John Price1 School of Mathematics University of New South Wales Sydney, NSW 2052, Australia and Edward Kelly School of Business Studies University of Dublin, Trinity College Ireland Keynote paper presented to the First International Workshop on Intelligent Finance: A Convergence of Mathematical Finance with Technical and Fundamental Analysis (December 13-14, 2004, Melbourne, Australia). Abstract Warren Buffett has been Chairman and CEO of Berkshire Hathaway, a general investment company, since 1965. Before that he headed various private investment partnerships. Over a period of 47 years, under Buffett’s leadership, these companies have outperformed broad market indices by an average of 11.16% per year. In 42 of the 47 years he has outperformed the market. Despite this record, rarely do any standard investment, finance or economics texts mention Warren Buffett. In this paper we look at possible reasons for this and examine the question posed in the title, namely whether or not Buffett is simply a statistical anomaly. We also describe some of the investment criteria used by Buffett and look at some historical studies implementing these criteria using the investment program Conscious Investor. 1. Warren Buffett: The Invisible Man The life of Warren Buffett is well documented in a range of biographies and analyses including Lowenstein (1995), Kilpatrick (2001), Hagstrom (2000), and O’Loughlin (2002) while Miles (2002) considers the type of managers preferred by him. Warren Buffett began his investing career working for the Graham-Newman Corporation in New York in 1954. This was the company partly owned by Benjamin Graham, the author of Security Analysis (with Graham Dodd) and who had lectured Buffett at Columbia. After Graham-Newman was wound up in 1956, Buffett returned to his native Omaha, Nebraska and started his remarkable investing journey. He established a number of private investment partnerships. Even though just a young man, he had very definite ideas how he wanted to run them. He made it clear that he would only provide a summary of his results once a year to the investors in his partnerships and that he would not disclose where he was investing the money. In an early letter to the partners he wrote, “All I want to do is hand in a scorecard when I come off the golf course. I don’t want you following me around and watching me shank a three-iron on this hole and leave a putt short on the next.” Furthermore, any investors could only add or withdraw capital on one day a year, December 31. (See Lowenstein (1995, p. 152).) Warren Buffett closed down all his partnerships in 1965 when he took charge of Berkshire Hathaway, at the time a textile company with headquarters in New Bedford, Massachusetts. If anyone had invested $10,000 with one of the original Buffett partnerships in 1956 and then nine
John Price is also chairman and CEO of Conscious Investing in Sydney, Australia.
years later reinvested in Berkshire Hathaway stock, that investment would now be worth around $270 million after all fees. Despite this exceptional record, as far as references to either the man or his methods in standard finance or economic texts, Buffett is virtually invisible. As documented in Kelly (2004), in a search of 23,000 pages of finance only 20 pages referred to Buffett. Similarly, a search of the leading academic journals for references to Buffett and Berkshire Hathaway located only a handful of articles. Even more, many of the references to Buffett are there simply to dismiss his results as a statistical anomaly. Nobel Laureate, William Sharpe described Buffett as a “three-sigma event” (see p. 312 of Lowenstein (1995)). Michael Lewis (1989) states “The reason [Buffett] is so rich is simply that random games produce big winners”. Noble Laureate, Merton Miller explains “if there are 10,000 people looking at the stocks and trying to pick winners, well 1 in 10,000 is going...