 PM, MegaEurope wrote:

    I wouldn't waste any more time responding to Solin.

    He's obviously the one misrepresenting Buffett's views, cherrypicking a tiny fraction of the thousands of words Buffett has written about how he has successfully beaten the market.

  • Report this Comment On December 22, 2010, at 7:23 PM, TMFKopp wrote:


    "the market is efficient at pricing in all available information quickly. the inefficiencies everbody like to point out, come from what investors actually do with that information."

    I'll give you that the market is quick to move stock prices when news hits the wires, but the question is whether the market (and therefore investors) is effective at taking that news and accurately determining what it means for the underlying value of the security.


  • Report this Comment On December 22, 2010, at 10:08 PM, greedwhenfearful wrote:

    Efficient markets. Yes, for today the prices are efficient. Investing is about tomorrow. Great investors predict the future, and put their money where their mouth is.


  • Report this Comment On December 22, 2010, at 11:34 PM, Merton123 wrote:

    The index Fund is very difficult to beat for mutual funds because of statistics. Why don't we pretend that the stocks in the NYSE represent a "population" of stocks? The various mutual funds select a sample (i.e., portfolio of stocks) hoping that their sample will not reflect the stock market average. When you consider all the mutual fund companies selecting samples - inevitable the total samples should reflect the market average (i.e., index funds) less the mutual funds expenses. And that is what the mutual fund industry has actually experienced. The individual stock picker has a higher probability of outperforming the mutual funds if they keep their portfolio concentrated (i.e., reduce their sample size); don't have a lot of turnover (i.e., minimizing sample size); and their belief about earning growth actually materializes. Mert

  • Report this Comment On December 23, 2010, at 10:17 AM, Shaherome wrote:

    I agree with your opinion, but I would confirm to this approcah only when this "investment research" consistently beats the market. How many money managers have beat the market, say about 90%. Bill Miller track was impressive 15 years only

  • Report this Comment On December 23, 2010, at 10:30 AM, TheTrendSetter wrote:

    I completely agree that the market is not exactly efficient when it comes to pricing. Although major news tends to be priced into a stock immediately, it does not deter large investment companies or individual investors from speculation. This speculation is where people who do their research can find good deals on companies that the market has beaten down.

    I'll give you a good example with the company ZAGG, the maker of InvisibleShield which protects smart phones. The recent recession beat down the stock from a high of $7.50 down to a low of $1.90 in just months. WHY? SPECULATION. The company only reported stronger growth and higher earnings during the entire period but still lost huge amounts of money. The stock has since returned to ITS FAIRLY VALUED PRICE of $7.50, and for smart investors who recognized the market had beaten this stock down and purchased it several months back have seen 100 to 200% gains.

    Does this seem like an efficient market to you?

  • Report this Comment On December 23, 2010, at 1:36 PM, johndog19 wrote:

    The market is quick, but not accurate. It quickly prices information as it comes in, but it doesn't know how to *value* that information. It consistently overvalues new information and tramples on the value of old information. If this weren't true, the needle would only move on days that there is actual new information. These aren't characteristics of an efficient market, just one that is quick and rash.

    In some sense, stock picking is speculation. In an truly efficient market, you might say that stock picking is anticipating that more good news is going to come out on a stock than the market currently anticipates, and therefore it is undervalued. The picker may or may not have very good reasons to believe this; he had better have reasons that the market doesn't know how to recognize.

    Well, in the inefficient market we actually have, this is only a very small part of stock picking. The bigger part is that, in picking the stock, the picker believes the market is signficantly under or over-valuing information it already has. The speculation is that the market will eventually come to realize this and correct for it, before unpredictable compromising news comes to the forefront.

    We know that the market is partially irrational. We know that there are wild swings--in individual stocks and the market as a whole--that correspond to no information in particular. We know that the market values stocks inconsistently from one ticker to the next, and even one month to the next.

    It is not unreasonable to expect that if you pick good companies that are historically undervalued, you will be pricing yourself into better opportunities for success. I suppose it is one of Solin's points that if you think you can do that, you're wrong. Maybe he's right about most people. But most people aren't taking advice from the Fool, either.

  • Report this Comment On December 23, 2010, at 2:28 PM, Glycomix wrote:

    Buffet's value-added was absolutely remarkable in the late 70's and early 80s when he beat the market by an average of 18.5 to 19.5% a year, and 89% to 90% increase in value over 5 years.

    From 1995 to 2000, he beat the market only by 5% per year, and he beat it only by 7% per year from 2001-2005. However, that's not bad. It's still a 25% increase in value the late 90s and a 35% increase in value from 2000-2005.

  • Report this Comment On December 23, 2010, at 2:50 PM, Glycomix wrote:

    To sum up my previous postings, In his worst moments, Buffett's accounts produced a 25% increase above that of the index fund over 5 years.

    In his salad days in the late 70s and early 80s, Buffett produced a 90% increase in the value of his account holders' .investments compared to the index funds.

    That doesn't mean that he didn't have losses, but Buffett was so nimble that he more than made it up over the remaining years in the 5 year history.

    With Buffett as your manager, you COULD invest and forget. With his 90 hrs/wk focusing in the financial reports of every stock in the market, he'd find the pick of the litter.

    The first question is "How do you find and value a stock with a competitive advantage?"

    The second one is... how long do you wait? Buffett had a long horizon. He never sold a winner if its fundamentals worked. Graham kicked all of his stocks out after 5 years. Buffet holds onto winners. That's what got him $47B in personal assets.

    Can we wait as long? How do you ensure that you have a winner? What are the signs that a stock is stronger than its problems. It wouldn't be undervalued if it didn't have problems. How do you determine that it's so strong that it won't go under?

  • Report this Comment On December 23, 2010, at 3:27 PM, TMFKopp wrote:


    "Efficient markets. Yes, for today the prices are efficient. Investing is about tomorrow. Great investors predict the future, and put their money where their mouth is."

    The idea behind efficient markets is that the market takes *everything* into account. So it would assume that all news and expectations for the future are priced into the stock, making the stock accurately priced.

    Silly yes, but that's how the theory goes.


  • Report this Comment On December 23, 2010, at 3:29 PM, TMFKopp wrote:


    "The market is quick, but not accurate. It quickly prices information as it comes in, but it doesn't know how to *value* that information. It consistently overvalues new information and tramples on the value of old information."

    Ding, ding, ding! Bingo!! I agree 1,000%


  • Report this Comment On December 23, 2010, at 4:04 PM, Merton123 wrote:

    The market value of any stock is based on supply and demand. As the other writers have pointed out the demand for a particular stock can change rapidly and may not have any connection to the stocks underlying fundalmentals. So why doesn't stock pickers have a better record for outperforming the indexes based on the irrational behavior of Mr Market? The answer is that the stock pickers as a group are not able to sit on their hands until the sure things comes along. Warren Buffet left New York and returned to Omaha so he could create psychological distance between himself and the market and wait for the right pitch. Mert

  • Report this Comment On December 23, 2010, at 4:20 PM, Merton123 wrote:

    Could there be better theories to explain why the majority of stock pickers under perform the indexes then efficient market? I believe that the academicians when asked to explain the market came up with their equivalent of God - the price of a stocks reflects all the information available. I have come to challenge this assumption. I believe that the reason why most stocks pickers underperform the market are attributable to :

    1. Law of Statistics

    2. Behaviorial issues

    Statistics states that if you pull a large enough sample that the sample will represent the average return in the stock market. The majority of stock pickers have over 50% stock turnover rate and because of their "excitement" end up pulling a representative sample (i.e., buying and selling stocks every day results over time of buying a large number of stocks). Mert

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