Warren Buffett is set to win this US$500,000 wager

Background on Warren Buffett’s US$500,000 wager: Warren Buffett said in  Berkshire’s 2005 annual report that  active investment management by professionals – in aggregate – would over a period of years underperform the returns achieved by rank amateurs who simply sat still.

Recalling his argument, he said in his FY2016 letter to Berkshire Hathaway shareholders: “I explained that the massive fees levied by a variety of “helpers” would leave their clients – again in aggregate – worse off than if the amateurs simply invested in an unmanaged low-cost index fund. ..

“Subsequently, I publicly offered to wager $500,000 that no investment pro could select a set of at least five hedge funds – wildly-popular and high-fee investing vehicles – that would over an extended period match the performance of an unmanaged S&P-500 index fund charging only token fees. I suggested a ten-year bet and named a low-cost Vanguard S&P fund as my contender. I then sat back and waited expectantly for a parade of fund managers – who could include their own fund as one of the five – to come forth and defend their occupation. After all, these managers urged others to bet billions on their abilities. Why should they fear putting a little of their own money on the line?
Mr Buffett went on to say: “What followed was the sound of silence. Though there are thousands of professional investment managers who have amassed staggering fortunes by touting their stock-selecting prowess, only one man – Ted Seides – stepped up to my challenge. Ted was a co-manager of Protégé Partners, an asset manager that had raised money from limited partners to form a fund-of-funds – in other words, a fund that invests in multiple hedge funds.

“I hadn’t known Ted before our wager, but I like him and admire his willingness to put his money where his mouth was. He has been both straight-forward with me and meticulous in supplying all the data that both he and I have needed to monitor the bet.

“For Protégé Partners’ side of our ten-year bet, Ted picked five funds-of-funds whose results were to be averaged and compared against my Vanguard S&P index fund. The five he selected had invested their money in more than 100 hedge funds, which meant that the overall performance of the funds-of-funds would not be distorted by the good or poor results of a single manager.
Each fund-of-funds, of course, operated with a layer of fees that sat above the fees charged by the hedge funds in which it had invested. In this doubling-up arrangement, the larger fees were levied by the underlying hedge funds; each of the fund-of-funds imposed an additional fee for its presumed skills in selecting hedge-fund managers.
“Here are the results for the first nine years of the bet – figures leaving no doubt that Girls Inc. of Omaha, the charitable beneficiary I designated to get any bet winnings I earned, will be the organization eagerly opening the mail next January.
“The compounded annual increase to date for the index fund is 7.1%, which is a return that could easily prove typical for the stock market over time. That’s an important fact: A particularly weak nine years for the market over the lifetime of this bet would have probably helped the relative performance of the hedge funds, because many hold large “short” positions. Conversely, nine years of exceptionally high returns from stocks would have provided a tailwind for index funds.

“Instead we operated in what I would call a “neutral” environment. In it, the five funds-of-funds delivered, through 2016, an average of only 2.2%, compounded annually. That means $1 million invested in those funds would have gained $220,000. The index fund would meanwhile have gained $854,000….”

Mr Buffett summed it up this way: “So that was my argument – and now let me put it into a simple equation. If Group A (active investors) and Group B (do-nothing investors) comprise the total investing universe, and B is destined to achieve average results before costs, so, too, must A. Whichever group has the lower costs will win…”

” The problem simply is that the great majority of managers who attempt to over-perform will fail. The probability is also very high that the person soliciting your funds will not be the exception who does well. Bill Ruane – a truly wonderful human being and a man whom I identified 60 years ago as almost certain to deliver superior investment returns over the long haul – said it well: “In investment management, the progression is from the innovators to the imitators to the swarming incompetents”,” Mr Buffett said.

Mr Buffett’s bottom line: When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients. Both large and small investors should stick with low-cost index funds.

Warren Buffett graces Cherry Coke cans

“It should come as no surprise that iconic investor Warren Buffett is one of the world’s best-known fans of Cherry Coca-Cola. At almost every public appearance for a generation, Buffett has been seen taking a swig of his favorite drink,” says a March 31, 2017 article (Chinese Consumers Do a Double-Take as Warren Buffett Graces Cherry Coke Cans) on the Coca-Cola website.

“What may come as a surprise is that Buffett’s likeness is gracing the front of Cherry Coke cans in China to promote the drink’s official Chinese launch.” said the article.

The article reminds one of Warren Buffett’s love for the Coke company. Berkshire Hathaway, of which Warren Buffett is the chairman, has a stake of 9.3 per cent in The Coca-Cola Company based on the FY2016 letter which Warren Buffett sent to Berkshire Hathaway shareholders.

An April 24, 2013 article ( ‘I Like to Bet on Sure Things’: Warren Buffett On Why He’ll Never Sell a Share of Coke Stock ) on the Coca-Cola website quoted Warren Buffett on why KO (Coca-Cola Company) will always have a “Buy” rating in his book.

