Ludwig von Mises, Meet Benjamin Graham: Value Investing from an Austrian Point of View

Chris Leithner Leithner & Co. Pty Ltd Leithner Investments Pty Ltd Level 3, Benson House 2 Benson Street Toowong, Queensl nd, !ustr li "hris#leithner."om. u www.leithner."om. u

P $er Pre$ red %or &!ustri n '"onomi"s nd (in n"i l ) r*ets+ The ,eneti n Hotel -esort C sino L s ,eg s, ./0.1 (e2ru ry 2334 I "*nowledge the hel$%ul "omments o% -o2ert Blumen nd Pro% -oger 5 rrison. DRA ! " #R!$%R &'MM%(!) *%L&'M%

Chairman: One other question and I will desist. When you find a special situation and you decide, just for illustration, that you can buy for 1 and it is worth ! , and you ta"e a position, and then you cannot realise it until a lot of other people decide it is worth ! , how is that process brou#ht about $ by ad%ertisin#, or what happens& '(ephrasin#) What causes a cheap stoc" to find its %alue& *raham: +hat is one of the mysteries of our business, and it is a mystery to me as well as to e%erybody else. ,-ut. we "now from e/perience that e%entually the mar"et catches up with %alue. Ben6 min 5r h m Testimony to the Committee on B n*ing nd Commer"e Sen. 7illi m (ul2right, Ch irm n 8.. ) r"h .1449

What we do is loo" for e/tremes in mar"ets: %ery under%alued or %ery o%er%alued. 0ustrian theory has certainly #i%en us an ed#e. When you ha%e a theory to wor" from, you a%oid the problem that comes with stumblin# around in the dar" o%er chairs and ni#htstands. 0t least you can be#in to %isualise in the dar", which is where we all wor". +he future is always unlit. -ut with a body of theory, you can anticipate where the structures mi#ht lie. It allows you to step out of the way e%ery once in a while. : mes 5r nt +he 0ustrian 1conomics 2ewsletter 8.11;9

AB)!RA&!
This $ $er shows th t v lue investors nd !ustri n S"hool e"onomists hold "om$ ti2le views 2out r nge o% %und ment l e"onomi" nd %in n"i l $henomen . These in"lude $ri"e nd v lue< ris* nd r2itr ge< " $it l nd entre$reneurshi$< nd time0$re%eren"e nd interest. Indeed, with res$e"t to these m tters e "h grou$ m y h ve more in "ommon with the other th n e "h h s with the m instre m o% its res$e"tive %ield. !s 2 "*ground, the $ $er uses the investment results o% Leithner & Co. Pty Ltd, nd %ew o% the $rin"i$les it h s used to gener te these results, to highlight nd el 2or te these "om$ ti2ilities. To v lue investors, !ustri n e"onomi"s is 8or should 2e9 "om$elling 2e" use it su2sumes re l e"onomi" nd %in n"i l events within 6usti%i 2le l ws o% hum n "tion. =nli*e m instre m e"onomi" nd %in n"e, !ustri ns not only "*nowledge 2ut lso em$h sise the im$ort n"e o% entre$reneurshi$< indeed, !ustri ns "*nowledge th t sust ined entre$reneuri l "umen, whilst h rdly wides$re d, is nonetheless li*ely to e>ist. In turn, v lue investing nd the results "hieved 2y $rominent v lue investors m y interest !ustri ns 2e" use 5r h mites hold ?u si0!ustri n views @ or, t ny r te, views th t re "om$ ti2le to !ustri n views @ with res$e"t to im$ort nt e"onomi" nd %in n"i l $rin"i$les. , lue investors lso illustr te the $ositive results th t entre$reneuri l "tion " n "hieve. Aes$ite the m ny %ollies o% governments nd m instre m e"onomists nd investors, whi"h o%ten $rom$t v lue investors nd !ustri ns li*e to do$t r ther dour short0term outloo*s, 2oth 5r h mites nd )isesi ns re long0term o$timists. To do$t their $$ro "hes to e"onomi"s nd investment is ultim tely to %%irm 2 si" % ith in hum n n ture, " $it lism, oneBs "ountry nd %uture th t will 2e t le st s $ros$erous s the $resent. The %uture envis ged 2y these e"onomists nd gener ted $ rtly 2y these investors hel$s to vindi" te this % ith.

Introdu+tion
Ludwig von )ises, one o% the twentieth "enturyBs most in%luenti l !ustri n S"hool e"onomists, migr ted to the =nited St tes in .1C3. Si>teen ye rs ye r, Ben6 min 5r h m, the %ounder o% modern se"urity n lysis, dis2 nded his investment "om$ ny, returned its ssets to sh reholders nd retired to southern C li%orni . Auring these ye rs they 2oth lived nd wor*ed in ) nh tt n, 2ut trod "ir"uit without dire"t re%eren"e to the other. )r 5r h m "ommuted 2etween his home t 1.st Street nd Centr l P r* 7est, his o%%i"e t 5r h m0Dewm n Cor$. nd his se"urities n lysis "l ss t Colum2i =niversity< nd Pro% )ises tre**ed %rom his %l t in 7est 'nd !venue to the D tion l !sso"i tion o% ) nu% "turers, The Dew Eor* Pu2li" Li2r ry, (ound tion %or '"onomi" 'du" tion in Irvington0on0Hudson nd 82eginning in .1C19 his semin r t DE=Bs 5r du te S"hool o% Business.. )ore gener lly, lthough )urr y -oth2 rd 8using $seudonym9 nd How rd H. Bu%%ett 8 Congressm n nd the % ther o% 5r h mBs most % mous student, "olle gue nd st nd rd02e rer, 7 rren Bu%%ett9 "ommiser ted during the .143s 2out the 2itter %ruits o% !meri" Bs interventionist %oreign nd domesti" $oli"ies, no $u2li"ly v il 2le in%orm tion suggests th t during these ye rs 5r h mite investors nd )isesi n e"onomists "rossed $ ths nd e>"h nged ide s.2 Perh $s th t is 6ust s well. H d they met or "orres$onded, it is re son 2le to su$$ose th t r nge o% $oli"y issues would h ve divided them. It is dou2t%ul, %or e> m$le, whether 5r h mBs dvo" "y o% "ommodity0 2 sed reserve "urren"y3 would h ve "omm nded )isesB ssent< nd it is still less li*ely th t 5r h mBs 2 "*ing o% the 'm$loyment !"t o% .1C; would h ve im$ressed )ises. Eet 5r h m, )ises nd their students nd dherents would surely h ve greed em$h ti" lly @ nd dis greed 6ust s strongly with the m instre m in 7 ll Street nd " demi @ with res$e"t to sever l %und ment l "on"e$ts nd their interrel tions. Perh $s most im$ort ntly, to 5r h mite investor nd n !ustri n S"hool e"onomist $ri"e nd v lue re distin"t things. Fver e>tended $eriods o% time they tend tow rds one nother. But t ny given moment they will li*ely di%%er %rom one nother< nd %rom one moment to the ne>t they m y diverge. This $ $er shows th t v lue investorsC nd !ustri ns hold "om$ ti2le views not only 2out the $ri"e nd v lue, 2ut lso 2out other vit l e"onomi" nd %in n"i l $henomen . These in"lude ris* nd r2itr ge< " $it l nd entre$reneurshi$< nd time0$re%eren"e nd interest. Indeed, with res$e"t to these m tters e "h grou$ m y h ve more in "ommon with the other th n e "h h s with the m instre m o% its res$e"tive %ield. !s 2 "*ground, the $ $er uses the investment results o% Leithner & Co. Pty Ltd, nd %ew o% the $rin"i$les it h s used to gener te these results, to highlight nd el 2or te these "om$ ti2ilities. ! $riv te nd unlisted "om$ ny est 2lished in .111 nd 5r h m0style
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See Ben6 min 5r h m, -enjamin *raham: 3emoirs of the 4ean of Wall 5treet 8)"5r w0Hill, .11;, ed. nd with n introdu"tion 2y Seymour Ch tm n9< nd ) rgit von )ises, 3y 6ears with 7udwi# %on 3ises 8Center %or (utures 'du" tion, .1/C9. See :ustin - imondo, 0n 1nemy of the 5tate: +he 7ife of 3urray 2. (othbard 8Prometheus Boo*s, 23339. See Ben6 min 5r h m, World Commodities and World Currency 8)"5r w0Hill, .1CC, re$r. ed. .11/9. This, l s, h s 2e"ome n m2iguous term. Pr "titioners o% 5r h mBs $rin"i$les nd methods re " lled v lue investors< 2ut, 6udging %rom the loose us ge o% the $hr se, not ll @ indeed, %ew @ v lue investors %ollow 5r h m. This $ $er uses the $hr se &v lue investor+ in its restri"tive 8i.e., 5r h mite9 sense.

