Episode Twenty-One: Bad Lessons from Buffett

This is a very under-appreciated tweet:

While /r/wallstreetbets gets all the headlines after Gamestop, the cult of Buffett keeps on chugging along. r/valueinvesting now has 124,000 members, and though the Boomer hedge funds that charge you 2% in fees just to buy Berkshire Hathaway and underperform the index have had a lot of outflows over the last decade, they’re still out there, cheerfully telling everyone that their time is just around the corner after fifteen years of underperformance.

The Buffett dogmas come in two types;

1) the things people thought Buffett said, but never did

2) Things he did say, but only to explain the way he manages money at modern-day Berkshire.

Modern-day Berkshire is a very different beast to what it was back in previous decades. The shift is a function of wealth and age. Berkshire has an old and retail-heavy shareholder base, composed of people with an unusually high percentage of their net worth in Berkshire. Buffett knows this and it makes him far more risk-averse than he used to be, as he has admitted in public (see from 5:10 onwards here).

The major reason for the various ways that Berkshire has changed, though, is just size. Buffett has too much money. His investable universe for stocks is basically all mega-caps, and for acquisitions really nothing below $20 billion is going to move the needle. But a very small investable universe dramatically raises the costs of getting it wrong, because you’re usually going to be selling at a big loss should you change your mind.

Moving onto a non-exhaustive list of the dogmas themselves…

Dogma One: The Moat

Of course moats exist. Some companies can do things that almost no other company can. Replicating the advanced capabilities of the Taiwan Semiconductor Manufacturing Corporation (TSMC) would require hundreds of billions of capital expenditure and vast amounts of human capital (which I suppose you’d have to poach from TSMC itself, at least in part). TSMC’s annual capex is now higher than the entire Taiwanese defence budget. Amazon likewise has an enormous moat in logistics, Google in search.

The concept of a moat, though, winds up being a less-than-helpful guide to investing because:

1) It is very easy to confuse a permanent moat with a temporary competitive advantage, which breeds a certain complacency in investing.

2) Competitors can and do innovate in ways that simply circumvent the moat, by destroying demand for the thing it protects.

3) Everyone knows that moats are good, so companies with clear and obvious moats will generally attract higher valuations.

Part of the reason why Buffett likes moats is that he frequently buys entire businesses than he plans to hold for extremely long periods of time within the Berkshire conglomerate. Most people, though, aren’t doing this. Yes, a railroad has a large regulatory moat because it’s much harder to build new railroads these days. Who cares? Literally almost everyone on the planet has a bigger investable universe than Buffett does nowadays. You really just don’t have to buy any railroads at all, whereas now he has to at least think about it.

At its worst, the obsession with moats leads to some really through-the-looking-glass nonsense, like this discussion on whether or not Corsair has a moat. No, of course it doesn’t, they make computer peripherals! But who cares? They have some tailwinds blowing them along (the rise of e-sports), make great products, and have consistently grown revenue and earnings per share very well. Corsair can be (and probably is, although we have no position) a fine investment for at least a few years even if it has no moat.

Dogma Number Two: Buy and Hold Forever

This is just a bad idea, unless you either buy the index, are gifted with incredible foresight, or get incredibly lucky. The average tenure of a S&P 500 company is down from 60 years or so back in the 1950s to under 20 years today. Very few companies get to chill out and compound for 20 years. Far more often they go out of business or get acquired, the fate of almost half of all listed companies in just a 10-year period. Aggressive portfolio turnover is, accordingly, very underrated.

Even looking at Buffett’s equity portfolio shows a lot of churn, with the exceptions of the big stakes in Coca-Cola, American Express, and Moody’s. From 1980-2006 his median holding period for a stock was just one year. His current largest position- in Apple - only dates back to 2016. Bank of America, another big Buffett winner, got added as a result of a sweetheart deal struck in the midst of the 2011, eurozone sovereign debt crisis.

NB: some of these holdings, such as Amazon and Snowflake, are not Buffett buys: they were added by his lieutenants Ted Weschler and Todd Combs.

It’s often-forgotten that earlier-career Buffett did everything from special situations to aggressive merger arb to activism, and a lot of other stuff in-between. You can make money in a lot of ways other than just buy & hold equities, and Buffett did - back when he was operating at the kind of smaller scale that made these strategies viable. It can’t be said enough that size really does matter when managing money.

Dogma Number Three: Tech is Bad and everything’s a bubble

Again, Buffett never said this, or anything close to it, so I’m not really sure where people got the idea (although Berkshire’s outperformance in the immediate aftermath of the bursting of the dot-com bubble clearly had something to do it with it).

The dot-com bubble, though, is poorly understood. In many ways it was just a general bubble in US large-cap stocks, with the tech bit of that merely the frothiest bit of what was a very frothy market. Company after company has charts that reach heights in 2000 they don’t attain again until 2007 - or ever.

A crude way of showing the 1990s run-up in US large-cap stocks and subsequent stagnation in the years preceding the Great Recession. Notably, none of these are “tech stocks”.

But frankly, not only are FANGMAN not remotely comparable to their dotcom bubble predecessors (Pets.com or early-life Amazon itself), but they aren’t even really comparable to the kind of large-cap companies of yesteryear. GE was a fairly mature hardware company (with attached unregulated bank) that once traded at a P/E ratio of 48: while FANGMAN have never been cheap on conventional metrics, they’ve never been quite so outlandishly priced.

Dogma Number Four: Buy Stuff with a low P/E ratio

To his eternal credit, Buffett himself has nobly fought against this one for years, pointing out that growth is an intrinsic part of value, he doesn’t think much about price/earnings or price/book ratios, and that correlations between low P/E ratios and subsequent returns are almost certainly spurious (in part, I think, the product of a desperate trawl for sources of predictability in stock returns without sufficient correction for multiple comparisons).

Even if, at one point, there was a real relationship between low price/earnings and subsequent returns, it almost certainly got arbitraged away by quant strategies and all the many, many Buffett imitator funds - none of which existed when Benjamin Graham was writing or when Buffett was generating his best returns. This is a very long-winded way of saying that you don’t have to buy Intel stock just because it looks cheap on conventional metrics. The long-term trajectory matters and there’s no quantitative analysis short-cut that gets you away from qualitative analysis.

Much as Tetlock’s Superforecasting surprised people by suggesting that the best results in geopolitical prediction are not the result of extensive quantitative analysis, so likewise in investing there is no replacement for good human judgement (unless you are Medallion Fund, but evidently this is a strategy that can’t scale). No one wants to hear this, though, because if you can’t reduce things to an easily digestible formula, the obvious implication is that only a small elite can do those things at all. The Buffett legacy, sadly, may wind up being more value destruction over the long term via the bad lessons people have learned from what has been, on any metric, an extraordinary career of exceptional brilliance.