Billionaire investor and businessman Warren Buffett has built an enviable investment record through his management of Berkshire Hathaway Inc. From 1965, when he took over the publicly traded company, through late September the stock grew from $18 a share to $75,700, an increase of 4,204%. That is equivalent to an annualized growth rate of almost 25% per year, well in excess of the stock market’s return of about 10% per year, as measured by the Standard & Poor’s 500 Stock Index.
In hindsight, someone who bought Berkshire Hathaway in 1965 and held it appears to be an investing genius. Although a handful of investors did just that, investors as a whole did not, notes Meir Statman, Finance Professor at Santa Clara University, and Jonathan Scheid, an analyst for Assante Asset Management in San Jose, CA. Hindsight, when applied to investing, is a dangerous and misleading exercise, and Berkshire Hathaway’s performance vs. that of most investors is a good example, the two argue in an academic paper written in 2001.
They note that Buffett himself has warned of the dangers of hindsight. In early 1966 the Dow Jones Industrial Average passed 1,000 for the first time but then fell back later that year. A few people called Buffett to warn him that it might fall further. Here was his reaction: “(1) if they knew in February that the Dow was going to 865 in May, why didn’t they let me in on it then; and (2) if they didn’t know what was going to happen during the ensuing three months back in February, how do they know in May?”
Statman and Scheid computed the “value-in-hindsight” price of Berkshire Hathaway in 1965, based on its actual price of $71,000 in 2000. An investor who could predict that Berkshire would beat the S&P 500 by such a large margin would have paid up to $1,383 per share in 1965. Investors should have realized that the $18 share price was a huge bargain.
So why does Buffett beat the market but the majority of investors do not? Theory and data show that insiders and entrepreneurs regularly beat the market, Statman and Scheid write. Insiders have access to unique information that gives them competitive advantages. Entrepreneurs have access to unique opportunities that earn returns well in excess of costs.
“Buffett is an extraordinarily skilled entrepreneur,” they note. “But the fact that Buffett beats the real market does not imply that today’s buyers or sellers of Berkshire Hathaway shares can expect to beat the stock market… We might find out, ten years from today, that $71,000 (in 2001) was a bargain price for Berkshire Hathaway shares. Or that it was a bubble price. But hindsight is not foresight.”