5 &v lue+ investor, it views m ny %in n"i l nd e"onomi" $henomen through !ustri n S"hool s$e"t "les.4 Its motto is its methodG to undert *e investment o$er tions th t re 2 sed u$on thorough rese r"h< to $rovide re son 2le s %ety o% $rin"i$ l nd o%%er n de?u te return< nd to in%orm its sh reholders regul rly, %ully nd in $l in l ngu ge 2out these investment o$er tions. 8! summ ry o% Leithner & Co.Bs results sin"e in"e$tion $$e rs in !$$endi> ..9 Pri+e, Value, Ris,, Individualism and )+e-ti+ism A.out Maths Ben6 min 5r h m 8./1C0.1H;9, uthor o% 5ecurity 0nalysis: 8rinciples and +echniques 8"o0 uthored 2y Pro% A vid Aodd, %ive editions .13C0.1;29, +he 0nalysis of 9inancial 5tatements 8.13H9 nd +he Intelli#ent In%estor 8%our editions .1C1023339 nd dire"tor o% 5r h m0Dewm n Cor$. 8.12;0.14;9, is widely reg rded s the %ounder o% modern %in n"i l n lysis.; 5r h mBs *ey insight is the $remise th t &investment is most su""ess%ul when it is most 2usinessli*e. !n investment o$er tion is one th t, u$on thorough n lysis, $romises s %ety o% $rin"i$ l nd s tis% "tory return. F$er tions not meeting these re?uirements re s$e"ul tive.+H 5r h m m int ined th t $ri"e is wh t is $ id nd th t v lue is wh t is re"eived< o2served th t over time $ri"e nd v lue gr vit te tow rds one nother 2ut th t t ny given $oint in time they m y diverge 8sometimes 2y wide m rgin nd %or n in"onvenient length o% time9< nd l mented th t most $eo$le r rely re"ognise @ nd more th n %ew wil%ully ignore @ the %und ment l distin"tion 2etween v lue nd $ri"e. , lue investors thus re6e"t the m instre m view th t the $ri"e nd v lue o% se"urity 8i.e., sto"*, 2ond or title to re l est te9 ne"ess rily "oin"ide t ll times./ 5r h m not only denied th t $ri"e nd v lue re synonyms<1 he lso re6e"ted the %in n"i l m instre mBs "onvi"tion th t the more vol tile the $ri"e o% se"urity the &ris*ier+ it is..3 To the m instre m, the "on"e$tion o% ris* is lmost inv ri 2ly $$lied to $er"eived li*elihood th t se"urityBs $ri"e will de"line @ even though the de"line m y 2e o% "y"li" l nd tem$or ry n ture nd even though the holder is unli*ely under these "ir"umst n"es to 2e %or"ed to sell. , lue investors, in "ontr st, &2elieve th t wh t is here involved is not true ris* in the use%ul sense o% the term I The bona fide investor does not lose money merely 2e" use the m r*et $ri"e o% his holdings de"lines< hen"e the % "t th t de"line m y o""ur does not me n th t he is running the ris* o% true loss I This
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See the Dewsletters, "ir"ul rs to sh reholders nd other m teri ls t www.leithner."om. u. Leithner Investments Pty Ltd, n institution l %unds m n ger using the s me investment $hiloso$hy, w s est 2lished in 233C. 5r h mBs m 6or 2oo*s, rti"les nd s$ee"hes h ve 2een re$rinted. See in $ rti"ul r +he Interpretation of 9inancial 5tatements: +he Classic 1:!; 1dition 8H r$erBusiness, .11/9< 5ecurity 0nalysis: +he Classic 1:< 1dition 8)"5r w0Hill, .11;9< +he Intelli#ent In%estor: 0 -oo" of 8ractical Counsel 8rev. ed. =$d ted with "omment ry 2y : son Jweig, H r$er Business, 23339< nd : net Lowe, +he (edisco%ered -enjamin *raham: 5elected Writin#s of the Wall 5treet 7e#end 8:ohn 7iley & Sons, .1119. 5ood se"ond ry des"ri$tions nd n lyses o% v lue investing in"lude : net Lowe, -enjamin *raham on =alue In%estin# 8(T Pitm n, .1149< : net Lowe, =alue In%estin# 3ade 1asy 8)"5r w0Hill, .11;9< nd Bru"e 5reenw ld et l., =alue In%estin#: from *raham to -uffett and -eyond 8:ohn 7iley & Sons, 233.9. See in $ rti"ul r 5ecurity 0nalysis: +he Classic 1:< 1dition, Ch $. 43 8&Ais"re$ n"ies Between Pri"e nd , lue+9 nd Ch $. 4. 8&Ais"re$ n"ies Between Pri"e nd , lue ContBd+9. 5r h m did not re son %rom %irst $rin"i$les tow rds this "ru"i l "on"lusion, 2ut the %irst gener tion o% !ustri ns nd )ises did 8see in $ rti"ul rs Ch $s. .. nd 2; o% >uman 0ction9. Leithner Letter Do. 42 82; !$ril 233C9 highlights the "om$ ti2ility o% the 5r h mite to the !ustri n "on"e$tion o% the distin"tion 2etween $ri"e nd v lue. See lso Chris Leithner, &, lue Investing, -is* nd -is* ) n gement+ nd Leithner Letter 43 82; ) y 233C9.

6 "on%usion m y 2e voided i% we $$ly the "on"e$t o% ris* solely to loss whi"h either is re lised through "tu l s le, or is " used 2y signi%i" nt deterior tion in the "om$ nyBs $osition @ or more %re?uently $erh $s, is the result o% the $ yment o% n e>"essive $ri"e in rel tion to the Kv lueL o% the se"urity I ) ny "ommon sto"*s do involve ris*s o% su"h deterior tion. But it is our thesis th t $ro$erly e>e"uted investment in "ommon sto"*s does not " rry ny su2st nti l ris* o% this sort nd th t there%ore it should not 2e termed Mris*yB merely 2e" use o% the element o% $ri"e %lu"tu tion.+.. In order 2etter to $$re"i te the inter$l y o% $ri"e, v lue nd ris*, 5r h m urged his students nd dire"ted his em$loyees to %o"us not u$on %in n"i l m r*ets s whole, or even u$on the se"urities th t "om$rise it, 2ut r ther u$on the individu l 2usinesses th t issue se"urities. (or 5r h m0style v lue investor, ris* resides in the "umul tive li*elihood th t one or more o% %our events o""ur. The %irst is th t thriving @ on the 2 sis o% its $ st nd "urrent o$er tions @ 2usiness "e ses in the %uture to $ros$er< the se"ond is th t n unre son 2ly high $ri"e is $ id %or su"h 2usiness 8or, e?uiv lently, th t the $ur"h ser m *es unduly o$timisti" ssum$tions 2out its $ros$e"ts9< the third is the $ossi2ility 8$erh $s s result o% mist *en or insu%%i"iently thorough rese r"h9 th t wh t the investor 2elieves to 2e good 2usiness is "tu lly medio"re or $oor one< nd the %ourth @ nd $erh $s most d ngerous @ is the $ossi2ility th t widely0 ""e$ted % ll "ies nd % lsehoods re re"eived s % "ts. These $ossi2ilities, nd not the vol tility o% individu l $ri"es or m r*etsB over ll levels, thre ten the results o% investment o$er tions. 5r h m there%ore $ id little d y0to0d y ttention to &the m r*et+ 8th t is to s y, the $resent or $redi"ted level o% ggreg te m r*et ver ges su"h s the S&P 4339 nd inste d su26e"ted individu l "om$ nies to det iled nd sust ined s"rutiny. , lue investors reg rd 8s y9 sto"* s sh re o% 2usiness whose v lue "orres$onds pro rata to the v lue o% the entire enter$rise. !t ny given moment, sto"*Bs $ri"e will seldom e?u l the investorBs estim te o% its v lue. Fver n e>tended $eriod o% time, however, its $ri"e nd v lue will tend tow rds one nother..2 (rom this insight %ollow two others. (irst, under "ert in "onditions se"urity m y 2e $ur"h sed t $ri"e less th n th t whi"h emerges %rom " utious estim te o% its v lue< nd the gre ter this dis$ rity the gre ter the investmentBs &m rgin o% s %ety.+ , lue investors, then, strive to 2e"ome nd rem in dis$ ssion te re lists who sell sele"ted se"urities to e ger 2uyers 8o$timists9 nd $ur"h se them %rom e ger seller 8$essimists9. Se"ond, to o2s"ure the distin"tion 2etween v lue nd $ri"e @ most not 2ly, to 2uy se"urity on the 2 sis o% its "urrent $o$ul rity nd in the ho$e th t its $ri"e, re%le"ting this $o$ul rity, will shortly rise @ is to %ors *e investment, em2r "e s$e"ul tion nd invite the im$ irment or loss o% " $it l. Be" use 5r h m0style v lue investors do not s$end %ruitless hours $ondering either &the m r*et+ or myri d nd esoteri" e"onomi" ggreg tes, they " n devote "onsider 2le time to % r more $rodu"tive $ur$oseG the se r"h %or individu l 2usinesses whose se"urities re v il 2le t re son 2le or 2 rg in $ri"es. To these investors, it is im$ort nt to em$h sise, the llo" tion o% " $it l is most su""ess%ul when it is r tion l< nd it is most r tion l when it is most 2usinessli*e. The most su""ess%ul investor, then, is the one who thin*s nd "ts li*e shrewd 2usinessm n. !""ordingly, with res$e"t to se"urity under "onsider tion v lue investors s* ?uestions su"h sG
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is the underlying 2usiness underst nd 2leN

