Fool Special
Book Review
The Warren Buffett Portfolio: Mastering the Power of the Focus Investment Strategy, by Robert G Hagstrom
[Buy this book from the Fool's Bookshop]
By Alan Oscroft (TMFAlan)
This is the latest offering by the author of that now famous work, The Warren Buffett Way, and it is very likely to sell many copies simply by having the word "Buffett" in the title. To this reviewer the "Buffett" tag is, at the same time, both a godsend and a millstone. Buffett is, it is true, one of the world's most successful and intelligent investors, and he stands in a small minority of people who can genuinely banish short-term share price movements, emotional greed and fear, and all that statistical and chartist nonsense from their armoury of investment tools. At the same time though, he did not single-handedly invent, nor is he the only protagonist of, the "focus investing strategy."
Hagstrom, unfortunately, does fall into the hero-worship trap a little, and the near-deification of Buffett that he is guilty of in parts can sometimes grate a little. But then, he does want to sell lots of copies, his previous book was about Buffett, and well, how would a book called "The John Maynard Keynes Portfolio" sell?
My other minor criticism at the outset is the title. Before we look at what this book is about, let's clearly state what it is not about. It is not about Warren Buffett's portfolio (though it does contain some tables in an appendix listing Berkshire Hathaway's stock holdings from 1988 to 1997). No, it is about the strategy of "focus investing," and all that really refers to is the increasingly widely understood investing method based on fundamental analysis and deep understanding of a relatively small number of companies (or "Foolishness", to give it a name that we are quite fond of round these parts).
Having got those little niggles out of the way, this is, in fact, a rather good book, and its writing style, though a little dry at times and lacking in humour, is easily accessible to beginners. There is nothing that is really new in this book, but it does draw a number of ideas together well, and that in itself makes it a valuable offering.
Amongst the first psychological barriers that investors, who are brought up on classic academic investment and economic theories, need to overcome are those twin evils of Portfolio Theory and Efficient Markets Theory. The first tells us that we need to measure and minimise the overall "risk" of our portfolios by diversification, but its fatal flaw is its misunderstanding of the real nature of risk. The second tells us that the world's markets are perfectly efficient, all available information is rapidly absorbed and used to place rational prices on all companies' shares, and that it is therefore impossible to consistently beat the market. Both theories are nonsense, and both are simply and expertly demolished by this book.
So where did modern "risk management" strategies originate? Hagstrom has no doubt, seeing the 1973 to 1974 bear market as the key event that had investors scuttling off to academia for the answers, and his argument is convincing. "Thus," he says, "for the first time in our history, our financial destiny rested not on Wall Street or in Washington, and not even in the hands of business owners. As we moved forward, the financial landscape would be defined by a group of university professors on whose doors the finance professionals had finally come knocking. From their ivory towers, they now became the new high priests of modern finance."
So what is the alternative? The alternative is, quite simply, to focus on quality and value, only buying into good companies when you firmly believe that they are selling at a significant discount to their intrinsic value. And when the probabilities of success are highest, invest most heavily. Quite a simple strategy really, but one that human psychology frequently prevents people from following.
And psychology is another subject that Hagstrom deals with well. Let's hear a few more of his words: "Psychology... has no place in the efficient markets hypothesis and modern portfolio theory. According to its advocates, market efficiency occurs because investors, with the benefit of full information, instantly and rationally set prices. But since when are people rational about money?" As he goes on to say, "attempting to develop financial understanding without taking into account the human factor is like trying to navigate with a compass but no map: you have ignored half the formula."
As an example of how illogical people can be when evaluating financial decisions, Hagstrom describes a study carried out by Richard Thaler, on two groups of people. The first group were handed $30 each and were told they could keep the cash and walk away, or gamble on the toss of a coin for an extra $9, losing $9 from the $30 if they lost. The second group were given no cash up front, but told they could gamble on the toss of a coin, taking $39 if they won, or $21 if they lost, or could opt to take $30 without gambling. Of the first group, 70% chose to gamble. Of the second group, only 43% took the gamble. Same offer, same odds, different presentation, different results. Was it just that the first group actually got their paws on the greenbacks first? Does this suggest that people are rational about money?
Predictability is another bugbear of Buffett's, as he doesn't really believe there is any worth talking about, and that stock forecasting is a pointless exercise. He reaches that conclusion by looking at the market as the complex adaptive system that it inevitably is. How many major shocks have upset the world's markets this century? How many of those were predictable? How many were accurately predicted? There will be plenty of future shocks too, but we won't know what they are until they happen. But fear not, Buffett is convinced that this uncertainty itself is "the friend of the buyer of long-term values."
Like any book discussing the Buffett phenomenon might be expected to, this one contains a number of classic and erudite quotations from the man himself. But it also liberally quotes from many others, including Buffett's partner, Charlie Munger, a man who is so often unfairly eclipsed by the fame of "The Sage".
Conclusion
Overall then, this is a pretty good read for Fools. It isn't a lengthy treatise on a single subject and doesn't demand a long stint of concentration. Instead, it covers a number of constituent subjects that combine to form the ethos of focus (or Foolish) investing, and as such, can be dipped into over a relaxed period.
Let's leave the last word to Warren Buffett....
"We bought The Washington Post Company at a valuation of $80 million back in 1974. If you'd asked any one of 100 analysts how much the company was worth when we were buying it, no one would have argued about the fact that it was worth $400 million. Now, under the whole theory of beta and modern portfolio theory, we would have been doing something riskier buying stock for $40 million than we were buying it for $80 million, even though it's worth $400 million -- because it would have had more volatility. With that, they've lost me."
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