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Geoff Gannon
Geoff Gannon

Warren Buffett, Benjamin Graham, and the Efficient Market Hypothesis - 26 Years Later

December 03, 2010

You’ve probably read “The Superinvestors of Graham and Doddsville”. It’s a talk Warren Buffett gave at Columbia – the school where Graham taught – on the 50th anniversary of the publication of Ben Graham’s Security Analysis. That was 1984.

This is 2010. Not much has changed.

The Efficient Market Hypothesis – which was then flying high – has certainly sunk low. But that didn’t have anything to do with Warren Buffett. A lot of the data didn’t support it. That helped the EMH fall into disrepute. But it was more a matter of methods. And rhetorical choices. The biggest blow was the rise of behavioral economics.

“The Superinvestors of Graham and Doddsville” has nothing to do with behavioral economics. It’s an argument against one method – the objective and empirical one – in favor of another – the subjective and historical one.

Some folks miss this. I’ve even seen people get confused by excerpts of Buffett’s lecture. They think Buffett was actually saying stock market winners are like lucky coin-flippers. He wasn’t. Buffett is quite sure value investors aren’t just lucky. They’re good.

So let’s trace the through line of Buffett’s argument. Buffett’s argument is that financial economists shouldn’t be studying stocks (the objects) but stock pickers (the subjects). They shouldn’t be studying the cards the players are given (the data) but the way the best players play those cards (their interpretation).

It’s a talk about intellectual epidemiology.

Buffett is saying there’s this scheme we all share. We got it from Ben Graham. It’s how we picture a stock in our mind’s eye. How we map the system. And you – financial economists – are shirking your duties if you just study what goes in and comes out of the black box that is our mind. Instead you need to crack the box and see the framework (paradigm) we – disciples of Ben Graham – all share.

It’s a neat argument. Economists don’t like it. Which is understandable given their methods. Buffett’s is asking a man with a hammer to tighten a screw.

But their reluctance is also kind of weird. Because what Buffett is proposing is exactly how economists study themselves. When a historian of economic thought writes an intellectual biography they do exactly what Buffett is proposing.

Buffett is saying economists should study investors the way economists study themselves.

That means they should:

1. Separate investors into intellectual tribes (value investing)

2. Identify their patriarchs (Ben Graham)

3. Trace the transmission of an idea through that tribe (Mr. Market)

4. And explain that idea to folks who belong to different times and tribes (buy a fraction of a public business – a stock – the same way you’d buy 100% of a private business)

Buffett does 3 things in this lecture:

1. Attacks the Efficient Market Hypothesis

2. Proposes Different Methods for Studying Investors

3. Applies Those Methods to Studying Ben Graham’s Disciples

Since you’ve heard attacks on the EMH before, we’ll skip #1. And since you’re probably a value investor, #3 would just be a catechism class. So I’m going to trace #2 through Buffett’s lecture.

The question: How should we study great investors?

Buffett’s answer…

1. Eliminate Luck

“The hypothesis that they do this by pure chance is at least worth examining. Crucial to this examination is the fact that these winners were all well known to me and pre-identified as superior investors…Absent this condition – that is, if I had just recently searched among thousands of records to select a few names for you this morning – I would advise you to stop reading right here.”

2. Identify a Special Group

“Scientific inquire follows such a pattern. If you were trying to analyze possible causes of a rare type of cancer – with, say, 1,500 cases a year in the United States – and you found that 400 of them occurred in some little mining town in Montana, you would get very interested in the water there, or the occupation of those afflicted, or other variables.”

3. Find the Connection

“In this group of successful investors that I want to consider, there has been a common intellectual patriarch, Ben Graham. But the children who left the house of this intellectual patriarch have called their ‘flips’ in very different ways. They have gone to different places and bought and sold different stocks and companies, yet they have a combined record that simply can’t be explained by random chance…The patriarch has merely set forth the intellectual theory…but each student has decided on his own manner of applying the theory.”

4. Trace the Common Thread

“I think the group that we have identified by a common intellectual home is worthy of study. Incidentally, despite all the academic studies of the influence of such variables as price, volume, seasonality, capitalization size, etc. upon performance, no interest has been evidenced in studying the methods of this unusual concentration of value-oriented winners.”

Buffett is advocating a kind of history of investment thought.


The “Superinvestors of Graham and Doddsville” may look like a cute little talk. Not intellectually substantial. Not really about methodology. Not really about economics.

There’s only one reason why anybody thinks that: Warren Buffett wrote it. And Warren Buffett isn’t an economist. He’s an investor. From Omaha.

Cover up the author’s name. Re-read the “Superinvestors of Graham and Doddsville”. And tell me it isn’t an argument about methods.

The point of the lecture isn’t that Buffett attacks the EMH. It’s how he does it. He says objective studies of price, volume, seasonality, size, etc. aren’t as useful as subjective studies of the investors who actually make the investments.

At its worst, this difference over methods actually leads to two people talking about the same thing in different languages. Neither can understand the other.

Economists talk about the value effect. Buffett talks about value investors.

Economists define value investors as investors who buy value stocks. Buffett defines value stocks as the stocks value investors buy.

Economists will argue they have a separate definition for value stocks. Which they do. And Buffett will argue he has a separate definition for value investors. Which he does.

What we’ve got here is a failure to communicate.

About the author:

Geoff Gannon

Rating: 3.9/5 (12 votes)


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