+he Intelli#ent In%estor, $$. .2.0.22. 5r h mBs $ r 2le o% &)r ) r*et+ on $$. 23C0234, 2.20224 o% +he Intelli#ent In%estor is $erh $s his sim$lest @ nd most eng ging nd $ro%ound @ st tement o% this insight.

7 does it h ve "onsistently % vour 2le o$er ting historyN re there ny o2vious nd m 6or % "tors whi"h might % vour 2ly or dversely %%e"t its $ros$e"tsN is its m n gement " ndid with sh reholdersN Aoes it re"ognise nd "orre"t its errors o$enlyN do m n gers tre t sh reholdersB %unds s i% they were their ownN h ve m n gers invested their own money 8 s o$$osed to o$tions lever ged g inst sh reholdersB %unds9 in the "om$ nyN Ao they own signi%i" nt $er"ent ge o% itN

In nswering these ?uestions, v lue investors ground their n lyses in sim$le rithmeti", $l in ver2 l logi" nd "ommonsensi" l eviden"e. Li*e !ustri ns, they distrust the unre listi" ssum$tions, st tisti" l models nd ggreg te d t whi"h "ontem$or ry %in n"i l n lysis t *es %or gr nted. In 5r h mBs words, written in .14/, &in CC ye rs o% 7 ll Street e>$erien"e nd study I h ve never seen de$end 2le " l"ul tions m de 2out "ommon sto"* v lues, or rel ted investment $oli"ies, th t went 2eyond sim$le rithmeti" I 7henever K" l"ulusL is 2rought in, or higher lge2r , you "ould t *e it s w rning sign l th t the o$er tor is trying to su2stitute theory %or e>$erien"e, nd usu lly lso to give s$e"ul tion the de"e$tive guise o% investment.+.3 Simil rly, v lue investors $l "e no "reden"e u$on &"onsensus+ m r*et, %in n"i l nd e"onomi" views< nd inso% r s $ossi2le they e>"lude emotion l "onsider tions %rom their n lyses. !""ordingly, they t *e t % "e v lue little o% wh t they re d in m instre m news$ $ers nd m g Oines< ""e$t without " re%ul "onsider tion even less o% wh t they he r on r dio nd television< run s % st s their legs " n " rry them %rom &ti$s+ nd never visit investment "h t sites on the Internet..C In short, the d ily torrents o% m r*et news, d t nd o$inion &h ve only one signi%i" nt me ning %or the true investor. They $rovide him with n o$$ortunity to 2uy when $ri"es % ll sh r$ly nd to sell wisely when they dv n"e gre t de l. !t other times he will do 2etter i% he %orgets 2out the sto"* m r*et nd $ ys ttention to his dividend returns nd to the o$er ting results o% his "om$ nies.+ Prominent v lue investors, su"h s )r 5r h mBs students nd em$loyees 7 rren Bu%%ett, Thom s Pn $$ nd 7 lter S"hloss, thus reg rd themselves not s tr ders o% $ie"es o% $ $er 2ut s entre$reneurs nd owners o% t ngi2le 2usinesses. They see* to invest on the 2 sis o% re listi" $remises, v lid logi" nd reli 2le eviden"e< redu"e the ris* o% $erm nent loss o% " $it l 8 s o$$osed to tem$or ry ?uot tion l loss9< 2e " utious when others re "on%ident nd de"isive when others re %e r%ul< nd there2y to in"re se the enduring v lue 8 s o$$osed to the e$hemer l m r*et $ri"e9 o% their " $it l. Grahamites as /Austrian0 %ntre-reneurs !n im$ort nt su20%ield o% the !ustri n S"hool, the theory o% entre$reneuri l dis"overy, o%%ers su$erior e>$l n tion o% how re l0world m r*ets wor*. Isr el PirOner is one o% its most $rominent "ontem$or ry e>$onents..4 The theory em$h sises the very %e tures o%
13 14

See &The Dew S$e"ul tion in Common Sto"*s,+ in Lowe, +he (edisco%ered -enjamin *raham. (or det ils, see Leithner Letter Do. 44 82; :uly 233C9. 15 See in $ rti"ul r PirOnerBs Competition and 1ntrepreneurship 8=niversity o% Chi" go Press, .1H39< +he 3eanin# of 3ar"et 8rocess 8-outledge, .11;9< >ow 3ar"ets Wor": 4isequilibrium, 1ntrepreneurship and 4isco%ery 8Institute o% '"onomi" !%% irs, .11H9< nd +he 4ri%in# 9orce of the 3ar"et 8-outledge, 23339. The -ole o% the 'ntre$reneur in the '"onomi" System 8the In ugur l :ohn Bonython Le"ture delivered 2y PirOner t