“I’m the kind of guy who likes to bet on sure things,” said Buffett, who served on Coke’s board of directors for 17 years. “No business has ever failed with happy customers… and you’re selling happiness,” said Warren Buffett.

“I like wonderful brands,” he added. “If you take care of a great brand, it’s forever.”

Philip Fisher’s five more don’ts for investors

1. Don’t overstress diversification
Investors have been so oversold on diversification that fear of having too many eggs in one basket has caused them to put far too little into companies they thoroughly know and far too much in others about which they know nothing at all. “It never seems to occur to them, and much less to their advisors, that buying a company without having sufficient knowledge of it may be even more dangerous than having inadequate diversification.
2. Don’t be afraid of buying on a war scare
War is always bearish on money. To sell stock at the threatened or actual outbreak of hostilities so as to get into cash is extreme financial lunacy. Actually just the opposite should be done. If an investor as about decided to buy a particular common stock and the arrival of a full-blown war scare starts knocking down the price, he should ignore the scare psychology of the moment and definitely begin buying. This is the time when having surplus cash for investment becomes least, not most, desirable…If war actually breaks out, the price would undoubtedly go still lower, perhaps a lot lower. Therefore the thing to do is to buy but buy slowly and at a scale down on just a threat of war. If war occurs, then increase the tempo of buying significantly. Just be sure to buy into companies with products or services the demand for which will continue in wartime, or which can convert their facilities to wartime operations.
3. Don’t forget your Gilbert and Sullivan
Gilbert and Sullivan are hardly considered authorities on the stock market. Nevertheless, we might keep in mind their “flowers that bloom in the spring, tra-la” which, they tell us, have “nothing to do with the case”.
Don’t be influenced by what doesn’t matter, says Philip Fisher. For some reason, the first thing that many investors want to see when they are considering buying a particular stock is a table giving the highest and lowest price at which the stock has sold in each of the past five or ten years. They go through a sort of mental mumbo-jumbo, and come up with a nice round figure which is the price they are willing to pay for the particular stock.
“Is this illogical? Is it financially dangerous?” asks Philip Fisher. His answer to both is an emphatic yes. It is dangerous because it puts the emphasis on what does not particularly matter, and diverts attention from what does matter. Another example is that many investors will give heavy weight to the per-share earnings of the past four or five years in trying to decide whether a stock should be bought. What counts is knowledge of background conditions. An understanding of what probably will happen over the next several years is of overriding importance.
4. Don’t fail to consider time as well as price in buying a true growth stock
5. Don’t follow the crowd

Five don’ts for Investors: Philip Fisher

Common Stocks and Uncommon Profits by Philip Fisher lists five don’ts for investors
1. Don’t buy into promotional companies
All too often, young promotional companies are dominated by one or two individuals who have great talent for certain phases of business procedure but are lacking in other equally essential talents. They may be superb salesmen but lack other types of business ability. More often they are inventors or production men, totally unaware that even the best products need skillful marketing as well as manufacture.
Their financing should be left to specialised groups. Ordinary individual investors should make it a rule never to buy into a promotional enterprise no matter how attractive it may appear to be.

2. Don’t ignore a good stock just because it is traded “over the counter”.
From the standpoint of marketability, a well-known, actively-traded stock on the New York Stock Exchange has advantage over the better over-the-counter stocks. But the better of the over-the-counter stocks are frequently more liquid than the shares of many of the companies listed on the American Stock Exchange and the various regional stock exchanges. “In short, so far as over-the-counter securities are concerned, the rules for the investor are not too different from those for listed securities. First, be very sure that you have picked the right security. Then be very sure that you have selected an able and conscientious broker. If an investor is on sound ground on both these respects, he need have no fear of purchasing stock just because it is traded ‘over the counter’ rather than on the exchange.”

3. Don’t just buy a stock because you like the “tone” of the annual report
Allowing the general wording and tone of an annual report to influence a decision to purchase a common stock is much like buying a product because of an appealing advertisement on the billboard.

4. Don’t assume that the high price at which a stock may be selling in relation to earnings is necessarily an indication that further growth in those earnings has largely been already discounted in the price

Philip Fisher uses a fictitious company XYZ to highlight a costly error in investment reasoning. XYZ has qualified magnificiently for years in regard to Philip Fisher’s 15 points (Philip Fisher’s “Fifteen Points to Look for in a Common Stock”)). The stock has sold for years from 20 to 30 times current earnings as the financial community appreciated XYZ’s excellence in terms of constant growth in sales and profits. This is nearly twice as much for each dollar earned as the sale price of the average stock that has made up, say, the Dow Jones Industrial Averages.
Now XYZ has just issued a forecast indicating it expects to double earnings in the next five years. On this basis, some investors jump to the false conclusions that since XYZ is selling twice as high as stocks in general and since it will take five years for XYZ’s earnings to double, the present price of XYZ is discounting future earnings ahead and is therefore overpriced. The fallacy in the reasoning here lies in the assumption that five years from now XYX will be selling on the same price-earnings ratio as will the average Dow Jones stock.
If XYZ continues its same policies, five years from now its management will bring out still another group of new products that will swell earnings. If this happens, why shouldn’t this stock sell five years from now for twice the price-earnings ratio of the more ordinary stocks as it is doing for now and has done for many years past? This is why some of the stocks that at first glance appear highest priced may upon analysis, be the biggest bargain, said Philip Fisher.

