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Attack Buffett? Not "Worth" It

Given the fact that Berkshire Hathaway is one of a select few companies that is currently increasing its book value, Bill Mann was somewhat surprised to see Worth issue an obituary on the type of investing Berkshire Chairman Warren Buffett espouses. Turns out Worth's author doesn't seem to know exactly what Buffett believes in. In this space, Mann sets the record straight.

By Bill Mann (TMF Otter)
August 22, 2001

Adam Hanft wrote an interesting piece for Worth's September edition titled "Mr. Buffett,Your Time Is Up" -- interesting in the same way a traffic accident is interesting. In the article, Hanft suggests that buy-and-hold investing, and the "religion" dedicated to it, is a
complete anachronism. As his poster child for the buy-and-hold movement, Hanft holds up Warren Buffett, chairman of Berkshire Hathaway (NYSE: BRK.A), and a long-time proponent of the benefits of getting rich slow.

I'll resist the easiest of retorts to anyone who criticizes Warren Buffett. There is little room for snide "And you are?" responses to someone who has made so paltry a contribution to the investing public as has he because, let's face it, that's most of us. And I am certain that
Buffett does not mind being questioned. In fact, I'm sure he appreciates any challenge to his intellect -- which Hanft's article certainly wasn't. Rather, it was a challenge to the basic laws of common sense and rhetoric, a feeble parry at the dandelion patch lying some yards in front of the lower ramparts of the fortress named "What Makes Sense In Investing."

This is not to say that Hanft's premise is completely off-base. He believes, not incorrectly, that there is no such thing as a static law in investing. Things change, and given the speed of the flow of information, it makes more sense than ever for investors to constantly challenge things that are taken as "truth." There are, for example, many portfolios built in the end of the 1990s based on the idea that "old economy" companies could not compete in the Internet era.

This idea, however, turned out to be dead wrong. Note, as illustration, my article Monday extolling the e-commerce strategy of specialty chemicals producer Sigma-Aldrich (Nasdaq: SIAL), which by this time was supposed to be completely overrun by newcomers like Ventro (Nasdaq: VNTR). It didn't happen, and Ventro and its ilk are on the way to the trash heap of irrelevance, which sits right out back from the Temple of Hubris.

I think Hanft has been to this particular temple, which gave him the gumption to take a swing at the greatest investor of all time. That said, his takeaway -- that we should seek to embrace "right-term" investing -- is solid. Warren Buffett would likely agree: His average
holding time for a stock is a little more than four years. Buffett sells when it comes time to sell. The Motley Fool has also espoused this notion: Paul Commins calls it "business-focused" investing.

"A" for Effort, "F" for execution
But the path Hanft uses to get to this point is on the wrong side of moronic. He wheels out the tired fact that people who invested at the height of the last real stock market bubble, in the late 1960s, had to wait more than 20 years before they got back to even. This is a historical reality, but Hanft fails to point out a strategy that could have been identified before this long lull and would have bettered these results. Joseph Granville, the most famous technical analyst of that time period, crashed and burned. Those who bought the "Nifty 50" in the 1960s, meanwhile, and held them through today have whipped all the major market indices -- thus proving that conveniently crafted examples are nothing but a double-edged sword.

Unfortunately, there is more where that came from. Hanft's opening premise is that buy-and-hold is conventional wisdom, yet he then goes on to say that "the experts" bailed out on long-term holding long ago, and that we inhabit a culture of impatience, as noted by the fact that our speed addiction has changed the way we invest. So the experts don't use
it, and individuals don't use it, and yet buy-and-hold is conventional wisdom? I don't think these two "facts" are mutually supporting.

Besides, what these two items actually say is that fund managers generally cannot focus on the long term because they are graded too closely on short-term results. Graded by whom? That's right, individual investors.

Hanft uses ten bullets to try to prove his point. Here, I'll use a few bullets for counterpoints, and to try to give a framework for how investors should think about the companies they hold.

1. Change is inevitable. Best to invest where you can reasonably anticipate it.
My favorite part of Hanft's argument was that change increases risk, that certain technology companies -- most notably Intel (Nasdaq: INTC) -- are hard put to maintain their edge in view of other companies' assault upon the leadership position. Newsflash,Hanft: Buffett agrees with you, which is why he doesn't buy companies when he isn't comfortable predicting what they will look like in a decade.

Buffett looks for simple businesses, ones that don't need to change much to maintain their leads. In many cases, these companies need not even grow: They must only return significantly more capital than is invested in them. Rather than say too many people believe this, I'd suggest there are too few. Almost from the moment it came public, Lucent (NYSE:LU) was destroying capital by returning negative cash flow. When its stock finally blew up, Lucent was held by more institutions and more individuals than any other stock in America.
The vast majority of these people thought the changes coming in telecommunications would benefit Lucent, and therefore themselves, but most had little ground upon which to make this assumption.

2. Ruthlessly analyze changes when they appear.
Hanft was dead on about this next point: Make sure the company you hold is the one you bought. Markets change, and so do companies. This is nothing new or controversial. Berkshire Hathaway recently sold all of its long-time holdings in mortgage funding companies Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) because Buffett perceived that their assets had become too risky. Buffett held these positions for a long time, but unloaded when he was no longer comfortable with what they were doing.

3. Don't invest with money you need.
Hanft points out that people no longer have a linear lifestyle. You may need some money to start a business when you are 35. That money -- ANY money you need in a period of two years or so -- should not be in the market in the first place. That's not an indictment of buy-and-hold. That's an indictment of poor common sense.

4. Find companies with barriers to entry.
Big money comes easier to unestablished companies now than at any time in modern history. These resources are deployed in order to create a market for that company.
Again, this is why Buffett shuns technology. (Funny how Hanft keeps bringing up technological innovation as a rejoinder to Warren Buffett, eh?) But how much money is it going to take for a company to unseat a Tiffany & Co. (NYSE: TIF)? How about, at this point, eBay (Nasdaq: EBAY)? These are companies that are literally going to have to give their leads away.

And leadership does not equal a barrier to entry. A culture of leadership, yes. Individuals, no. Buffett knows this all too well. The man who ran GEICO for him, Jack Byrne, left several years ago to pursue his own thing at a small insurance holding company called White Mountains (NYSE: WTM). GEICO has not suffered appreciably for Byrne's
departure because his replacement was well-groomed. A company that lacks this culture is not a good candidate for a long-term holding.

I'm not sure what Hanft's article was meant to achieve. It could have been so much more. Perhaps he didn't come up with the title -- these things aren't always left to the author. If the goal was to gain readership and score advertising revenues, I'm sure calling Warren Buffett to the carpet will be a major success. To my mind, however, this will come at the expense of credibility, because Hanft chose a poor target and made weak arguments.

Berkshire Hathaway added on 6.5% in book value in 2000, a full 15% better than the S&P 500, and 50% better than the Nasdaq. Of the companies listed in this article, only White Mountains did better. If Buffett's time is really up, he's sure enjoying his victory lap, using the same business-centric approach he always has.

Fool on!

Bill Mann, TMFOtter on the Fool Discussion Boards
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