8 re l0world m r*ets th t the m instre m model o% $er%e"t "om$etition e>"ises. )ost im$ort ntly, dise?uili2rium, not e?uili2rium, "h r "terises the inter "tions mong 2uyers nd sellers< nd dise?uili2rium 8 nd its sso"i ted "y"le o% error, dete"tion, "orre"tion nd renewed error9 underlies entre$reneuri l "tivity nd dis"overy. ) r*ets do indeed tend tow rds m r*et0"le ring $ri"esG 2ut they never tt in e?uili2rium 2e" use numerous events @ the "onst nt "h nge o% $l ns, dis"overy o% new in%orm tion nd te"hnology, "ommission o% errors nd their dis"overy nd re"ti%i" tion @ intrude. !lert entre$reneurs, 2e they $rodu"ers, "onsumers or investors, dete"t errors nd, through $ro"ess o% tri l nd error, le rn how they " n 2e remedied. F"" sion lly, dise?uili2rium lso en 2les $res"ient entre$reneurs to nti"i$ te "h nges in othersB $l ns nd de"isions. !""ordingly, movements o% $ri"es, "h nges o% methods o% $rodu"tion nd distri2ution, nd "hoi"e o% out$uts stem ultim tely %rom "h nges in "onsumersB $l ns nd desires< nd entre$reneuri l error, dis"overy nd "orre"tion set these m r*et %or"es in motion nd in%luen"e them in dire"tions th t serve "onsumersB wishes. !lert entre$reneurs reve l where nd how the stru"ture o% $rodu"tion " n 2e im$roved in order to serve "onsumers 2etter. 'ntre$reneuri l dis"overy is the oil th t en 2les the m r*et me"h nism to o$er te so smoothly. ! dee$ "h sm se$ r tes the theory o% entre$reneuri l dis"overy %rom the m instre m model o% $er%e"t "om$etition. To m instre m e"onomists, the de"isions to 2uy nd sell in the m r*et re mere m them ti" l deriv tions. ! de"ision, in other words, is &m de+ 2y &given+ model, $ro2 2ility distri2ution nd d t . The m instre m model thus elimin tes the re l0li%e, %lesh0 nd02lood de"ision0m *er @ the he rt o% the !ustri n e"onomi"s nd v lue investing @ %rom the m r*et. ) r*et utom tons do not err< ""ordingly, it is unthin* 2le th t n o$$ortunity %or $ure $ro%it is not inst ntly noti"ed nd gr s$ed. The m instre m e"onomist, goes the reve ling 6o*e, does not t *e the Q.3 2 n*note lying on the %loor 2e" use he 2elieves th t i% it were re lly there then some2ody would lre dy h ve gr 22ed it. In sh r$ "ontr st, !ustri ns re"ognise th t de"isions re t *en 2y re l $eo$le whose $l ns re im$er%e"tly "le r, indistin"tly r n*ed, o%ten intern lly0in"onsistent nd lw ys su26e"t to "h nge. (urther, t ny given moment m r*et $ rti"i$ nt will 2e l rgely un w re o% other m r*et $ rti"i$ ntsB $resent nd %uture $l ns. It is $ rti"i$ tion in the m r*et th t m *es 2uyers nd sellers 2it more *nowledge 2le 2out their own $l ns nd slightly less un w re o% othersB $l ns. ) r*et $ rti"i$ nts will inevit 2ly m *e mist *es< %urther, it is $ro2 2le th t they will not utom ti" lly noti"e them. !""ordingly, it is not 6ust $ossi2le @ it is ty$i" l @ th t o$$ortunities %or g in 8&$ure $ro%it+9 $$e r 2ut re not inst ntly dete"ted. -e"ognising the o2vious @ n mely th t he h s $ossi2ly 2een the %irst to noti"e it @ the !ustri n will there%ore t *e the Q.3 note in dvertently dro$$ed on the %loor nd ignored 2y his m instre m "olle gue. !n &!ustri n+ "t o% entre$reneuri l dis"overy, then, o""urs when m r*et $ rti"i$ nt see*s nd %inds wh t others h ve overloo*ed.

!del ide, South !ustr li on 33 :uly .1/C9 is n e>"ellent %ive0$ ge $rR"is o% this rese r"h. Leithner Letter Do. 4/ 82; F"to2er 233C9 det ils the simil rities 2etween the 2eh viour o% &!ustri n+ entre$reneurs nd 5r h mite investors.

9 In these res$e"ts, 5r h mite v lue investors re &!ustri n+ entre$reneurs..; To "ite 6ust one e> m$le, 7 rren Bu%%ett dis"overed lu"r tive o$$ortunity 8one o% the %irst o% m ny in his long nd su""ess%ul " reer9 when he wor*ed t 5r h m0Dewm n Cor$. )r Bu%%ett re" lls.H th t &-o"*wood & Co., Broo*lyn 2 sed "ho"ol te $rodu"ts "om$ ny o% limited $ro%it 2ility, h d do$ted KL st In (irst FutL inventory v lu tion in .1C. when "o"o w s selling %or Q3.43 $er $ound. In .14C, tem$or ry short ge o% "o"o " used the $ri"e to so r to over Q3.;3. Conse?uently -o"*wood wished to unlo d its v lu 2le inventory ?ui"*ly. But i% the "o"o h d sim$ly 2een sold o%%, the "om$ ny would h ve owed "lose to 43S t > on the $ro"eeds. The .14C T > Code " me to the res"ue. It "ont ined n r" ne $rovision th t elimin ted the t > otherwise due on LI(F $ro%its i% inventory w s distri2uted to sh reholders s $ rt o% $l n redu"ing the s"o$e o% "or$or tionBs 2usiness. -o"*wood de"ided to termin te one o% its 2usinesses, the s le o% "o"o 2utter, nd s id .3 million $ounds o% its "o"o 2e n inventory w s ttri2ut 2le to th t "tivity. !""ordingly, the "om$ ny o%%ered to re$ur"h se its sto"* in e>"h nge %or the "o"o 2e ns it no longer needed, $ ying /3 $ounds o% 2e ns %or e "h sh re. (or sever l wee*s I 2usily 2ought sh res, sold 2e ns, nd m de $eriodi" sto$s t S"hroeder Trust to e>"h nge sto"* "erti%i" tes %or w rehouse re"ei$ts. The $ro%its were good nd my only e>$ense w s su2w y to*ens.+ It is im$ort nt to em$h sise th t this dis"overy, li*e Bu%%ettBs nd 5r h mBs m ny others, did not derive %rom in%orm tion th t other 2uyers nd sellers "ould not $ossess. These "ts o% entre$reneuri l dis"overy stemmed %rom the lert n lysis o% $u2li"ly v il 2le in%orm tion nd the su$erior dete"tion o% o$$ortunities th t others h d sim$ly overloo*ed. Fn numerous o"" sions, 5r h m nd his students nd %ollowers h ve %ound $romising $l "es to loo* nd h ve 2een the %irst, in e%%e"t, to dete"t the $iles o% notes th t others h ve disreg rded nd le%t lying on the %loor. !ny2ody, %or e> m$le, "ould h ve 2ought $ rts o% !meri" n '>$ress, +he Washin#ton 8ost, 5'ICF 8whose enormous $otenti l 5r h m w s the %irst to %ind9 nd Co" 0Col when )r Bu%%ett did< 2ut %ew s w wh t he s w, ignored the irrelev n"ies nd re soned so "le rly. Inste d, most were distr "ted 2y myri d worries @ nd e"onomi" nd %in n"i l % ll "ies @ nd so very %ew %ollowed Bu%%ettBs le d. These e> m$les re signi%i" nt in nother res$e"tG they rightly im$ly th t 5r h mites re PirOneri n 2ut not S"hum$eteri n entre$reneurs../ , lue investors, in other words, strive to dis"over &routine+ dis"re$ n"ies 2etween $ri"e nd v lue. By $ur"h sing tem$or rily underv lued se"urities or selling overv lued se"urities, they en"our ge e?uili2rium 8i.e., $ri"e nd v lue to $$ro>im te one nother more "losely9. But 5r h m nd his %ollowers h ve tended to es"hew new %irms or %irms th t $rodu"e r di" lly new goods nd servi"es. Perh $s most not 2ly, over the de" des they h ve gone to gre t lengths to void &te"hnology+ %irms. They h ve done so 2e" use these %irms re di%%i"ult to v lue< nd they re di%%i"ult to v lue $ rtly 2e" use %ew o% these %irms re &S"hum$eteri n+ @ th t is to s y, the goods nd servi"es they $rodu"e " use "onsumers to re rr nge their $re%eren"e s" les in un%oresee 2le w ys nd there2y gener te e>tended 82ut not $erm nent9 dise?uili2rium in the m r*et.
16

&'ntre$reneuri l 6udgment,+ s id )ises, &" nnot 2e 2ought on the m r*et. The entre$reneuri l ide th t " rries on nd 2rings $ro%it is $re"isely th t ide whi"h did not o""ur to the m 6ority. It is not "orre"t %oresight s su"h th t yields $ro%its, 2ut %oresight 2etter th n th t o% the rest. The $riOe goes only to the dissenters, who do not let themselves 2e misled 2y the errors ""e$ted 2y the multitude. 7h t m *es $ro%its emerge is the $rovision %or %uture needs %or whi"h others h ve negle"ted to m *e de?u te $rovision.+ 17 See )r Bu%%ettBs .1// letter to sh reholders t www.2er*shireh th w y."om. 18 I th n* -o2ert Blumen %or 2ringing this $oint to my ttention.

