At the beginning of my investment career, I spent a lot of time and effort trying to search for the investing system that Warren Buffett (Trades, Portfolio) employed. In my mind, I thought that the Oracle of Omaha must have a straightforward investment process, which would be published somewhere to help other investors.
It took me some time to realize that this system did not exist.
The Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) CEO has spent the last seven decades refining and streamlining his investment strategy. However, even after all of this work, he has still not been able to come up with a template that is suitable for filtering through every company.
No formula
Investing is more of an art than science, and there's no formula in existence that can help you make the correct investment decisions. There are so many variables to consider for every business and business model that no formula would ever be correct 100% of the time.
That fact hasn't stopped people searching. In the 1970s and 1980s, economists and Wall Street analysts thought they had found the holy grail of investing formulas in the efficient market hypothesis. This quickly became widely accepted on Wall Street as the go-to method for security selection.
Buffett was a vocal critic of the efficient market hypothesis. He even went so far as to write an essay explaining why it was incorrect, using real-world examples of value investors who had outperformed it. This essay, titled "The Super Investors of Graham and Doddsville," has become required reading for all value investors.
Everyone wants a system
In the spring of 1991, as part of a series of lectures to students at the University of Notre Dame, Buffett explained why he decided to write this essay as a rebuttal to the popular way of thinking at the time:
"It goes back to a debate I was having with Mike Jensen [a proponent of the efficient market theory who famously wrote in 1978 that "there is no other proposition in economics which has more solid empirical evidence supporting it than the Efficient Market Hypothesis"]. [I rebutted the efficient market hypothesis in] The [Super]Investors of Graham and Doddsville. It was an address I gave on the 50th anniversary of Security Analysis. Dave Dodd was there – 90 years old, marvelous guy. And in that room were a half a dozen or more of us who had gone on to study or work, or have some association with Ben Graham. We weren't all five-sigma types, but we've always gotten five-sigma, or three-sigma, or something results. So it isn't because he had carefully culled us out from all over the country, like the Notre Dame football team. We were there just because we kind of stumbled in. And we listened to the guy and then went out and applied it in different ways – totally different ways."
As Buffett went on to explain, there was nothing particularly extraordinary about this group of investors, and they all used a relatively different approach to investing:
"I mean, Walter Schloss [has always] owned hundreds of different stocks. Walter is not a 150 IQ guy. Charlie Munger (Trades, Portfolio) is. There were all different types of with a common philosophical bond. They did not learn any little secrets of technique – they did not learn any systems."
Understanding this point is all part of becoming a better investor. There's no one specific system investors can use to find good quality stocks, but there are certain qualities that link good quality business. Understanding the difference between these two approaches is key, as Buffett went on to explain:
"Everybody wants a system...They all want some [system] that you can run through a computer and simulate it out. I mean I tell 'em if past performance were the key to it, the Forbes 400 would consist of librarians. Everybody would be looking it up. It doesn't work that way. They want it to work that way. It would be so nice if it did, but it is not that way. It's like picking out a basketball team. You look for guys who are seven feet tall, you look for a guy who can stay in school, there are a whole bunch of things. And there are certain things that point you toward getting the best five guys out there on the court. But I can't give them a formula. I can't say, "here's a little formula and if you go to Emporia, Kansas and apply this formula without actually seeing the guys play basketball and working with them, you'll pick up the best basketball team." You won't."
Disclosure: The author owns shares of Berkshire Hathaway.
Read more here:
- Buffett's Views on How to Prepare for a Recession
- Warren Buffett: Figuring out the Durability of a Business
- Warren Buffett Undervalued Stocks
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