Warren Buffett’s Billion Dollar Secrets

Are financial markets efficient?

NO! Citing a well-known quote from Warren Buffett: ” I’d be a bum on the street with a tin cup if the markets were always efficient.” What does Buffett (one of the most successful investors in recent times) mean by this? Obviously, that markets are NOT always efficient.

The Efficient Market Hypothesis(EMH), assumes that share prices reflect all available information and that it is impossible for investors to generate excess returns. Eventually, stocks always trade at their “fair” value, making it impossible for investors to either buy undervalued stocks, and/or sell stocks that are overvalued. If this were the case, why participate in the markets at all? Save for the dividends - if issued.

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I am mostly a Value Investor, following an investment strategy that involves buying stocks that appear under-priced by some form of fundamental analysis (e.g. Discounted Free Cash Flow, DFCF). Through DFCF, I can get a rough estimate of a stock’s intrinsic/fair value. If the stock’s intrinsic value is greater than the market value, I would consider buying it, because there is certain “Margin of Safety”. If financial markets were indeed efficient, none of this would make sense. Sometimes, stocks enjoy great popularity (a “Keynesian beauty contest”), often completely separate from their fundamentals, but showing strong upward-trending prices. Example: Tesla (TSLA) today (January 2020).

Do managers care about shareholders?

Do they have to? Having been a shareholder during various times of my life and of a variety of public companies, I am inclined to say NO. Despite their obligation to maximize “shareholder value”, most senior managers are first and foremost concerned about their own remuneration (including bonuses!) and…to survive. It is a common assumption that shareholders are the owners of the company; they are not.

In pure legal terms, shareholders have a claim on earnings. Shareholders do not have a final say over most big company decisions. But, boards of directors do. That is the reason why so-called “activist shareholders” obtain enough shares to demand a seat on the board of directors and are thus able to directly influence corporate strategy. In addition, managers do not have a real incentive to care about shareholders.

Shareholders are often widely dispersed around the country, or the world, and generally do not attend the annual meetings, or bother to fill out a proxy. The shares they own about the company in question are often a small part of a larger diversified portfolio. Finally, most shareholders lack the knowledge and skills to have a well-rounded opinion on management performance. Be aware if one or more members of the board of directors have “friendly relations” with the CEO.

Can one trust public authorities (politicians)?

A leading question. According to sociologist/political economist Max Weber (1864-1920), the true political leader has three qualities: passion (a commitment to the matter at hand, or the passionate dedication to a cause); a feeling of responsibility (owning the results of their actions); and a sense of proportion (an acute awareness of the realities). Weber: “Those destined for political leadership must have strength of character (ethics); and a deep sense of purpose and responsibility.” We all know that today (2020), NO politician in whatever country possesses all those qualities, or adheres to those standards.

The political arena is a very tough and hostile environment, where the weak perish quickly. To survive politicians lie consistently; fake sincerity and amiability, and empty promises for the sole purpose of getting re-elected. A politician’s inaccurate statements are either intentional lies meant to mislead the public, or they confirm that those who are supposed to be in charge of oversight have no idea what they are supposed to oversee - especially in the area of finance! Whether whole governments can be trusted is a matter of geography. Both the Swiss and Canadians have considerable trust in their governments; the Greeks much less so. Whatever your location, be vigilant and sceptical about trusting public authorities.

How to decide when facing irrationality?

Irrationality is all around us, all the time. Economic models still assume, a “homo economicus” always acting perfectly rationally, i.e. in his/her own best interest, making unbiased choices based on all available information. On that subject, I have always liked the quote attributed to John Maynard Keynes: “Markets can stay irrational much longer than you can stay solvent.” Economist Robert Shiller even wrote entire book on the topic entitled Irrational Exuberance.

My main point: People are not rational and most economic models are wrong. Actually, individuals operating in the financial markets are usually quite emotional and irrational. Together, these irrational individuals can create market trends and valuations that are far removed from a company’s fundamentals like earnings and cash flows. The price of the stock becomes a highly-predictable reality, as investors continue to boost the perceived trend. What to do? 1). The trend is your friend, i.e stay with the trend as long as you can. Technical Analysis (MACD, RSI) can give you some indication when the trend may reverse. 2). Fundamental Analysis: Look at some key ratio’s to get an idea about the company’s growth, profitability and overall financial health

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