10

!s n e> m$le, $erson l "om$uters, the v rious so%tw re $rogr ms they "ont in nd the t s*s they " n ""om$lish h ve, sin"e the .1/3s, $rom$ted m ny millions o% "onsumers to $ur"h se v st mounts o% PC h rdw re nd so%tw re. The "onsumers who h ve s$ent 2illions on these goods nd servi"es h ve de"lined to s$end this money on the m ny other things th t it " n 2uy. Hen"e the dvent o% the PC, Internet nd the li*e h s $rom$ted m ny o% their users signi%i" ntly nd $erh $s dr m ti" lly to d6ust their $re%eren"es orderings< nd this d6ustment h s ne"essit ted "orres$onding re" li2r tions o% m ny %irmsB " $it l stru"ture. !""ordingly, it is not su%%i"ient to s y th t "ert in lert 8&PirOneri n+9 entre$reneurs noti"ed th t 2its o% met l, $l sti" nd lines o% "ode "ould 2e 2ought nd ssem2led t $l "e ! %or Q..33 nd sold t $l "e B %or 8s y9 Q2.33< r ther, it is more $t to s y th t the ide s o% Sili"on , lley nd other &S"hum$eteri n+ entre$reneurs introdu"ed "onsumers to new sets o% goods, servi"es nd "hoi"es. !he uture Is Largel1 But (ot Radi+all1 #n+ertain 5r h mites re"ognise th t the %uture is inherently un"ert in. Th t is to s y, there is no $ro2 2ility distri2ution nd there re no d t th t " n &model+ it. The %uture is not r di" lly un"ert in, in the sense th t Ludwig L "hm nn m int ined, 2ut it is l rgely so. Li*e m ny !ustri ns, 5r h mites ""e$t th t one " n *now some things 8su"h s histori" l d t , rel tionshi$s o% " use nd e%%e"t nd hen"e the l ws o% e"onomi"s9, nd there%ore th t to some e>tent the $ st does $ro6e"t into the %uture..1 5r h mites do not gree, in other words, th t nything " n h $$en< 2ut they re "utely w re @ 2e" use they h ve le rnt %rom un$le s nt $erson l e>$erien"e @ th t the une>$e"ted " n nd o%ten does h $$en. They lso "*nowledge th t %ore" sting the %uture is the 6o2 o% entre$reneurs, not e"onomists or 2ure u"r ts, nd there%ore th t the entre$reneur0 investor0%ore" ster must 2e " utious nd hum2le.23 !""ordingly, 5r h m0style v lue investors $ y no ttention to the $redi"tions o% &m r*et e>$erts+ nd "omment tors 2out the level o% or movements in over ll %in n"i l m r*ets, the $ri"es o% individu l se"urities, et". The v st m 6ority o% &m r*et e>$erts+ nd t l*ing he ds, it is im$ort nt to re"ognise, re not !ustri n entre$reneursG they do not llo" te their own or othersB " $it l nd their %ortunes do not de$end u$on the "orres$onden"e o% their $l ns to su2se?uent events. )r 5r h m re"ognised this short"oming nd w s there%ore under no illusion 2out m r*et $rognosti" torsB 2ilities. &The %urther one gets w y %rom 7 ll Street, the more s"e$ti"ism one will %ind 2out the $retensions o% sto"*0 m r*et %ore" sting or timing.+ Indeed, &in our K5r h m nd AoddL e>$erien"e nd o2serv tion, e>tending over 43 ye rs, we h ve not *nown single $erson who h s "onsistently or l stingly m de money 2y M%ollowing the m r*etB. 7e do not hesit te to de"l re th t this $$ro "h is s % ll "ious s it is $o$ul r.+ )r Bu%%ett h s dded2. &%ore" sts m y tell you gre t de l 2out the %ore" ster< 2ut they tell you K$re"ious littleL 2out the %uture.+ In +he Intelli#ent In%estor, 5r h m lso noted th t & side %rom %ore" sting the movement o% the gener l m r*et, mu"h e%%ort nd 2ility re dire"ted in 7 ll Street tow rd sele"ting sto"*s or industri l grou$s th t in m tter o% $ri"e will Mdo 2etterB th n the rest over % irly short $eriod in the %uture I 7e do not
19 20

I m gr te%ul to -o2ert BlumenBs $ rti"ul rly "le r elu"id tion o% this $oint. -e%le"ting u$on his investment e>$erien"e, whi"h 2eg n in .1.C nd ended in .1H., 5r h m "on"luded &through ll vi"issitudes nd " su lties, s e rthsh *ing s they were un%oreseen, it rem ined true th t sound investment $rin"i$les $rodu"ed gener lly sound results. 7e must "t on the ssum$tion th t they will "ontinue to do so.+ 21 See )r Bu%%ettBs .1/3 letter to sh reholders.

11 2elieve Kthis ende vourL is suited to the needs nd tem$er ment o% the true investor. !s in ll other "tivities th t em$h sise $ri"e movements %irst nd underlying v lues se"ond, the wor* o% m ny intelligent minds "onst ntly eng ged in this %ield tends to 2e sel%0 neutr lising nd sel%0de%e ting over the ye rs.+ ! "om$rehensive study, $u2lished in the >ulbert 9inancial 4i#est in : nu ry .11C, "orro2or tes this $osition. >94 %ound th t, o% the .3/ m r*et0timing nd e"onomi" %ore" sting newsletters th t were n lysed during the $re"eding %ive ye rs, the $redi"tions o% only two "orres$onded even "rudely to su2se?uent events. This num2er is mu"h sm ller th n the one th t would 2e e>$e"ted 2y $ure "h n"e. It demonstr tes th t &m r*et e>$erts+ " nnot system ti" lly get things right @ 2ut th t they do system ti" lly get things wrong. ) r*et timers, in other words, re seldom in dou2t 2ut virtu lly lw ys in error. It is noteworthy th t 7 rren Bu%%ett nd Peter Lyn"h 8one o% the most $rominent nd su""ess%ul %unds m n gers o% the l st %our de" des9, dis"l im ny 2ility to $redi"t %in n"i l m r*etsB over ll level or dire"tion. !""ording to Lyn"h,22 &thous nds o% e>$erts study over2ought indi" tors, $ut0" ll r tios, the (edBs $oli"y on money su$$ly I nd they " nBt $redi"t m r*ets with ny use%ul "onsisten"y, ny more th n giOO rd s?ueeOers "ould tell the -om n 'm$erors when the Huns would tt "*.+ 5r h m0style v lue investors lso $ y no heed to m instre m e"onomistsB %ore" sts 2out m "roe"onomi" ggreg tes su"h s in%l tion, e>"h nge r tes, 6o2lessness, tr de nd 2udget de%i"its nd the li*e. This is 2e" use the 2ility to %ore" st these things is t 2est tenuous. !nd even i% they "ould 2e %ore" st re son 2ly ""ur tely, they would distr "t r ther th n in%orm.?! In )r Bu%%ettBs words, &i% (ed Ch irm n !l n 5reens$ n were to whis$er to me wh t his monet ry $oli"y w s going to 2e over the ne>t two ye rs, it wouldnBt "h nge one thing I do.+ Su2suming nd 6usti%ying this st n"e is 7illi m SherdenBs det iled review o% rese r"h th t tests the ""ur "y o% m "roe"onomi" %ore" sts.?< He %ound th t
22

%ore" sters " nnot $redi"t turning $oints in the e"onomy< their 2ility to %ore" st ""ur tely is, on ver ge, neither 2etter nor worse th n guessing< in"re sed so$histi" tion 8i.e., more $ower%ul "om$uters, more "om$li" ted e"onometri" models nd gre ter mounts o% d t 9 h s not im$roved the ""ur "y o% %ore" sts< there is no eviden"e th t %ore" stersB s*ill h s in"re sed sin"e the .1H3s 8i% nything, their s*ill, su"h s it is, h s deterior ted over time9< &"onsensus+ %ore" sts 8i.e., the "om2in tion o% individu l %ore" sts into single, ver ge %ore" st9 re no more ""ur te th n the individu l %ore" sts whi"h "om$rise them< the %urther into the %uture th t e"onomists ttem$t to $ro$hesy, the less ""ur te their %ore" sts 2e"ome<

Peter Lyn"h, One @p on Wall 5treet 8Simon & S"huster, .1/19, $. /4. Ar 5reens$ n, in ungu rded moments, seems to gree. Fn 2 ) r"h 233C he told the '"onomi" Clu2 o% Dew Eor* &des$ite e>tensive e%%orts on the $ rt o% n lysts, to my *nowledge, no model $ro6e"ting dire"tion l movements in e>"h nge r tes is signi%i" ntly su$erior to tossing "oin. I m w re th t o% the thous nds who try, some re ?uite su""ess%ul. So re winners o% "oin0tossing "ontests. The seeming 2ility o% num2er o% 2 n*ing org nis tions to m *e "onsistent $ro%its %rom %oreign0e>"h nge tr ding li*ely derives not %rom their insight into %uture r te "h nges 2ut %rom m r*et m *ing.+ 24 7illi m Sherden, +he 9ortune 5ellers: +he -i# -usiness of -uyin# and 5ellin# 8redictions 8:ohn 7iley & Sons, .1119.
23

12 there re no individu l %ore" sters who re "onsistently more ""ur te th n their $eers.

