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What Accounts for Warren Buffett's Success?

Michael Lewis's long review of the new biography of Warren Buffett is about as good as you'd expect. That is to say, it's very, very good. For instance:

A shrewd evaluator of businesses and the people who ran them, Buffett turned himself, at a young age, into a kind of odds-calculating machine. As Schroeder puts it, "he tended to extrapolate mathematical probabilities over time to the inevitable (and often correct) conclusion that if something can go wrong it eventually will." This habit of mind informed not just his investment decisions but also much else--for instance, his obsession with nuclear proliferation. In Buffett's mind, it is not a question of if but when a nuclear bomb explodes in a big city, and the goal should be not to prevent it but to reduce the odds, and put the terrible day off for as long as possible.

That "over time" bit is important. Buffett has the credibility to make long investments and eschew short-term considerations. Despite being best of class, his approach is curiously marginal. On the other hand, maybe that's because his approach only works for him. And not because he's the only guy able to implement it. Maybe Warren Buffett is just very, very lucky:

Suppose that there were ten thousand investment managers out there, which is not an outlandish number, and that every year half of them, entirely by chance, made money and half of them, entirely by chance, lost money. And suppose that every year the losers were tossed out, and the game replayed with those who remained. At the end of five years, there would be three hundred and thirteen people who had made money in every one of those years, and after ten years there would be nine people who had made money every single year in a row, all out of pure luck. Niederhoffer, like Buffett and Soros, was a brilliant man. He had a Ph.D. in economics from the University of Chicago. He had pioneered the idea that through close mathematical analysis of patterns in the market an investor could identify profitable anomalies. But who was to say that he wasn't one of those lucky nine?

Or maybe we're seeing a a mixture of uncommon talent and historical anomaly. Honestly, it's hard to say.

By Ezra Klein  |  May 19, 2009; 4:59 PM ET
 
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Comments

Suppose you provide liquidity to your conglomerate through control of several large financial firms, like insurers, and take equity holdings in several large banks. And suppose you do this during a 25 year explosion of credit, when total debt went from 150%of GDP, to 375%....

Buffett made a lot of smart investments over the years, but for much of it, his returns were juiced by the credit super bubble.

Posted by: Bob_in_MA | May 19, 2009 5:10 PM | Report abuse

Bob_in_MA:
Except he didn't take as big a part as he could have. He stayed away from the tech bubble. He had to trust that GEICO was competently run back in his early investing days. One could also say he was smart enough to see right through Greenspan's and profit from it.

Posted by: Calvin_Jones_and_the_13th_Apostle | May 19, 2009 5:26 PM | Report abuse

"he stayed away from the tech bubble"

maybe that was merely a lucky strategy.
i believe that i have heard buffet say in numerous interviews that he didnt buy a company if he didnt know what they did.
whatever contributed to his success over the years, clearly his unassumingly homespun and rockwellian, midwestern manner contributed to his popularity.
he fit the image of a nice "billionaire" who could be eating a hotdog at your family picnic on the fourth of july.

Posted by: jkaren | May 19, 2009 6:20 PM | Report abuse

two of warren buffet's more recent purchases are very interesting...
maybe his investment strategy for choosing companies is just simple and pragmatic...based on the companies and not primarily on considerations of economic conditions.
kind of like will rogers, who said about the purchase of land...
"you dont wait to buy land, you buy land and wait."
burlington northern in 2007,
and more recently, iscar, the israeli company that is one of the
world's largest manufacturers of industrial cutting tools.

Posted by: jkaren | May 19, 2009 6:35 PM | Report abuse

Come people! This isn't a settling old scores blog, this is a wonk blog! Let's have some numbers. Take a look at Buffett's returns.

http://allfinancialmatters.com/2008/04/02/a-look-at-berkshire-hathaways-annual-market-returns-from-1968-2007/

He was killing it for decades! He never blew up. At some point you have to say it's not luck (Was Michael Jordan just lucky because he made so many shots?) Buffett talks a lot about value investing, but in the old days, the 1950s and 1960s, he was doing everything, arbitrage, buyouts, etc. But once you're running a company worth $100 billion it's pretty tough to move the needle. In the last ten years he's run his company as well as any other competently run insurance company:

http://bit.ly/gOJ6x

And a lot better than poorly-run insurance companies (e.g., AIG).

Michael Lewis is all wet on this one. He wrote, "The reason he is rich is simply that random games produce big winners," which is code for the efficient markets hypothesis, and is exactly the kind of free-market triumphalism that led to our current financial crisis.

(It'd be nice if WaPo allowed links in comments)

Posted by: chrismealy | May 20, 2009 12:01 AM | Report abuse

Ew. "Come on people" is what I meant.

It'd also be nice if we could edit comments like all the cool blogs let you do nowadays.

Posted by: chrismealy | May 20, 2009 12:14 AM | Report abuse

What chrismealy said.

Think on this: Buffett was already a very successful investor when George Goodman, writing as 'Adam Smith,' made the general public aware of him in "Supermoney" in 1972.

Let's say, for purposes of a thought experiment, that he was one of the 1000 most successful investors in the world at that time. And let's say they all got there on luck.

Then, by dumb luck, ONE of those thousand would have continued that run of luck through the next decade, to 1982. Buffett could have been that one. But that one would have crashed and burned many years ago.

But Buffett didn't. End of story.

Posted by: rt42 | May 20, 2009 10:46 AM | Report abuse

Ezra,

Buffett started his investment partnership in 1957. He never had a down year. When his partnership ended in 1969, $10,000 invested in 1957 became $260,000 12 years later. After taking full control of Berkshire Hathaway thereafter as his investment vehicle, Buffett had his first, and only down year (as measured by book value per share) in 2008. The stock market was down -37% in 2008. Buffett was down just (JUST) -6% in 2008. "Lucky nine??" A single down year in 50 years!! Are you kidding?? Buffett is still a Ruthian-prodigy after DECADES!! Amazingly, his never-to-be-replicated track record as an investor, could well be surpassed as one the on greatest corporate CEOs ever.

Lucky???

AYFKM!!!

David A. Rolfe
Chief Investment Officer
Wedgewood Partners, Inc.
St. Louis, Mo

Long: Berkshire Hathaway stock for +11 years

Posted by: drolfe | May 20, 2009 9:16 PM | Report abuse

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