Tuesday, March 20, 2012

Buffett's Biographer Accuses him of Hypocracy

Alice Schroeder, who wrote the "authorised" biography of Buffett, The Snowball, is now arguing that Buffett has been making major mistakes in the past few years, including an increasing focus on partisan politics and policy, engaging in investment practices he condemns in others and - gasp - mediocre investment returns.

Just before we explore her argument - a word about Schroeder, as I have read her biography of Buffett.
Schroeder's biography is a must read for any Buffett follower.  If you have not read it, buy it NOW.  You will quickly realize why what only Buffett does what he does.  Quite simply - if you are an Outside Passive Minority Investor (OPMI) you are not following Buffett's investment style.  This doesn't mean you shouldn't use Graham/Dodd principles or look for great growth companies like Philip Fisher.  It just means, don't be fooled by mutual funds and newsletters selling their "Buffett-like" investing advice.

The most amazing story in the book to me was hearing about how Buffett would pour over the Value Line Investment Survey and the Moody's stock profiles.  In the days long before the internet, these were essential tools for doing stock screens.  You had to request the SEC filings of companies, unless you owned their stock, so there was more than a bit of effort required.  Buffett, not wanting to miss any good opportunities, noted that he reviewed and valued EVERY SINGLE company in the books.  He notes that there were many on which he didn't spend much time, but here was a guy putting a value on each of 2000 companies about every 3 months.  So dedicated was he to this practice that he piled the books into the back of his car when he went on his honeymoon.  Most of us just look at a few companies we know of or have heard of.  Some more of us look at various screens and the like, Buffett set out to value every listed US company.

Back to Schroeder's argument - I rather agree with some of her points.  Buffett has become a celebrity businessman, and most celebrities like having the floor.  Since politics is simply the biggest stage their is, it may be that he is drawn to it like a moth to a flame. Schroeder is right, he is entitled to his opinions and to enter the public space to share them.  But she is also right to argue that Buffett's true legacy is Berkshire and that the company operates in lots of heavily regulated industries, including insurance, banking, transport and energy and that it all seems rather well, not right, that Buffett should be so tightly wound up with the people who should be setting policy for his firms.  It is worse when Buffett argues that policies from which he has benefitted should be denied others.  This is a ladder pull by someone high up the economic slope.  Should future investors really be denied the same opportunities to build wealth that he has enjoyed?

Likewise, she notes that the same person who decried derivatives as "financial weapons of mass destruction" himself runs a book of derivatives with billions in nominal value.  True, Buffett sold the options, so he hopes (and expects) the options to expire worthless - enabling Berkshire to keep the money - but in acknowledging that like nuclear energy or chemical engineering, or kitchen knives, derivatives have potential to be employed usefully and productively as well as destructively - Buffett has done an about face on the topic.  Yes, his current position is more correct - the danger lies mostly with the user, since the thing itself is morally neutral - but it is his earlier position that is used to argue for overhauls of the global financial industry.  And if he thinks that the main problem is the banks can't handle derivatives (and prop trading) then why is he buying them and saying how smart they are?

Her biggest criticism is that Buffett is earning poor returns.  Since 2000 this has largely been true - even measured by Buffett's yardstick, growth in Book Value per share vs. the S&P.  There are a few reasons for this - one is that the sums of capital Buffett needs to deploy are now so large that paradoxically, his investment universe is shrinking.  He needs investments that enable him to deploy billions in capital on a single deal, and there are only a few hundred firms where this is possible.  Most of these firms do not have significant amounts of undervaluation, since they are solid businesses and so it is more difficult to make outsized returns on these investments, (though I believe that large and mega cap stocks have actually represented the best values in the market over the past 5 years).  In general, I believe his purchases of large cap stocks have been sound, they are all strong companies trading a reasonable prices (although their growth may be suspect).

Buffett's other problem is legacy.  He has acquired a stable of good businesses, but since "trees do not grow to the sky" many of these businesses are reaching maturity, and in some cases may even be in decline (the Washington Post comes to mind.  For the first time, the company did not make the list of significant equity investments).  Buffett is not at liberty to sell them, however, because he made a deal with the owners of those businesses that Buffett would be a permanent home for them.  This means the full range of strategic options for businesses in such a situation, which normally would include mergers, are not available to his companies.  Berkshire's investors got the gains up front, now they have to pay the piper.  This is not to say they got a bad deal, only that slower growth is in Berkshire's future.  If decline is managed well, as it was with the original textile businesses, it can even produce value for shareholders.  But is the board prepared to manage these firms into what may be terminal decline in some cases?  Hard to say.

It seems reasonable that the share price is undervalued.  Berkshire has incredible earning power, but future returns on equity are likely to be satisfactory, not extraordinary, and so the company will trade nearer to book value than in the past.  Whether that is Buffett's fault, in the sense of making poor current decisions, brought on, as she believes by declining acumen, or whether it is really just the burden of historical investments now earning normal returns, remains to be seen.

I think the jury is still out on this, even if Schroeder is right to question Buffett's judgment.


  1. What struck me is the extent to which Mr. Buffet is tied up closely with the regulators that his businesses are in. Had not realized this before

  2. Buffett is well connected. His ownership stake in the Washington Post and personal friendship with Kay Graham meant that he spent quite a bit of time in DC with important folks there.

    So, yeah, the folksy businessman plays much rougher than his public persona suggests. Like most businesses BRK also engages in regulatory capture.