5iven these dis"on"erting 8%or m instre m e"onomists nd investorsT9 results, 5r h m0 style v lue investors *ee$ %irmly in mind two seemingly %li$$ nt 2ut nonetheless very im$ort nt &l ws+ o% m instre m e"onomi"s. The %irst is th t, %or every e"onomist, there is n e?u l nd o$$osite e"onomist. The se"ond l w is th t 2oth re li*ely to 2e wrong. In the words o% Phili$ (isherG &I 2elieve th t the e"onomi"s whi"h de ls with %ore" sting 2usiness trends m y 2e "onsidered to 2e 2out s % r long s w s the s"ien"e o% "hemistry during the )iddle !ges. The mount o% ment l e%%ort the %in n"i l "ommunity $uts into this "onst nt ttem$t to guess the e"onomi" %uture m *es one wonder wh t might h ve 2een ""om$lished i% only %r "tion o% su"h ment l e%%ort h d 2een $$lied to something with 2etter "h n"e o% $roving use%ul.+24 ) r*et timers, "omment tors nd m instre m e"onomists, then, " nnot %oresee e"onomi" events nd develo$ments with ny use%ul degree o% ""ur "y. !nd even i% they "ould, the ggreg te $henomen u$on whi"h they %i> te re ty$i" lly o% little interest to 5r h mites. Hen"e v lue investors ignore n lysts, e"onomists nd others who "l im th t they $ossess "le r "ryst l 2 lls. But 5r h mite investors do not ignore the %uture per se. Quite the "ontr ryG they $l n not 2y m *ing $ rti"ul r $redi"tions 2out wh t will h $$en 2ut 2y "onsidering gener l s"en rios @ $ rti"ul rly $essimisti" s"en rios @ o% wh t might "on"eiv 2ly h $$en. They then stru"ture their "tions nd investments in order to redu"e the ris* o% $erm nent loss o% " $it l in the event th t undesir 2le events nd develo$ments "tu lly o""ur. 5r h mites lso re"ognise th t i% m r*ets tend tow rds 2ut never tt in st te o% e?uili2rium, nd i% $ro%it0see*ing entre$reneurs "onstitute the &oil+ th t en 2les the m r*et me"h nism to o$er te nd d $t so smoothly, then over time $ rti"ul rly t lented nd shrewd nd lu"*y entre$reneurs will tend, more o%ten th n not nd rel tively "onsistently, to ""umul te " $it l.2; Less su""ess%ul entre$reneurs, on the other h nd, will "onsistently lose some @ nd eventu lly ll @ o% their " $it l. It is %or this re son th t 5r h mites se r"h in"ess ntly %or 2usinesses th t $ossess "onsistently solid nd rel tively st 2le tr "* re"ords, nd the demonstr ted 2ility to surmount v riety o% une>$e"ted "h nges nd vi"issitudes.2H &on+e-tions of &a-ital Goods and &a-ital !t the "entre o% the 5r h mite $$ro "h to investment re two "on"e$tions @ " $it l goods nd " $it l @ th t "on%orm to )isesi n "on"e$tions.2/ C $it l goods, ""ording to )ises, re &tools nd h l%0%inished $rodu"ts, or goods re dy %or "onsum$tion th t m *e it $ossi2le %or m n to su2stitute, without su%%ering w nt during the w iting $eriod, more time0 2sor2ing $ro"ess %or nother 2sor2ing shorter time.+ C $it l goods en 2le entre$reneurs to $rodu"e goods nd servi"es whose ?u ntity, ?u lity nd $ri"e "on%orm more "losely to "onsumersB dem nds. The v riety o% things dem nded 2y "onsumers @ to s y nothing o% their "om2in tions o% ?u ntity, ?u lity nd $ri"e @ is enormous< ""ordingly, " $it l goods nd the individu l %irms th t use them re heterogeneous.
25 26

Philli$ (isher, Common 5toc"s and @ncommon 8rofits 8:ohn 7iley & Sons, .11;9, $. ;2. The gre ter the length o% time, the more the sto"h sti" element o% lu"* nd "h n"e is removed. Bu%%ett nd "oin0%li$$ing in &the Su$erinvestors o% 5r h m0 nd Aoddsville+ 27 See in $ rti"ul r 5ecurity 0nalysis, Ch $. 2H. 28 (or det ils, see Leithner Letter Do. C. 82; ) y 23339.

13 (urther, "onsumersB dem nds "onst ntly "h nge< %or this re son, entre$reneurs in"ess ntly m ss nd dis ssem2le " $it l goods. 5r h m "on"urred, nd throughout +he Intelli#ent In%estor, %or e> m$le, he sought &to 2ring home in "on"rete nd vivid m nner some o% the m ny v rieties o% "h r "ter, %in n"i l stru"ture, $oli"ies, $er%orm n"e nd vi"issitudes o% "or$or te enter$rise I+21 (rom the $oint o% view o% v lue investor, it is m *es sense to distinguish the notion o% " $it l goods %rom the "on"e$t o% " $it l. !""ording to )ises, &the "on"e$t o% " $it l is the %und ment l "on"e$t o% e"onomi" " l"ul tion, the %oremost ment l tool o% the "ondu"t o% %% irs in the m r*et e"onomy I C $it l is the sum o% the money e?uiv lent o% ll ssets minus the sum o% the money e?uiv lent o% ll li 2ilities s dedi" ted t de%inite d te to the "ondu"t o% the o$er tions o% de%inite 2usiness unit. It does not m tter in wh t these ssets m y "onsist, whether they re $ie"es o% l nd, 2uildings e?ui$ment, tools, goods o% ny *ind nd order, "l ims, re"eiv 2les, " sh or wh tever.+ ! %irmBs " $it l, then, "orres$onds to its 2 se o% net ssets s reve led 2y entre$reneurs in the m r*et. Simil rly, to 5r h mite %irmBs " $it l is its 2 se o% net ssets 8or, more "onserv tively, its wor*ing " $it l9.33 5r h mites, li*e )isesi ns, "*nowledge rough 2ut nonetheless system ti" lin* ge 2etween m r*ets nd " $it l stru"ture. I%, s !ustri ns h ve demonstr ted %rom %irst $rin"i$les nd v lue investors h ve o2served over the de" des, entre$reneurs "ting in m r*ets " n ttr "t, de$loy nd rede$loy " $it l goods nd v lue " $it l su"h th t they in"re se $rodu"tion, "onsum$tion nd st nd rds o% living, then t most times 8 nd setting side the e%%e"ts o% government nd "entr l 2 n* intervention into the m r*et9 " $it l goods will 2e $ri"ed 8&" $it lised+9 t le st roughly r tion lly.3. To 2e sure, v lue is not synonym o% $ri"e< e?u lly im$ort ntly, however @ nd $re"isely 2e" use they tend tow rds one nother @ v lue nd $ri"e re not unrel ted. To investors who err on the side o% " ution, $ri"es will o%ten 2e somewh t, o"" sion lly signi%i" ntly 2ut seldom dr m ti" lly 2ove 6udi"ious ssessments o% v lue. Simil rly, $ri"es will o"" sion lly 2e signi%i" ntly 2ut r rely dr m ti" lly 2elow 2usinessli*e ssessments o% v lue. To 5r h mites nd )isesi ns li*e, in other words, m r*ets re im$er%e"tly 2ut still re son 2ly &e%%i"ient.+ )r Bu%%ett on"e told his sh reholders &"orre"tly o2serving th t the m r*et w s %re?uently e%%i"ient, Kthe e%%i"ient m r*ets enthusi stsL went on to "on"lude in"orre"tly th t the m r*et w s lw ys e%%i"ient. The di%%eren"e 2etween the $ro$ositions is night nd d y.+ !""ording to 5r h m, the v lue o% 2usiness to n investor stems ultim tely %rom n ssessment o% the ?u lity o% its " $it l< nd th t ssessment de$ends u$on the 2ility o% th t " $it l "onsistently to $rodu"e goods nd servi"es desired 2y "onsumers. The enter$riseBs %in n"i l st tements $rovide the 2est me ns to s"ert in this ?u lity. How, then, does 5r h mite re son tow rds n o$inion 2out given se"urityBs v lueN By n lysing the %in n"i l st tements 8i.e., its st tement o% $ro%it0 nd0loss nd 2 l n"e sheet9
29 30

