This post will profile three legendary investors, John Burr Williams, John Bogle and Warren Buffett. I will examine their respective approaches to investing.
John Burr Williams
John Burr Williams (1899-1989) was one of the first economists to change the traditional “casino” view of market pricing, instead he argued that markets determine stock prices from their “intrinsic value”. In his 1938 paper, The Theory of Investment Value, he wrote:
“The investment value of a stock is the present worth of all future dividends to be paid upon it . . . discounted at the pure [riskless] interest rate demanded by the investor.” (Donaldson, 2007)
Essentially Williams proposed that the present value of a stock is equivalent to the long-term worth of future net cash flows. Alternatively, one could say that the present value of a stock is the discounted value of future earnings. Whilst it is generally agreed that Williams did not pioneer present value, he was, however the first to develop a method to calculate it with the dividend discount model (or DDM).
The use of present worth in conjunction with portfolio theory is the most widely used stock valuation method used today.
John Burr Williams believed that the volatility of the stock market is not due to variations of intrinsic value but speculation. Whilst Williams was opposed to speculations he did caution against it as a long term investment strategy as stated below.
“To gain by speculation, a speculator must be able to foresee price changes. Since price changes coincide with changes of marginal opinion, he must, in the last analysis, be able to foresee changes in opinion. Successful speculation consists in just this. It requires no knowledge of intrinsic value as such, but only what people are going to believe intrinsic value to be” (Donaldson, 2007)
As a footnote, William’s anticipated the Modigliani Miller theorem by stating that a company’s capitalization does not influence the present value of a stock since it is derived solely from future dividends.
John Bogle
John Bogle (1929-) is the retired CEO of The Vanguard Group, a company he founded in 1974. The Vanguard Group is the second largest mutual fund company in the world and it was the first company to offer an indexed mutual fund.
Bogle is a staunch believer in indexed mutual funds over actively managed mutual funds and believes that indexed funds offer superior returns over the long term.
Bogle believes in a simple and common sense investment approach that includes the following eight tenants.
- Select low-cost funds
- Consider carefully the added costs of advice
- Do not overrate past fund performance
- Use past performance to determine consistency and risk
- Beware of stars (as in, star mutual fund managers)
- Beware of asset size
- Don’t own too many funds
- Buy your fund portfolio – and hold it
(Bogle, 2009)
During Bogle’s undergraduate studies at Princeton he found that three quarters of mutual funds underperformed a hypothetical market portfolio. Essentially the premium earned from an actively managed fund was insufficient to cover the cost of the fund management.
Bogle retired as chairman of Vanguard in 1999. Today the group manages approximately $1,300,000,000,000 in assets.
Warren Buffett
Warren Buffett (1930-) is an American icon. Buffet is a businessman, philanthropist and most important, a very successful investor.
With the recent economic downturn, Buffett relinquished his position as the world’s richest person to his good friend Bill Gates. Buffett’s personal wealth is currently a staggering $37 billion.
Buffett is known for his frugal lifestyle and also his vehement adherence to value investment philosophy. His investment approach is influenced by his mentor, former teacher and employer, Ben Graham. Graham advocated a cautious approach to investing, preferring stocks that are priced significantly below their intrinsic values.
In 1956, when Graham retired, Buffett moved back to his home town of Omaha Nebraska and started Buffett Partnership Ltd, an investment partnership. By 1962, Buffett was a millionaire and began purchasing stock of a textile company called Berkshire Hathaway. He bought shares worth between $8 and $15 even though the working capital of Berkshire Hathaway exceeded $20 per share. In 1969, Buffett liquidated the partnership but continued as chairman of Berkshire Hathaway.
Shares of Berkshire Hathaway began trading in 1979 for $775. These shares have increases quite significantly even considering their recent drop as reported by the New York Times.
“Mr. Buffett’s company, Berkshire Hathaway, reported a 62 percent drop in net income for 2008 and posted a decline in book value per share for only the second time since he took control in 1965. Shares of the company, which peaked in late 2007 at more than $148,000 apiece, closed Friday at $78,600.” (Segal, 2009)
Contributing to this loss was Berkshire Hathaway investment in preferred stock of Goldman Sachs and General Electric. Both stocks have experienced consider declines in stock value. This and other losses forced the SEC recently to demand increased disclosure of the valuation of contracts.
It has been suggested that Berkshire Hathaway intentionally perpetuates a “Warren Buffett myth”. The myth, it is suggested, is a self-fulfilling prophesy as other investors mirror Buffets investments.
Berkshire Hathaway shares currently sell for $84,574 (as of 3/20/2009) making them the highest priced shares on the New York Stock Exchange. The exorbitant price is due to Buffet’s refusal to split the stock as a deterrent for short-term investors. Despite the sky-high price, Berkshire Hathaway’s stock has yet to be included in the S&P500.
Ben Graham pioneered the value investing approach of purchasing stock below their intrinsic value. Graham called this discount from a stocks market price to its intrinsic value, “margin of safety”. Warren Buffett…
“…has taken the value investing concept even further as his thinking has evolved to where for the last 25 years or so his focus has been on "finding an outstanding company at a sensible price" rather than generic companies at a bargain price.” (Value Investing, 2009)
Comparing legends
John Burr Williams is essentially a value investor. Not only did Williams pioneer the theory of value investing but he formally expressed the theory of discounted cash flow in his 1928 text, The Theory of Investment Value. Williams also recognized the effect of speculation and cautioned against its unpredictability.
John Bogle was no less of a pioneer. Bogle was able to prove that an investor was better off investing his/her funds in a market index portfolio than most mutual funds. Bogle consequently established no-load market index mutual fund that out performed most of his competitors.
Warren Buffett is the current undisputed king of investors. Being the second richest person in the world is testament to this fact. Like Williams, Buffet is a value investor. However unlike Williams, Buffet was able to benefit from a rewarding mentorship and research in the field of investment theory. Research in the 1960’s included the capital asset pricing model (or CAPM). CAPM can be used to calculate the expected return on an individual asset in a portfolio which in turn can be used to calculate the discounted or “intrinsic” value. Warren Buffet is unquestionably the master of calculating the intrinsic value of assets.
Conclusions
Both Williams and Buffett can be considered value investors. Essentially they believe the market to be inefficient and are banking on the fact that the market has not fully realized the future cash flow of a particular stock. It is undeniable that value investing is a successful investment approach.
Numerous academics have published studies investigating the effects of buying value stocks. These studies have consistently found that value stocks outperform growth stocks and the market as a whole. (Value Investing, 2009)
Having said that consider the following quote from Warren Buffet.
“Growth and Value Investing are joined at the hip” (Growth Investing, 2009).
This statement suggests that Buffet believes that the differences between growth and value stock are trivial.
References
- Donaldson G, 2007, Donaldson Capital: Rising Dividend Investing: John Burr Williams and the Theory of Investment Value
http://risingdividendinvesting.blogspot.com/2007/03/john-burr-williams-and-theory-of_09.html - Donaldson G, 2007, Donaldson Capital: Rising Dividend Investing: John Burr Williams: Investing Versus Speculating
http://risingdividendinvesting.blogspot.com/2007/03/john-burr-williams-investing-versus.html - Segal D. 2/28/2009, In Letter, Warren Buffett Concedes a Tough Year, New York Times,
http://www.nytimes.com/2009/03/01/business/01buffett.html?_r=1&scp=7&sq=warren%20buffet&st=cse
Thanks for sharing, Learn more about expert business acumen training
ReplyDelete