Warren Buffett's revenge

One theme running through "The Real Warren Buffett" is that it is more instructive to look at Buffett as a leader than as a stock picker, because, in this modern age, it simply isn't possible to beat the market as Buffett has done so successfully over his life. In other words, there's nothing to learn from Buffett as super-investor, but there are nuggets of useful wisdom to glean from how he runs his businesses and manages the cohort of CEOs who report to him -- even though the vast majority of us are unlikely to find ourselves overseeing an empire of insurance, furniture and gas pipeline companies.

Though not the primary focus of the book, this thesis dovetails with a sub-theme that pops up from time to time: how the stock market has matured over the course of Buffett's life. Once upon a time, goes the theory, great bargains were easy to come by. If you burrowed into the quarterly reports, and Moody's analyses, and asked a lot of questions (and, it is clear, no one has ever been or is likely to ever be better than Buffett at this kind of work), then you could identify a company whose stock price was below what it should be. Then, you buy and hold. This is "value" investing. Think of it as the antithesis to day-trading, which is all about betting on which direction a stock will go in the next day, or hour, or minute, and buying and selling accordingly.

But great bargains aren't so easy to find anymore, says O'Loughlin, and his view is buttressed by the supremacy of the so-called efficient market theory. Efficient market theory holds that a company's stock price, at any given time, represents the market's fair appraisal of all the publicly known knowledge about a given company. You can't beat the million eyeballs of the market, goes the theory, so don't even try.

Efficient market theory is a mainstay in academia and accepted wisdom on Wall Street, O'Loughlin tells us (as Lowenstein does in his own biography, which is as much a history of investing in the latter half of the 20th century as it is a penetrating look at Buffett). The increasing difficulty in beating the market, O'Loughlin explains, is one reason that Buffett eventually focused on buying whole companies rather than simply trying to outperform the Dow every year by picking and choosing stocks. (It should be noted, however, that Buffett is still a major speculator, of sorts, owning large chunks of companies like American Express and Coca-Cola.)

No doubt, there are subtleties of efficient market theory that I don't understand, and I look forward to learning more about its intricacies. But to those who lived through the recent stock market bubble with their eyes open, the theory appears to have some holes large enough for a thundering herd of bulls (or bears) to romp through. The market fever that drove stocks like Netscape, Yahoo and Amazon to utterly absurd heights surely can't be characterized by the word "efficiency." And the idea that publicly known information leads to an accurate appraisal of a corporation also doesn't seem to hold water, when so many companies specialize in jiggering their figures to beat analyst estimates and produce short-term spikes in the stock price.

One objection might be that efficient market theory doesn't work when companies are run by crooks, such as Enron and WorldCom, and so such examples must be discarded. But that ignores a larger reality: The system has been set up so that every company has reason to cook its books as much as it can get away with. The incentive that stock options give executives to maximize the short-term stock price at the expense of future earnings is just one example (and something that Buffett has historically railed against, earning him the enmity of Silicon Valley technology executives). Of equal, or greater, importance is the lack of oversight for the accounting firms that are supposed to make sure that the figures provided by publicly traded companies are accurate -- or, to extend the net even further, the ascendant ethos of deregulation, which assumes that, left to itself, the market will punish "bad" companies, weed out liars and cheats, and ensure the economy's health.

In a perfect world, efficient market theory may well be plausible. And in a perfect world, perhaps all our business leaders would conduct themselves with the probity and integrity of a Warren Buffett (although it seems unlikely that even in such a utopia, every multibillionaire would also be a registered Democrat who gives money to Planned Parenthood). But we don't live in a perfect world.

The question is, what is more within our grasp? Can we, as individuals, start acting like Warren Buffett, and follow the precepts for managing people outlined in "The Real Warren Buffett"? Or should we take the other route and attempt to ensure that people who aren't Warren Buffett aren't allowed to run amok through Wall Street, defrauding investors?

Maybe the answer is a little bit of both. But for those who would like to believe in efficient market theory, the path forward seems obvious. If you let people do what they want and, even worse, structure the system so that they benefit from not being forthcoming and honest, then you are not going to have an efficient market. Everybody knows that an unsupervised kindergarten turns into a nightmare of chaos and uncapped markers. Why is it so hard to understand that a truly free market, one that gives regular investors and Warren Buffetts equally fair opportunities to make informed investment decisions, requires tough, rigidly enforced rules?

Warren Buffett, as depicted in "The Real Warren Buffett," isn't forced to rap his underlings on the knuckles very often. But that isn't because his management strategy turns swine into pearls. It's because, after accumulating capital as a canny investor, he made smart decisions as to which companies he would purchase. If they weren't already being run by the kinds of people that he respected and trusted, he didn't, in the vast majority of cases, buy them.

He made a few mistakes, and like the good Nebraskan boy he is, he fessed up to them, taken his lumps, and moved on. But the rest of us don't have the luxury of doing business only with people we can trust -- especially if that business is in the form of making stock market investments based on inaccurate information. We need help -- we need a government that will crack the whip rather than wink and look the other way. Something tells me Warren Buffett might agree.

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