$. CC;. See lso his "om$ rison o% $ irs o% "om$ nies in Ch $s. .3, .H nd ./. See >uman 0ction $. 2;2< nd 5ecurity 0nalysis $$. ./.0./3, 334033/, ;..0;.; nd ;H20;HC. 31 I m inde2ted to -o2ert Blumen %or the gist o% these two senten"es. Blumen dds th t i% $ri"es were ty$i" lly irr tion l, then over time no ""umul tion o% " $it l "ould o""ur. =nder those "ir"umst n"es, entre$reneurs would 2e 6ust s li*ely to de$lete s to in"re se ""umul ted " $it l. Indeed, ssuming th t the w ys to w ste " $it l re % r more numerous th n $ro%it 2le 2usiness nd investment ide s, i% $ri"es were irr tion l th n the de$letion o% " $it l would 2e the rule. Eet during the $ st sever l "enturies in !nglo0!meri" n nd other "ountries, " $it l h s "le rly ""umul ted nd st nd rds o% living h ve risen. Hen"e the rough 2ut nonetheless system ti" lin* 2etween m r*ets nd " $it l stru"ture. Fver time, in other words, entre$reneurs re 2le to llo" te " $it l to $rodu"tive uses nd there2y to ""umul te it.

14 o% the 2usiness th t underlies it. In 5r h mBs words,32 &my re$ut tion @ su"h s it is, or $erh $s s re"ently revived @ seems to 2e sso"i ted "hie%ly with the "on"e$t o% Mv lue.B But I h ve 2een truly interested solely in su"h s$e"ts o% v lue s $resent themselves in "le r nd "onvin"ing m nner, derived %rom the 2 si" elements o% e rning $ower nd 2 l n"e0sheet $osition.+ Capital and the -alance 5heet The n ture nd ?u lity o% %irmBs ssets s y mu"h 2out its desir 2ility s n investment. The " sh net o% de2t on its 2 l n"e sheet is usu lly e siest to n lyse. &7hen the " sh holdings Kon the 2 l n"e sheetL re e>"e$tion lly l rge in rel tion to the m r*et $ri"e o% the se"urities, this % "tor usu lly deserves % vour 2le investment ttention. In su"h " ses, the sto"* m y 2e worth more th n the e rnings re"ord indi" tes 2e" use good $ rt o% the v lue is re$resented 2y " sh holdings th t "ontri2ute little to the in"ome ""ount. 'ventu lly the sto"*holders re li*ely to get the 2ene%it o% these " sh ssets, either through their distri2ution or their more $rodu"tive use in the 2usiness.+33 The n lysis o% other " tegories o% sset nd li 2ility is mu"h less str ight%orw rd. C sh ssets " n 2e ""e$ted t % "e v lue< 2ut 2uildings, m "hinery, non0m r*et 2le se"urities nd so on m y %et"h s little s h l% 8or less9 o% their st ted v lue in li?uid tion. Conversely, the 2 l n"e sheet m y "ont in di monds in the rough. -e l est te whose st ted v lue is 8s y9 Q43m m y, in the h nds o% nother entre$reneur, 2e worth Q.33m. )ore gener lly, nd s 5r h m w s "utely w re, the v lue o% ssets on the 2 l n"e sheet is su26e"tive in the sense th t these v lues o%ten "orres$ond only roughly to their origin l $ur"h se $ri"e, the $ri"e t whi"h they "ould $resently 2e sold or their %uture re$l "ement "ost. !""ordingly, nd 2sent %irm grounds to the "ontr ry, when n lysing %irms 5r h m routinely dis"ounted "urrent ssets su"h s re"eiv 2les 2y s mu"h s .30 24S, "urrent ssets su"h s %ungi2le inventories 2y t le st .3S 8 nd non0%ungi2le inventories 2y 24043S9 nd %i>ed nd mis"ell neous ssets su"h s s$e"i lised m "hinery, e?ui$ment nd non0m r*et 2le se"urities 2y s mu"h s 430.33S. The most di%%i"ult ssets to ssess, s 5r h m re"ognised, re int ngi2le ssets su"h s ""ounting goodwill, $ tents nd tr dem r*s, li"enses nd m sthe ds, " $it lised -&A nd ny other non0$hysi" l resour"es th t give 8or $ur$ort to give9 "om$ ny some "om$etitive dv nt ge in the m r*et$l "e. !t the s me time, however, he lso *new th t the e rnings gener ted 2y int ngi2les re ty$i" lly less vulner 2le to "om$etition th n ssets th t re?uire re$e ted " sh investments. Indeed, his ttitude w s h l%0"entury he d o% its timeG &under modern "onditions, so0" lled Mint ngi2les,B goodwill or even highly e%%i"ient org nis tion re every whit s re l %rom doll rs nd "ents st nd$oint s re 2uildings nd m "hinery. (urthermore, when "onditions re % vour 2le the enter$rise with the rel tively sm ll " $it l investment is li*ely to show more r $id r te o% growth. Frdin rily it " n e>$ nd its s les nd $ro%its t slight e>$ense nd there%ore grow more r $idly nd $ro%it 2ly %or its sto"*holders th n 2usiness re?uiring l rge $l nt investment $er doll r o% s les.+3C 7hen s*ed 2out the im$ort n"e o% net ssets t Ber*shire H th w yBs .114 !5), )r Bu%%ett noted th t it me sures histori" l in$ut< investment v lue, on the other h nd, dis"ounts %uture out$ut. Boo* v lue, when it is st ted su"h th t it re son 2ly ""ur tely
32

=ttered in s$ee"h delivered in .1H4 nd entitled &Three Sim$le )ethods o% Common Sto"* Sele"tion.+ +he Interpretation of 9inancial 5tatements, $. 23. 34 5ecurity 0nalysis, $. 4HH.
33