5. Don’t quibble over eights and quarters
Here Philip Fisher uses a real example. A gentleman who has demonstrated a high order of investment ability wanted to buy 100 shares of a stock that was trading at 35.5. He put his order in at 35 as he wanted to save fifty dollars. The stock never sold again at 35. Twenty-five years later, it was selling at over 500. In an attempt to save fifty dollars, the investor failed to make at least $46,500.

Philip Fisher’s scuttlebutt method

For a man like Berkshire Hathaway chairman Warren Buffett who doesn’t personally own an iPhone, one wonders why he more than doubled Berkshire Hathaway’s holdings in Apple to about 2.5 per cent in January 2017. At that point, Mr Buffett owned US$17 billion worth of the tech giant’s stock

In a CNBC report on 27 February 2017 titled “Billionaire Warren Buffett more than doubled his holdings in Apple in 2017”, Mr Buffett, when asked why he raised the stake in Apple, was quoted as saying “because I liked it”. The legendary investor cited Apple’s
consumer-retaining power and CEO Tim Cook’s smart capital deployment strategy.

“Apple strikes me as having quite a sticky product, and an enormously useful product to people that use it,” Buffett said.

What was interesting is that Mr Buffett went on to say that the late investor Philip Fisher’s 1958 book “Common Stocks and Uncommon Profits” had inspired him to research how consumers felt about Apple products.
Mr Fisher talked about something called the “scuttlebutt method“, Mr Buffett said, adding that this method “made a big impression on me at the time, and I used it a lot”.

The “scuttlebutt method”, said Mr Buffett, is essentially going out and finding out as much as you can about how people feel about the products that they use.

Let’s look further into who Philip Fisher was and what his “scuttlebutt method” was all about.

American stock investor Philip Arthur Fisher (September 8, 1907 – March 11, 2004) was best known as the author of the investment guide book known as  Common Stocks and Uncommon Profits. The book has the reputation of staying in print since it  first published in 1958.

Phillip Fisher was referred to by Mr Buffett as “a respected investor and author” in a  letter to Berkshire Hathaway shareholders. Among his best-known  followers is Mr Buffett  who reportedly has said on some occasions that “he is 85% (Benjamin) Graham and 15% (Philip) Fisher”. Benjamin Graham (May 8, 1894 – September 21, 1976) is the father of value investing and Mr Buffett is his best known student.

Back to the “scuttlebutt method”, which provides clues that are needed to find really outstanding investments. Philip Fished said he called it “scuttlebutt method” for lack of a better term.

“The business ‘grapevine’ is a remarkable thing,” said Philip Fisher. “It is amazing what an accurate picture of the relative points of strength and weakness of each company in an industry can be obtained from a representative cross-section of the opinions of those who in one way or another are concerned with any particular company.”

“Most people, particularly if they feel sure there is no danger of their being quoted, like to talk about the field of work in which they are engaged and will talk rather freely about their competitors. Go to five companies in an industry, ask each of them intelligent questions about the points of strength and weakness of the other four, and nine times out of ten a surprisingly detailed and accurate picture of all five will emerge,” said Mr Fisher.

According to Philip Fisher, competitors are only one and not necessarily the best source of informed opinion. Much also can be learned from both vendors and customers about the real nature of the people with whom they deal. Research scientists in universities, in government and in competitive companies are another fertile source of worthwhile data. So are executives of trade associations, according to Philip Fisher.

“The next step is to contact the officers of the company to try and fill out some of the gaps still existing in the investor’s picture of the situation being studied,” said Mr Fisher.

Benjamin Graham on dollar-cost averaging

In Chapter 5 (The Defensive Investor and Common Stocks) of The Intelligent Investor, Benjamin Graham, the father of value investing, touched on various aspects of defensive investment, among which was dollar-cost averaging, an application of a “formula investment”.

Elaborating, he said: “The New York Stock Exchange has put considerable effort into popularizing its ‘monthly purchase plan’, under which an investor devotes the same dollar amount each month to buying one or more common stocks.”

“During the predominantly rising-market experience since 1949 the results from such a procedure were certain to be highly satisfactory, especially since they prevented the practitioner from concentrating his buying at the wrong times,” added Benjamin Graham.

The father of value investing cited a comprehensive study of formula investment plans in which the author Lucile Tomlinson presented a calculation of the results of dollar-cost averaging in the group of stocks making up the Dow Jones industrial index. The average indicated profit at the end of 23 ten-year buying periods was 21.5 per cent, exclusive of dividends received. There were of course some instances of a substantial temporary depreciation at market value.

The author of the study said: “No one has yet discovered any other formula for investing which can be used with so much confidence of ultimate success, regardless of what may happen to security prices, as Dollar Cost Averaging.”


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