Berkshire Hathaway
Greenwald vs. Buffett on Efficient Markets

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By ValueSnark
August 10, 2004

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In the interview of Bruce Greenwald, he claims that markets are efficient and uses the often-cited example of asymmetrical information held by the buyer and seller of a stock to make his case. The fact that a buyer and seller hold different opinions of a stock they trade doesn't by itself prove (or disprove) that markets are efficient. After all, a perfectly efficient market implies that every trader has complete and correct information about all the facts that determine the value of a company. In such a world, a firm's value would change when the relevant facts change, but those facts would be instantaneously known by everyone. A world of omniscient traders would be a world in which stock prices literally couldn't change and no trader would ever make profits or suffer losses.

In a world of efficient markets, there could never be a 50 cent dollar, or an 85 cent dollar, let alone a Grahamian "net net." All quoted dollars would be worth 100 cents.
But even if markets aren't perfectly efficient, they are imperfectly efficient. They are efficient to the extent that the facts that determine corporate values (or Greenwald's asset values, earnings power values, and franchise values) and therefore stock prices are known and acted upon. But since *all* the facts are never known by *all* traders, there is scope for investor-entrepreneurs to invest profitably--and to invest unprofitably. Stock prices change to reflect imperfect and constantly changing knowledge and share valuations.

Warren Buffett once scoffed at the idea of efficient markets by saying that if they were efficient, he'd be a bum with a tin cup, or words to that effect.

In his great treatise _Man, Economy, and State_, Murray N. Rothbard pointed out that entrepreneurs make profits not by being correct in their entrepreneurial undertakings in an absolute sense (remember, there's no such thing as perfect information and even the best investors err), but by being more nearly correct than their less well-informed competitors.

Buffett has spent at least half a century proving Rothbard's point. Berkshire's chairman is an information processing machine, but not an infallible one to be sure, as he would be the first to admit. But by practicing the tenants of Graham's teachings, combined with his own insights (well discussed in Greenwald et al.'s book), he has shown that markets aren't efficient and that the quest for value in "Hidden Gems" can be well worth the effort.


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