Sunday, July 20, 2008

Book Review-"Even Buffett Isn't Perfect"

I am a complete sucker for investment books. My wife accuses me of owning several thousand books that have essentially the same title, usually some variant of Value Investing, valuation, or intrinsic value, or securities analysis. Of course, I have every Buffett or Munger book known to man as well as everything about or by Benjamin Graham. By the way, speaking of Graham, my good friend Geoff Gannon is putting together a series which will review Securities Analysis chapter by chapter. For those who are serious value investing students, I suspect that you will enjoy Geoff's always thorough and thoughtful posts.

Vahan Janjigian, a fellow CFA, is executive director of Forbes Investment Advisory Institute and publishes a number of newsletters with Forbes. He also has a blog and serves on the investment committee of a large RIA.

Dr. Janjigian's book gingerly attempts to criticize some of Buffett's mistaken investments and controversial points of view. I think the book is more successful with the latter than the former.

Janjigian admires Buffett's discipline and capital allocation methodologies. He admires Buffett's ability to manage executive talent. His last sentence in the book summarizes his viewpoint,"Based on the evidence, it is certainly fair to conclude that WB is one of the greatest investors-if not the greatest investor-of all time."

So where are Buffett's mistakes? Janjigian criticizes Buffett's views on taxation, especially those on estate taxes. I agree with Janjigian that there is an irony if not an artificiality or phoniness about urging the continuity of high estate taxes and concomitantly avoiding the situation through setting up trusts and foundations Evidence of avoiding income taxes is evident throughout Berkshire's life...the company and Buffett have always used the IRS Tax Code to their advantage. There is clearly nothing wrong with that but similarly. it is somewhat disingenuous to urge higher taxes after a career of avoiding them.

Like any investor, Buffett has made some mistakes. This is not a game of perfect, but rather one where investors should attempt to understand the downside risks in making an investment. The outcomes can be highly uncertain...the future always is hazy and usually, initial assumptions are plain wrong, either on the optimistic or the pessimistic side of expectations.

Janjigian addresses the Buffett diversification versus concentration question. "Buffett believes that if you can't invest enough money to have some say in how the company's capital is to be deployed, you are better off diversifying your portfolio." This is simply not true. Most Buffetteers and wannabes certainly attempt to focus their portfolios. WB does not say not to fact, for the average investor who is not inclined to do sufficient due diligence, diversification is a salvation. For many professional portfolios, the great bulk of the portfolio is indexed. But in cases where one has specialized knowledge or skills, satellite investments outside the cord index are made and should add performance. Diversification is a protection against ignorance. If one is able to do due diligence, and select successful businesses at reasonable valuations, diversification will not serve you other than to reduce volatility and an unfortunate corollary, reduce returns.

VJ does a decent job in discussing attributes of diversification in a non-mathematical approach to statistical correlation. This is one of the strongest elements in this book.

Much of the rest of the book is in my view, completely obvious. "Buffett buys stocks cheap, not cheap stocks." "Successful investors must be able to distinguish between great companies and great stocks." VJ has an amazing grasp of the obvious and adds little insight into valuation of growth stocks. There are far better sources than this book for this element.

VJ addresses the fact that value works over the long run but growth or rather momentum can work over the short run. Buffett never trashes growth but views it as a partner in helping undervalued stocks recover when growth becomes temporarily disrupted. Other than Buffett's famous comments about lemmings, he has never discussed momentum investing per se, at least to my knowledge.

VJ makes some dangerous statements about PIPE stocks indicating that WB has been successful in buying special issue "Private Investment in Public Equity" holdings such as Salomon Brothers or US Air. True, these had special terms that a large buyer can extract but it is misleading to believe that what some brokers present as PIPEs will offer the average investor better returns. Most PIPE offerings are made in very small cap, highly risky businesses. VJ does suggest that the best access to such investments is through a hedge fund or through Berkie itself.

VJ makes the point that "Unless you have access to Buffett-like resources, it is better to think of yourself as a stock buyer than a business buyer." The argument that managements will rarely listen to outside advice is humbling for both institutional and retail investors. However, retail investors and small institutional investors can be very successful in motivating and organizing larger investors to add pressure to a board. The principle of thinking long term as an owner of a business rather than a punter of stocks is an important part of any real value investor's credo. I have known many managers who "played" stocks rather than owned businesses and who were looking for trends rather than valuation rationales for stocks. They are assuredly not value managers. I have had investee company managements who have indicated that I should just sell the stock if I didn't like what they are doing. Again, these are managements who just don't get "it." If the business has a strong moat that is not being defended, get rid of the management but hang onto the business. VJ's advice is ill-conceived at best in this topic.

