Buffett’s Book Pick Guides Fuss to Marks Beating Market
Warren Buffett, in his annual letter to shareholders of Berkshire Hathaway Inc. (BRK/A) last week, said the best investment he ever made was buying a copy of “The Intelligent Investor” by Benjamin Graham.
The billionaire isn’t the only prominent investor who considers the 1949 book money well spent. Daniel Fuss of Loomis Sayles & Co., Oaktree Capital Group LLC’s Howard Marks and David Herro of Harris Associates LP credit the text with shaping their thinking about how markets work and what it takes to succeed.
Graham’s follow-up to 1934’s “Security Analysis” introduced the world to “Mr. Market,” a manic-depressive whose mood can swing between extremes of optimism and pessimism. The job of the investor, in Graham’s view, was to figure out independently what a business is worth, buying when the market offers bargains and selling when prices no longer make sense. It’s a formula his followers say still holds true.
“I picked up some good habits from that book,” Fuss, 80, manager of the $22.7 billion Loomis Sayles Bond Fund, said in a telephone interview from Boston. “I learned that when the world doesn’t like a security but you see its underlying value, you should buy it. It’s that simple.”
“The Intelligent Investor” repeated many of the prior work’s arguments in a smaller volume aimed at a broader audience. Buffett read the book in 1949 before studying under Graham at Columbia and working for his investment firm.
The book paints the investing herd as fickle. Sometimes Mr. Market’s idea of value appears reasonable, Graham wrote. “Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him and the value he proposes seems to you a little short of silly.”
Marks, 67, head of the world’s largest distressed debt investment firm, absorbed the lesson that the time to sell is when the crowd is exuberant and the time to buy is when it’s discouraged.
“That’s behavioral investing and I don’t know of any other example of behavioral investing before that,” Marks, who helped start Los Angeles-based Oaktree (OAK) in 1995, said in a telephone interview.
Graham’s books laid out a method for evaluating stocks and bonds, establishing what he called the “intrinsic value” of a security. Investors needed to build a “margin of safety” into their calculations to provide a measure of protection in the event that markets or the economy turned down, he said.
Seth Klarman, founder of Baupost Group LLC, a Boston-based hedge-fund firm, wrote the 1991 book “Margin of Safety” that is sometimes viewed as a modern-day companion to Graham’s works. Klarman, 56, whose oldest fund averaged annual gains of 18 percent over the past three decades, was also the editor of the sixth edition of “Security Analysis,” published in 2008.
Some of Graham’s statistical tools can seem “primitive” by today’s standards, which doesn’t stop his key message from staying relevant, said fund manager William Miller of Baltimore-based Legg Mason Inc.
“Graham said you should buy stocks the way you buy groceries, not the way you buy perfume,” said Miller, 64, who is best known for beating the Standard & Poor’s 500 Index in his Legg Mason Capital Management Value Trust (LMVTX) for a record 15 straight years through 2005.
“That crystallized it for me,” he said by phone. “It made it intellectually and emotionally real.”
Herro, 53, said he had a similar reaction when he first read “The Intelligent Investor” in 1986. Herro, who earned a master’s in economics from the University of Wisconsin-Milwaukee before being hired to buy international stocks for an Iowa insurer that became Des Moines-based Principal Financial Group Inc., recalled how clearly Graham’s message resonated.
Rather than play the markets, the book advised, investors needed to determine value and buy at a discount, said Herro, who in 2010 was named international stock-fund manager of the decade by Morningstar Inc.
“Graham said, ‘Let the market give you what it gives you,’” Herro, chief investment officer of Chicago-based Harris, recalled in a phone interview.
Fuss, who read “The Intelligent Investor” about 50 years ago, said it helped sort out his thinking about buying stocks and bonds. His Loomis Sayles Bond Fund (LSBDX) invests in a range of assets and beat 98 percent of peers over the past five years, according to data compiled by Bloomberg.
In the 1960s, the book’s philosophy helped steer Fuss toward bonds secured by railroad equipment. The securities would drop in price when railroads failed, which happened frequently in that era, he said.
“At that point you could get the bonds really, really cheap,” Fuss said.
Reasoning that in a growing economy the equipment would retain its value, Fuss profited when the bond prices eventually recovered.
John C. Bogle, founder of Valley Forge, Pennsylvania-based Vanguard Group Inc., described Graham’s 1949 book as “the wisdom of the ages.”
“It’s eternal common sense,” Bogle, who wrote the forward to a 2005 edition of “The Intelligent Investor,” said in a telephone interview. “Graham looked at investing as a business, not speculating on stocks.”
Graham’s view clashes with those who believe in the efficient-market hypothesis, the notion that the prices of publicly traded securities reflect all available information. Eugene F. Fama, a University of Chicago professor, shared last year’s Nobel Prize in economics for research asserting that because markets are efficient, trying to beat them is an exercise in futility.
Trying to outperform the market is a zero-sum game with as many losers as winners, said John Cochrane, a colleague of Fama at the Booth School of Business.
“To play it you must believe the other players are morons,” Cochrane wrote in an e-mail. “And they believe you are a moron. Half are deluded.”
Even fans of Graham’s book point to shortcomings. Graham’s analysis of securities rested heavily on the value of a company’s assets, said Donald Yacktman, president of Austin, Texas-based Yacktman Asset Management Co. Graham didn’t give much weight to future cash flows, nor did he focus much on the quality of the businesses he bought, according to Yacktman.
Buffett, said Yacktman, married Graham’s analysis with an emphasis on high-quality businesses, buying stocks such as Atlanta-based Coca-Cola Co. (KO) and San Francisco-based Wells Fargo & Co. (WFC) and holding them for years.
“You can go back and study,” Yacktman, 72, said in a telephone interview from Austin, Texas, “but in the end you have to stand on your own two feet in this business.” The $11.5 billion Yacktman Focused Fund (YAFFX) beat 85 percent of rivals over the past five years, according to data compiled by Bloomberg.
Buffett, Graham’s best-known disciple, has controlled Omaha, Nebraska-based Berkshire since 1965, compounding its book value at almost 20 percent a year, about twice the rate of return on the Standard & Poor’s 500 Index. Book value, a measure Buffett highlights, gauges a company’s net worth.
In his letter posted online March 1, the 83-year-old praised the logic and clarity of “The Intelligent Investor,” and said it changed his financial life. As Buffett wrote, “Of all the investments I ever made, buying Ben’s book was the best (except for my purchase of two marriage licenses).”
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