Beat Warren Buffett at his own game
Reprinted courtesy of MarketWatch.com
Published: Jan. 5, 2019
To read the original article click here
Like his hometown of Omaha, Warren Buffett has won many new fans in the past 15 to 20 years. Buffett is smart, generous, industrious, famous and known for integrity. But is he really the world’s best investor?
There are many ways one can look at Buffett and his investing philosophy. I’ll take this opportunity to explore three interesting questions:
- How have his investments fared over the past 15 years?
- If he’s so smart, why does he set the bar so low for measuring his success?
- Does his estate plan do the best possible job to take care of his wife if she should outlive him?
First topic: Buffett’s investment results are usually seen as identical to the performance of a multinational holding company, Berkshire Hathaway BRK.A, +0.13% , of which Buffett is chairman, chief executive officer and the largest shareholder.
Berkshire Hathaway is sometimes described as an insurance company, and it does in fact own Geico. But the company also is the outright owner of BNSF Railway, the second largest freight railroad network in North America, as well as some other companies you may have heard of, including Dairy Queen and Fruit of the Loom.
Berkshire Hathaway also has significant holdings in Mars Inc., American Express AXP, +0.24%, Coca-Cola KO, -0.36%, Wells Fargo WFC, -0.09% and IBM IBM, -0.06%.
If you buy stock in Berkshire Hathaway, you are essentially buying this pool of investments, all of which are ultimately chosen by Buffett.
Buffett uses an unusual (at least among CEOs) benchmark to evaluate how his company is doing: The five-year trailing total return of the Standard & Poor’s 500 Index SPX, 0.08%.
Last year, for the first time in nearly 44 years, Berkshire Hathaway’s gains in book value (an accounting term that measures corporate worth) underperformed by that measure.
That underperformance hasn’t diminished the ardor of Buffett’s fan club. Those fans (especially longtime Berkshire Hathaway shareholders) can rejoice over his success at beating the S&P 500 for the past 15 years. But I think they should hold him to a higher standard. This leads to the second question I want to address.
Second topic: Comparing the progress of a portfolio with the S&P 500 is extremely simple. But this index is made up of one asset class — large-cap U.S. stocks including all the big, familiar names. These are well-run companies, many of them quite profitable: Names like Apple, Exxon and Google (and Berkshire Hathaway itself).
The index represents the results of buying the best-run large U.S. businesses and holding on to them.
But that’s not strictly what Buffett does. He is a value investor, trying to buy companies when they are cheap and “on sale” because of what he regards as temporary or unimportant problems.
Such stocks have higher expected returns than those of the S&P 500 index — and for that reason, I believe his results should be held up to a different set of indexes: Ones that track value indexes.
How does Buffett’s legendary performance hold up in such a very reasonable comparison?
The following annualized performance figures, from Morningstar, tell an interesting story. All are for the 15 years ended May 2. (Note that the closest cousin to Buffett’s investment style in this list is the U.S. large-cap value index.)
- Berkshire Hathaway 6.4%
- Standard & Poor’s 500 Index 4.2%
- U.S. large-cap value index 7.4%
- U.S. small-cap value index 12.2%
- International large-cap value index 7.1%
- International small-cap value index 11.5%
- Emerging markets value index 11.5%
The average of these five value indexes over this 15-year period is 9.9%. For investors who are spooked by international stocks, the average of the two U.S. value indexes is 9.8%.
Also see:6 steps to the ultimate retirement portfolio
All these indexes, by the way, have been and still are readily available in the form of low-cost index funds. They are compiled by Dimensional Fund Advisors, which manages many billions of dollars for institutions and which has its own no-load mutual funds loosely based on those indexes.
Vanguard, by the way, has two U.S. value funds: Vanguard Value Index VIVAX, +0.42% and Vanguard Small-Cap Value Index VISVX, +1.08%. For this 15-year period, they returned, on average, 7.7%, significantly more than Berkshire Hathaway.
Owning such funds is easier and much less expensive than running a huge holding company like Berkshire Hathaway. And as these fund results show, owning value funds can be more profitable.
So I will pose a couple of questions that nag at me (and which should be nagging at Buffett’s fans): Why doesn’t he use the average of these value indexes as the benchmark for his company?
Wikipedia says of Buffett: “He is widely considered the most successful investor of the 20th century.”
If his company, over 15 years, grows less than two-thirds as much as two low-cost index funds that take a similar investment approach, why has Mr. Buffett been elevated to that status?
By the way, the index-fund approach is based on thousands of stocks. That is much less risky than the approximately 50 stocks in Buffett’s portfolio.
Third topic:Buffett recently revealed part of his estate plan, the part that will take care of his wife, Astrid, if she outlives him. Does his plan do the best possible job of taking care of her? You tell me.
Buffet’s will leaves some cash to a trustee for his widow’s benefit along with this advice: Hold 10% in short-term government bonds and the other 90% in Vanguard’s 500 Index Fund VFINX, +0.12%, which replicates the S&P 500 index.
In his annual letter to Berkshire Hathaway shareholders, Buffett wrote: “I believe the trust’s long-term results from this policy will be superior to those attained by most investors.”
I agree with that. But once again Warren Buffett seems to be setting the bar pretty low.
If you want to invest like Buffett, be a value investor. If you want to perform better than Buffett, consider this mix: From 1927 through 2013, a portfolio with 40% in bond funds and 60% divided equally among the S&P 500, a large-cap value index and a small-cap value index had a higher return than a 100% S&P 500 portfolio, 11% versus 9.8% — at considerably less risk because of the bond funds.
It’s a mystery to me why Buffett doesn’t do something more like that for his widow. During the last two bear markets, a 90/10 split would have exposed Mrs. Buffet to losses of 40% to 50%. She, like you, deserves better than that.
I realize that I may get some unflattering mail because of this article and the related podcast I recorded. But if I’ve made some readers think about Warren Buffett’s record in a new way — and consider holding their own investments to a higher bar — then I’m OK with that.
Richard Buck contributed to this article.
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