Is Warren Buffett over the hill? Widely regarded as the greatest investor in history, the so-called Oracle of Omaha has enjoyed unprecedented investing success for more than half a century.
A $1,000 investment in Berkshire Hathaway, Buffett's investment vehicle, in 1965 would be worth more than $24 million today; the same investment in the S&P 500 index would be worth just $145,000.
These days, Buffett’s not doing too bad – far from it. Berkshire shares rose 21.9 per cent last year, just about outperforming the S&P 500 index. In 2016, shares soared 23.4 per cent, trouncing the index by 11 percentage points. However, the last decade has been a decidedly inglorious one by Buffett standards. Berkshire has generated annual returns of 7.7 per cent over that period, compared with annualised returns of more than 20 per cent over the last 53 years.
Importantly, Buffett has also underperformed the S&P 500, which has returned annualised returns of 8.5 per cent over the last 10 years.
Buffett devotees might baulk at the notion that he has lost his touch and point out that previous obituaries lamenting the demise of his investing style have been premature. Between the summer of 1998 and early 2000, Berkshire shares fell 44 per cent even as the market, galvanised by feverish excitement surrounding the overheated technology sector, soared 32 per cent. That prompted US financial magazine Barron's to publish a piece entitled "What's Wrong, Warren?" in December 1999. The article suggested Buffett "may be losing his magic touch", saying he was "viewed by an increasing number of investors as too conservative, even passé".
Berkshire shares averaged annualised returns of 30 per cent between 1965 and 1989
Within months, however, the dotcom bubble had burst. Since then, shares in Berkshire have enjoyed a sevenfold rise.
Ongoing underperformance
Still, underperforming over a two-year period is very different to underperforming over a 10-year period. Buffett's ongoing underperformance bolsters the sceptical stance taken by statistician Salil Mehta, who has consistently argued in recent years that Buffett's best days are long gone.
In 2014, Mehta noted Buffett had underperformed in four of the last five years, compared with just six out of the previous 44 years. Mehta calculated there was only a 3 per cent chance that this about-turn in performance was due to bad luck.
He also noted the diminution in returns was part of a long-term trend. Berkshire shares averaged annualised returns of 30 per cent between 1965 and 1989, compared with 10 per cent for the S&P 500; the differential shrank dramatically over the next 25 years, falling to 14 per cent versus 10 per cent for the overall market. "There were essentially two careers," said Mehta, comparing Buffett to basketball star Michael Jordan. "In the first, he was a superstar. And in the second, late in his career, he just wasn't one any more."
Why? In 2016, Mehta reflected on Buffett’s “quite mediocre” returns by suggesting that “luck finally ran out on the great investor”, saying the “particular trading strategy that he used stopped working and his performance dissipated”.
Now, Buffett is a relatively flexible investor not tied to any one strategy, but he is, at heart, a value investor, someone who prizes buying profitable businesses selling for reasonable prices.
Value investing has been a winning strategy for most of the last century, but the last decade has been a barren one for value investors, so much so that many have questioned whether it remains a viable strategy. Still, even if value investing is dead – and there is a strong case to be made that this is not the case, and that the cycle will eventually turn – that would not prove Buffett is finished. After all, no other value investor has come even close to earning anything like the returns Buffett has enjoyed over the last 52 years, indicating there is more to Buffett than simple bargain-hunting.
Buffett said last year that he hates cash but high valuations means he's finding it very difficult to put his money to better use
At the same time, there's no doubt the investing game has become harder. George Soros once said, he was a "one-eyed king among the blind" in his early career and that his own "amateurish" research was sufficient to give him a market-beating edge. Those days are long gone. It was a lot easier to easier to beat the markets in the days of old, and this increased difficulty is reflected in Buffett's investing edge thinning over time.
Problem of scale
Above all, however, Buffett is hobbled by one major obstacle – size. Throughout his investing career, Buffett has consistently warned that the more money you have to invest, the more difficult it becomes to sustain outsized returns. In 1999, he noted that his best returns were achieved in the 1950s, when he “killed the Dow”. However, “I was investing peanuts then. It’s a huge structural advantage not to have a lot of money. I think I could make you 50 per cent a year on $1 million. No, I know I could. I guarantee that.”
Today, Berkshire is valued at more than $500 billion. The sheer scale of the company means it has had to gradually move away from stock-picking and to instead buy businesses outright. In the mid-1990s, for example, stocks accounted for about three-quarters of Berkshire’s assets. At the end of 2017, however, Berkshire’s stock portfolio accounted for less than 38 per cent of its market capitalisation.
Berkshire’s enormous size is reflected in a similarly enormous cash pile, which currently stands at a record $116 billion.
Buffett said last year that he hates cash but high valuations means he’s finding it very difficult to put his money to better use. Last year, Berkshire spent just $2.7 billion on acquisitions, compared with $31 billion in 2016. A good acquisition demands a “sensible purchase price”, Buffett wrote in last month’s annual client letter, but that requirement “proved a barrier to virtually all deals we reviewed in 2017, as prices for decent, but far from spectacular, businesses hit an all-time high”. Price, he opined, “seemed almost irrelevant to an army of optimistic purchasers”.
Bear market
Continued high prices mean a bear market might be good for Buffett and Berkshire, allowing the company to gobble up good businesses at more reasonable prices. The fact stocks have been in a bull market for almost all of the last decade may partly explain Berkshire’s underperformance.
Indeed, Buffett himself has previously pointed to the difficulty of outperforming during bull markets. In 2014, he noted that Berkshire had underperformed in 10 of the previous 49 years, with all but one of those shortfalls occurring in years where the S&P 500 gained at least 15 per cent.
Still, the simplistic idea that Buffett does well in bear markets and badly in bull markets is, well, simplistic. During the 1990s bull market, for example, Berkshire outperformed the S&P 500 in seven of the eight years between 1991 and 1998. Similarly impressive returns were delivered during some of the most bullish years in the 1980s.
It’s not fair to say that Buffett has lost his touch. His public pronouncements and shareholders letters are as insightful as ever. However, today’s markets are more difficult to beat than the markets of old, while the sheer size of Berkshire will inevitably constrain the company.
Buffett may well beat the market in 2018 and beyond, but the supersized returns of yesteryear are gone for good.
