Unconventional Investment Strategies of Warren Buffett: Beyond Market Trends and MPT
Warren Buffett, one of the most successful investors in the world, has always stood out from the crowd with his unique investment strategies. While mainstream investing has largely been dominated by the tenets of Modern Portfolio Theory (MPT), Buffett and his partner Charlie Munger have never been conventional - to the chagrin of some, perhaps.
Conventional Investing vs. Buffett’s Approach
By the 1970s, the United States saw the rise of conventional investing as epitomized by the Modern Portfolio Theory (MPT). This framework emphasizes the importance of diversification and utilizes metrics such as Beta to assess risk. However, this approach has criticisms, with the Duals (Buffett and Munger) openly denouncing it, terming it total junk.
A Different Definition of Risk
While conventional investing views Beta as a measure of risk, the Duals see risk in a much more tangible, industrial sense. For example, the risk faced by a railroad owner in the past century might have stemmed from concerns such as the competition from the emerging trucking industry or the potential spike in energy costs. These are risks that directly impact the business, similar to the risks Buffett assesses today.
The Noah’s Ark Approach and Unconventional Mass Diversification
Conventional investing often follows the “Noah’s Ark” approach: investing in a wide range of assets to ensure that no single investment can sink the entire portfolio. However, for the Duals, such a strategy is a sign of ignorance. They argue that for professionals, mass diversification is for those who “know next to nothing.”
Instead of spreading investments across hundreds of stocks, Berkshire Hathaway (BRK) is highly concentrated in a few quality companies. As of 31 December 2020, four major companies - Apple, Coca-Cola, American Express, and Bank of America - accounted for nearly 80% of Berkshire’s stock holdings, valued at around $192 billion.
Banking as a Focus Area
Buffett's expertise in banking is particularly noteworthy. For decades, he has been a significant investor in banks, a sector that other investors often shy away from. During the 2011-12 period, Buffett’s assessment of Bank of America (BAC) was that it could deliver a 400% gain over six years, a far cry from conventional wisdom at the time.
The key to Buffett's reasoning lies in understanding the fundamentals of the business, rather than relying on short-term fluctuations. Traditional Wall Street, influenced by MPT, failed to recognize the long-term value of Bank of America, which did not materially grow its assets during that period. Buffett recognized that Wall Street’s understanding of risk was flawed, arguing that economic reality – not market volatility – is the true determinant of value.
Revisiting Earnings and the Buffett Approach
Conventional investing often relies on Price/Earnings (P/E) ratios and Earnings Per Share (EPS), which can be manipulated by companies. Buffett, on the contrary, prefers to discuss earnings yield, recognizing that asset prices are influenced by interest rates rather than earnings alone. This approach ensures that he focuses on the intrinsic value of a business rather than its market perception.
This method requires investors to be true students of business, not finance. While conventional investing often sees stock picking as a lottery, the Buffett approach is decidedly unconventional but has been highly successful. It emphasizes patience, long-term thinking, and a deep understanding of the business fundamentals, leading to sustained growth and profits.
Conclusion
The unconventional strategies employed by Warren Buffett and Charlie Munger have proven to be highly effective over the years. By questioning the conventional wisdom of Modern Portfolio Theory and focusing on the tangible risks and fundamentals of businesses, they have built an empire that continues to thrive. This unique approach to investing not only sets them apart from the crowd but also offers a valuable lesson to aspiring investors willing to think outside the box.