Too Little Too Late for Discarding The Concept of “Value Investing?”
With a surprise ending, Warren Buffett set the record straight a long time ago but the myth lives on
In our previous post, we introduced the concept of alternate finance. Motivated by one of our favorite scenes from Back To The Future, we argued that the concept of “value investing” may not have been born in the halls of academia or on Wall Street, but rather in a book publisher’s meeting. We said:
We can’t help but draw some parallels. Slightly paraphrasing Doc Brown, it seems that what we are currently experiencing in finance is an alternate reality for Warren Buffett, us, and perhaps a few others, but reality for everyone else. We genuinely believe that we inhabit a world of alternate finance.
Upon consideration of this sentence for a few seconds, you might feel puzzled. Isn’t Warren Buffett the greatest “value investor” of all time? Does he not believe in “value investing”? Wasn’t Buffett the one who used the phrase “value investing” three times in this article, which later became an appendix in The Intelligent Investor? If all the above are correct, then why would today’s finance be an alternate reality for him? Wouldn’t it be more accurate to characterize him as the creator of it?
These are all valid questions. As is generally the case, uncovering the truth requires several steps:
i) Straight from the horse’s mouth: We should ignore what others (the media, etc.) tell us about Buffett, regardless of how widespread it is. We should only consider what Buffett himself has said.
ii) Assume nothing: We understand it may be hard for some to let go of the concept of “value investing.” They’ve heard it probably thousands of times. Could everyone be wrong? As difficult as it is to admit, myths can persist due to complicated incentive structures that feed on themselves.
Ask yourself this: If Ben Graham, the “Father of Value Investing,” never actually uttered the phrase in The Intelligent Investor, and if Warren Buffett, Graham’s most famous and arguably most successful disciple, doesn’t believe in the concept, does it make sense to hold on to preconceived notions?
We don’t think so. If we must discard what we believed to be true based on verifiable, irrefutable data, so be it. It’s better to correct a mistake rather than doubling down. In this post, we shared with you a secret: we informed you that Ben Graham did not use the phrase “value investing,” not even once, in The Intelligent Investor. In our previous post, we explained how the concept may have emerged in a publisher’s meeting regarding the 1986 edition of The Intelligent Investor, the first edition released after Ben Graham’s passing, and we hypothesized that this might have possibly happened due to Warren Buffett using the phrase in one of the appendices. In this post, we’ll come full circle and close the loop by analyzing the positions Buffett took afterward regarding “value investing.”
As far as we can tell, this article is the first time Warren Buffett mentions “value investing” (one mention on p. 14 and two more mentions on p. 15). According to Wikipedia, the article was published in the Fall 1984 issue of Hermes, a Columbia Business School magazine, and was based on a speech given on May 17, 1984 at the Columbia University School of Business in honor of the 50th anniversary of the publication of Security Analysis. As mentioned above, this is the article that ended up becoming an appendix in The Intelligent Investor.
Did Buffett mention “value investing” before? We are not sure; we can’t conclusively say whether that’s the case or not. However, what we did find was a fairly extensive profile of Buffett by John Train, the author of Money Masters of Our Time and a few other books. The article was featured in Financial World in 1979, a copy of which is available on this blog.
Notably, the phrase “value investing” is nowhere to be found in this piece. The closest it gets is a quote from Buffett who promises to his co-investors:
Our investments will be chosen on the basis of value, not popularity.
Sure, Buffett is saying he is an investor and has no interest in speculation. That is well-known. It works: Buffett generated twice the returns of the S&P index over a 57-year span (1965-2022), 19.8% vs 9.9%. What is less clear is why others who shared the same mindset later started dabbling with speculation. Bill Miller is the perfect example because he and Buffett seemed philosophically aligned until a few years ago (invest not speculate). Bill Miller is now a proud owner of Bitcoin. But we digress…
The next stop in our research: Buffett’s investor letters. Arguably they provide the best insight into Buffett’s mind. Buffett started writing investment letters in 1965, but the online versions that are available started in 1977. This is right after Graham’s passing and before the Financial World profile mentioned above was published. Thus, we think 1977 is as good a starting point as any. If Buffett mentioned “value investing” in his letters, there is a bigger chance of finding them after 1977 than before.
We did not find any mention of “value investing” in any of the letters until the 1988 letter, in which Buffett mentioned the phrase once:
It’s particularly impressive that Dave could practice as well as preach. Just as Keynes became wealthy by applying his academic ideas to a very small purse, so, too, did Dave. Indeed, his financial performance far outshone that of Keynes, who began as a market-timer (leaning on business and credit-cycle theory) and converted, after much thought, to value investing. Dave was right from the start.
Okay. Together with the 1984 piece referenced above (three mentions), this is the fourth mention of the phrase “value investing" by Buffett (if you know of others, let us know). We can’t help but wonder: Did he use the phrase again in subsequent investor letters?
Yes, as far as we can see, just one more time, in the 1992 letter, where he mentioned it twice. However, this is not just another mention. It is the last mention (in the investor letters at least), but it is a The Sixth Sense-type surprise ending. M. Night Shyamalan would be proud.
This is what Buffett said in the 1992 letter:
In addition, we think the very term "value investing" is redundant. What is "investing" if it is not the act of seeking value at least sufficient to justify the amount paid? Consciously paying more for a stock than its calculated value - in the hope that it can soon be sold for a still-higher price - should be labeled speculation (which is neither illegal, immoral nor - in our view - financially fattening). (emphasis added)
Right there, this is an overlooked yet extremely important milestone in the history of finance. This is Buffett communicating to the financial community that “value investing” is like the spoon in the Matrix movie: It doesn’t exist. This is Warren Buffett realizing that he may have made a mistake and correcting himself. He continues:
Whether appropriate or not, the term "value investing" is widely used. Typically, it connotes the purchase of stocks having attributes such as a low ratio of price to book value, a low price-earnings ratio, or a high dividend yield. Unfortunately, such characteristics, even if they appear in combination, are far from determinative as to whether an investor is indeed buying something for what it is worth and is therefore truly operating on the principle of obtaining value in his investments. Correspondingly, opposite characteristics - a high ratio of price to book value, a high price-earnings ratio, and a low dividend yield - are in no way inconsistent with a "value" purchase.
With that 1992 investor letter, Warren Buffett set the record straight, but the damage had already been done. The “value investing” concept had a life of its own now and it could not be stopped. It did not need Graham (who had passed away 16 years prior) or Buffett. Buffett must have surely been relieved as he solved the intellectual puzzle in his head, if he hadn’t already. For the rest of the finance community, there is no evidence that Buffett’s 1992 letter registered as more than a blip on the radar. As is unfortunately the case with many corrections, the original error remained the dominant position. The unfortunate state of affairs where we find ourselves is this: Warren Buffett’s true feelings about “value investing” are buried in one of his 58 investor letters. The value investing myth, on the other hand, lives on.
There is no spoon, but nearly everyone believes there is.
