Editor’s note: This article was first published in July 2014; the figures and claims it cites, including Buffett’s average annual return of 24% or 19%, the claim that no stock in any market meets value-investing criteria today, and where the fastest-growing fortunes come from, are as of 2014.
You have to learn to question everything. We must constantly question even the things whose truth hurts to discover. Does this mean we’re going to say that Warren Buffett is not the best investor around today, or that value investing is not a valid investment method? Not at all. Quite the opposite. But we need to look beyond the myth surrounding Warren Buffett, and the truth is that Warren Buffett is not one of the richest men in the world because of his skill at picking stocks, even though it has helped.
In the financial industry there is a great myth that by using value investing and holding solid stocks with good dividends and steady growth, anyone can become a multimillionaire. That is false, because depending on how much we have available to invest, however profitable our investments were, it could take us up to 150 years to become multimillionaires. In other words, to get rich from stock market investing alone, you would have to invest huge sums of money that ordinary people rarely manage to put together.
It is said that Warren Buffett’s fortune is the result of compound interest over more than 50 years, bearing in mind that Buffett’s average annual return is 24% (according to Forbes), or 19% according to other sources, which does indeed make him one of the best investors on the planet.
But his wealth doesn’t come from investing. The stock market is merely a vehicle for multiplying the wealth generated by Buffett’s real talent, which is not investing but business.
It is something we had more or less already discussed, but now Cullen Roche explains it perfectly in his book Pragmatic Capitalism: What Every Investor Needs to Know About Money and Finance.
Roche is clear about it: he thinks the Warren Buffett myth is one of the biggest misconceptions in the financial world. People believe Buffett is a wise investor with a special talent for stock picking, someone who works very hard to find the intrinsic value in a company undervalued by the market and then holds the shares forever.
We invest in a company like Coca-Cola or Visa and don’t worry if it falls 50%, because that will be an opportunity to buy more cheaply. And with this technique, over the years we’ll watch our money shoot up until we become real multimillionaires.
According to Roche, that is completely false and very ineffective for investors. And the truth is that Roche is right.
Where does Warren Buffett’s money come from?
Warren Buffett’s tens of billions don’t come from value investing or from his stock picking. That is a fact. That is why we always insist that if you’re not Warren Buffett, be careful about investing like Warren Buffett: if you expect a stock market storm, you have to get out of the markets. Only an idiot would watch his shares lose 50% of their value if he could have seen it coming. It really makes no sense.
Warren Buffett is probably one of the best and most sophisticated businessmen in history.
What Buffett has achieved is much more complex than that. In reality, Buffett made his biggest fortune by creating a hedge fund in 1956 called Buffett Partnership Ltd., acting more as an entrepreneur than as a stock “picker” and charging large sums for managing the fund to hundreds and thousands of investors. In other words, he made his fortune the same way Bill Ackman and hundreds of other fund managers do today, amassing billions in assets by managing other people’s capital.
See also: The 4 phases of a financial bubble
In fact, for many people Buffett is not so much the professor of value investing as the master who taught today’s hedge funds to charge investors high fees for good returns.
And once you have earned billions in this legitimate business, that is when value investing does its work, because €100,000 doesn’t multiply the same way as €1 billion.
The great secret of Buffett’s wealth lies in the brilliance of what sits behind Berkshire Hathaway. What started as a textile company ended up becoming not only an insurance and investment company but a conglomerate that doesn’t just buy shares in companies: it buys and runs them. In other words, Buffett doesn’t just become a shareholder; he acquires a real stake so he can play an important business role within those companies, because that is Buffett’s true talent.
Nor is it true that Buffett’s returns come only from value investing.
Buffett has used leverage in his investments (a little, but he has used it) and has made countless speculative investments, earning 1.2 billion on the very investment products he once called “financial weapons of mass destruction”. Not to mention that part of the huge returns he has made during this crisis came from his work as a lender, where he made billions lending money in exchange for high interest rates and the acquisition of warrants and stock options, terms only Warren Buffett could get.
What we mean by all this is that people rarely get rich from stock market investing alone. Most billionaires are businesspeople who later invest in the stock market. In fact, today the fastest-growing fortunes come from two places:
Silicon Valley, through the creation of technology companies that are sold or valued at billions, and Wall Street, meaning the managers who charge fees for managing other people’s wealth and investment capital.
That said, none of this takes away from value investing as one of the smartest investment methods there is. It will rarely make you rich, although it can deliver high returns.
According to Cullen Roche, the reason this Buffett myth gets sold is that it suits the financial industry for you to believe that by buying an index fund, or leaving your money in the hands of expert stock pickers, you will become as rich as Buffett, when the probability of that happening is practically zero.
But I insist that this article is not meant to undermine Warren Buffett’s credibility as an investor, but to question a belief about the best investment method. When we have little money, we sometimes have to take on more risk in the stock market, because value investing probably won’t get us there. What’s more, today you won’t find a single stock in any market in the world that meets the requirements of value investing. So you have to adapt the method.
To understand it better, read: How Warren Buffett analyses stocks before investing in them.
Further reading
Featured image: Marcbela (Marc N. Belanger), Public domain, via Wikimedia Commons.