Swinging for the fat pitch is WB's approach. WB does not suffer from analysis paralysis and VJ believes that some of WB's recent deals have had inadequate due diligence. Sometimes the obvious should not take very long!

WB readily admits to being "dead wrong." Salomon was a mistake that took an extraordinary amount of work to escape. Gen Re was much worse with poor judgment on WB's part re underwriting discipline and the derivatives book of GenRe securities. NetJets capital intensity does not seem to fit the usual Buffett textbook. Pier One had no moat. Mistkaes all. VJ actually misses the most egregious errors that I recall, namely Dexter Shoe which gave away 1.6% of BRK or about $3.5 Billion in value for what is now a tiny fragment of H.H. Brown Shoe Group, another BRK sub. Dexter, Buffett calls his worst mistake. VJ doesn't even address this. There have been others. WB was the largest investor in Handy and Harman, the silver processor and refiner. Unfortunately, it was also an auto parts supplier and metal bender. Buffett's endless fascination with silver attracted him to H&H. H&H ultimately merged into WHX, which went chapter 11 in 2003. Berky had escaped H&H many years before this ignominious end.

VJ dislikes WB's views about corporate governance. It is incorrect to say that Buffett opposes employee stock options. It was the accounting for them that he faulted as well as the low hurdles that most company's managements clear to get them. In many cases, the only requirement for managements to achieve is respiration, and there are even cases where compensation continues into the after-life! There is nothing misleading about WB issuing options in subsidiary companies with clear performance mandates versus his public statements about employee stock options issuance.

The composition of WB's board has been controversial in the past. No it certainly was not independent historically with Warren and Charlie, Susan and Howard Buffett; Malcolm Chace, Walter Scott were old business cronies; Ron Olson was a partner in Munger's old firm. But VJ missed the most obvious point, Buffett for most of the time that he was involved in BRK owned over half the stock. It was absolutely iron clad clear that management's interests were aligned with shareholders. Unlike most public corporations, management owned most of the stock. The role of the board is not to protect minority shareholder interests but rather to ensure that shareholders' interests are protected. This point is missed by VJ.

Bottom-line, if you are looking for advice to imitate WB's investment style, this is not the best source. If you are looking for a comprehensive list of WB's mistakes in judgment, this is incomplete. If you are looking for views on taxation contra to those of WB, read Steve Forbes rather than VJ's book.

The key takeaways after each chapter provide an excellent summary of each chapter. The final chapter, "Conclusion" successfully highlights the important points.

Dr. Janjigian has attempted to provide an antidote to the usual glorious heaping of praise that most Buffett books (and CNBC coverage) provide. The reality is that nobody walks on water (or parts the sea depending on your point of view.) Even great investors frankly screw up royally. But the incidence in the case of Buffett is remarkably low, the damage is a scratch or fender bender rather than a complete wreck. Should all of us be so fortunate, or disciplined!!


At 1:08 PM, Blogger Randy said...

And Buffett's position on taxes is based more on a desire for fairness rather than higher taxes, though clearly he's also in favor of balancing the budget. A position which I think we all agree with. I.e. he doesn't want separate tax rates for differing kinds of income so that the rich can pay a lower percentage of their net income than the poor. I agree heartily with him there even though I benefit far more than most from the current capital gains tax rates and the fact that payroll taxes are entirely elective for me.

Where you and I and Steve Forbes can agree to disagree with Warren is on whether the estate tax promotes fairness, or is even needed.

But if this guy can't get Warren's investing approach correct, can't get any of his political positions correct except maybe one, what is the use of this book?

I'd really like to see a detailed book on Buffett's investing that talks solely about his investing (not social or political) mistakes and explores both the errors in judgment but also the psychology that led to the mistaken judgment, ala "Influence" by Cialdini. That would be a nice break from the typical "warren is god" epistles, and far more useful.

At 1:58 PM, Blogger Rick said...

I had been hoping that this might be the book you envision. Perhaps my expectations were just too high.

I think it would be unfair to question whether the book is useful or not. There is nothing wrong with "discovering" that WB is not perfect but as I said, much of this should be fairly obvious. However, missing what WB himself has described as his greatest mistake is an unfortunate oversight in my view.

Political or economic views are not really the basis of what I believed the mission of this book was. I agree that WB's mission is to restore fairness to the tax code.Whether we agree or not is opinion not a matter of being right, wrong, or perfect.

Thank you for your comment!

At 2:28 PM, Blogger Alisa said...

This is a great blog for Value Investors. I just started my investment journey: and I find myself leaning towards the priciples of Value Investing. They just make since to me. I am so excited about what you mentioned about going through Security Analysis - one chapter at a time. In my eagerness to be a successful investor, I brought the book and have been going through it... and would love some company. Not just anyone is willing to talk about stock analysis... not to many of my friends care. :)

Be well.


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