People point to Warren Buffett as proof for how and why active stock picking works, but they don’t understand that it might just be that he has to exist.
Click here for a little primer on Warren Buffet if you are not familiar with him.
The argument here is that his performance is nothing more than a rare, but statistically explainable, occurrence. In his article “Beware of the 5 sigma“, Matt Koppenheffer explains that 95% of all US males are between 5’5″ and 6’2″. 95% represents two standard deviations, or sigmas. He goes on to point out that Manute Bol at 7’6″ is a 10 sigma event. Clearly he exists, and we all know that it is just a rare occurrence. Warren Buffett’s track record is estimated to be between a 3 sigma and 5 sigma event. So is it that much of a stretch to infer that his record is nothing more than luck?
I don’t doubt that there are people who exist with superior stock picking abilities. I know I am not one of them, and I’m pretty sure that Warren Buffett is one of them. So how do I reconcile the statistics and the phenomenon of Warren?
There are a couple of things to consider:
1. Buffett has real and direct influence on the direction of the companies he buys (either in part or in whole). He, or someone close to him, sits on the boards of these companies and imparts his business wisdom. It’s clear he knows what needs to exist for a company to be profitable and sustainable.
2. These days, when Buffett buys a company so do a lot of other investors just because Buffett bought it. It could very well be that Buffett was really lucky in the early part of his career for long enough until he was considered a demi-god. After that point, anything he bought benefited from cult-like loyalty and copy-cat investors – two facts that can help drive a price of a stock up (or keep it from falling as fast). “He’s done so well for so long, that he must know what he is doing!”
The truth is, we will never really know what was behind his stellar record when it eventually comes to an end with his passing. At least, it would be hard to prove it because his track record does not fall outside the bounds of what is possible.
I choose to believe that there is skill there and that there will be future Buffetts, but I also know that I will never be able to identify any of the Buffetts before they establish their track records. And that’s the problem.
What are your thoughts on Buffett? Skill or luck?