15 re%le"ts e"onomi" re lity, $rovides %loor through whi"h $ri"e not norm lly % ll. In 5r h mBs words, &we do not thin* th t ny Kh rdL rules m y re son 2ly 2e l id down on the su26e"t o% 2oo* v lue in rel tion to m r*et $ri"e, e>"e$t the strong re"ommend tion lre dy m de th t the $ur"h ser *now wh t he is doing on this s"ore nd 2e s tis%ied in his own mind th t he is "ting sensi2ly.+34 Capital and the Income 5tatement &The whole "om$le> o% goods destined %or "?uisition is ev lu ted in money terms,+ s id )ises, & nd this sum @ the " $it l @ is the st rting $oint o% e"onomi" " l"ul tion. The immedi te end o% "?uisitive "tion is to in"re se or, t le st, to $reserve the " $it l. The mount th t " n 2e "onsumed within de%inite $eriod without lowering the " $it l is " lled in"ome. I% "onsum$tion e>"eeds the in"ome v il 2le, the di%%eren"e is " lled " $it l "onsum$tion. I% the in"ome v il 2le is gre ter th n the mount "onsumed, the di%%eren"e is " lled s ving. !mong the m in t s*s o% e"onomi" " l"ul tion re those o% est 2lishing the m gnitudes o% in"ome, s ving nd " $it l "onsum$tion.+3; 5r h mites $$l ud nd strive to im$lement this $oint. Qu lity ssets tend to gener te ste dy e rnings< nd e rnings re vit l 2e" use &sto"*s sell Kon the 2 sis o%L e rnings nd dividends nd not on " sh0 sset v lues.+3H Qu lity ssets, in other words, tend to $rodu"e enough revenue to $ y " sh nd non0" sh e>$enses 8in"luding mortis tion nd de$re"i tion9, re$ y de2t 8 nd there2y gener te net in"ome9, $ y re son 2le dividend nd still ret in resour"es su%%i"ient to m int in nd $erh $s in"re se stre m o% e rnings into the %uture. 5r h m ssumed, nd de" des o% e>$erien"e h ve %%irmed, th t the gre ter the ?u lity nd st 2ility o% $ st e rnings, the more re son 2le the ssum$tion @ in the 2sen"e o% other eviden"e to the "ontr ry @ th t ste dy e rnings would "ontinue into the ne r %uture. By his re"*oning, "om$ nyBs e rnings were st 2le when 8.9 e rnings dou2led during the most re"ent ten ye rs nd 829 they de"lined 2y no more th n 4S two or %ewer times during th t interv l. Eet 5r h m w s very w ry 2out ny utom ti" ssum$tion th t trend o% e rnings o2served in the $ st would "ontinue into the %uture. 7hilst & trend shown in the $ st is % "t, M%uture trendB is only n ssum$tion. The $ st, or even " re%ul $ro6e"tions, " n 2e seen s only Mrough inde>B to the %uture.+3/ )r Bu%%ett greesG &I h ve no use wh tever %or $ro6e"tions or %ore" sts. They "re te n im$ression o% $$ rent $re"ision. The more meti"ulous they re, the more "on"erned you should 2e. 7e never loo* t $ro6e"tions 2ut we " re very mu"h 2out, nd loo* very dee$ly, t tr "* re"ords. I% "om$ ny h s lousy tr "* re"ord 2ut very 2right %uture, we will miss the o$$ortunity.+31 )ore s$e"i%i" lly, when e> mining %irmBs tr "* re"ord 5r h mites see* "le r eviden"e o% its 2ility to e>$ nd the m rgin 2etween its revenue nd " sh nd non0" sh e>$enses. This " n ent il "tions su"h s the redu"tion o% "osts, in"re se o% $ri"es, e>$ nsion into new m r*ets, nd revit lis tion or dis$os l o% un$ro%it 2le or insu%%i"iently $ro%it 2le o$er tions. To do these things "onsistently over time is, in e%%e"t, su""ess%ully to reinvest ret ined e rnings nd to in"re se the "om$ nyBs " $it l 8 nd, more o%ten th n not, " $it lis tion9.

35 36

Ibid. >uman 0ction, $. 2;.. 37 5ecurity 0nalysis, $. ;3/. 38 Ibid., $. C.. 39 Ber*shire H th w y, In"., .114 !nnu l 5ener l )eeting.

16 !ime Preferen+e, Interest and Rate of Return Fn wh t 2 ses, then, do 5r h mites re son tow rds n ssessment o% given se"urityBs v lueN (irst, they ssess the stru"ture o% the underlying %irmBs " $it l nd the st 2ility o% its e rnings. Se"ond, they s"ert in their time $re%eren"e 8i.e., the e>tent to whi"h they re $re$ red %orego "onsum$tion tod y in order to "onsume more in the %uture9 nd thus their desired r te o% return. !lthough v lue investors h ve never used the term &time $re%eren"e,+ em2edded within the 5r h mite $$ro "h to the v lu tion o% se"urities is notion o% time $re%eren"e nd interest th t is "om$ ti2le with !ustri n underst ndings o% these "on"e$ts.C3 !s use%ul ment l e>er"ise, v lue investors tend to "onsider these 2str "t $oints 2y "om$ ring whether the ownershi$ o% given nd rel tively &ris*y+ investment, su"h s $ rti"ul r "om$ nyBs sh res, is $re%er 2le to th t o% &ris* %ree+ 8i.e., !!!0r ted "or$or te or government9 2ond.C. !s rough rule th t dmits m ny " ve ts nd e>"e$tions, 5r h mites de"ide th t the sh re is $re%er 2le to the 2ond when its yield is nd is li*ely to rem in signi%i" ntly gre ter th n th t o% "om$ r 2le 2ond< "onversely, 2ond is more ttr "tive th n the sh re when its yield is e?u l to or gre ter th n th t o% "om$ r 2le sto"*. !s sim$le illustr tion, "onsider Telstr Cor$. Ltd 8one o% !ustr li Bs l rgest "or$or tions, $resently 4.S owned 2y the Commonwe lth P rli ment9 nd !ustr li n 5overnment de2t. !ssume th t you " n 2uy either one sh re t Q/.23 8its ver ge "losing $ri"e in F"to2er .1119 or hy$otheti" l %ive0ye r Commonwe lth 5overnment 2ond t $ri"e o% Q/.23 nd yield o% ;.34S 8the ver ge yield $rev iling in F"to2er .111 %or Commonwe lth 2onds m turing in Se$tem2er 233C9. (urther, ssume th t whi"hever you "hose you re &long term+ investor< th t is, you will hold your investment %or %ive ye rs. I% you $ur"h sed the 2ond then 2y l te 233C it w s virtu lly "ert in th t you would e rn Q2.4H 8i.e., 4..C "ents $er ye r %or %ive ye rs9 in "ou$ons nd u$on redem$tion would "olle"t tot l $ro"eeds o% Q.3.HH 8i.e., Q/.23 o% $rin"i$ l $lus Q2.4H o% "ou$ons9. !l s, 2e" use they re not %i>ed nd re su26e"t to wide v ri tion %rom one ye r to the ne>t, sh reBs &"ou$ons+ re very di%%i"ult to $redi"t with ny re son 2le degree o% ""ur "y. Be" use the investor must m *e ssum$tions 2out its "ou$ons, the n lysis o% the sh re is 8rel tive to th t o% the 2ond9 less str ight%orw rd nd more $rone to error. Cle rly, however, nd wh tever our ssum$tions, i% the Telstr sh re $ur"h sed l te in .111 t Q/.23 is going to 2e 2etter investment th n the 2ond then it must return t le st Q.3.HH 2y l te 233C. 5iven the gener l eu$hori $rev iling in !ustr li l te in .111 @ nd the virtu lly0un nimously enthusi sti" st tements 2out Telstr 2y government ministers, 2ro*ers, n lysts nd m r*et "omment tors @ this seemed to 2e n e sy hurdle %or Telstr to 6um$. But i% one h d $$lied re son r ther th n emotion to oneBs de"ision, then one would h ve ?ui"*ly re lised th t this hurdle w s "onsider 2ly higher th n the v st m 6ority o% m r*et $ rti"i$ nts re"ognised. T 2le . shows Telstr Bs "tu l "ou$on in .111 82H "ents9. It lso shows its $ro6e"ted "ou$ons %or the ne>t %ive ye rs under the then0un"ontroversi l 8"onsidering n lystsB
40

41

(or det ils, see &-is* nd -eturnG -est ting Some (und ment ls %or , lue Investors+ nd Leithner Letter Do. 4. 82; ) r"h 233C9. These 2onds, $ rti"ul rly government 2onds, re ty$i" lly du22ed &ris*0%ree+ 2e" use their $ro2 2ility o% de% ult is reg rded s minis"ule. Cle rly, however, nd 6udging %rom the histori" l re"ord, to own long0d ted 2onds %or e>tended $eriods o% time is to 2e r the h rm%ul "onse?uen"es o% virtu lly0 inevit 2le shrin* ge o% the $ur"h sing $ower o% the Q!, U, Q=S, et". In this sense, these 2onds re h rdly &ris* %ree.+

17 st tements nd &"onsensus+9 ssum$tion th t they would grow without interru$tion nd t "om$ound r te o% .HS $er ye r. !t the end o% %ive ye rs, "umul tive "ou$ons o% Q2.43 @ sli#htly less than the bondAs cumulati%e coupons @ would ""rue to the Telstr sh reholder s dividends, ret ined e rnings or some "om2in tion o% the two. (urther, note th t only in the %i%th ye r o% ownershi$ 8i.e., in 233C9 does Telstr Bs yield e>"eed th t o% &ris* %ree+ Commonwe lth 2ond 8H.2S versus the 2ondBs ;.34S9. =nder these ssum$tions, then, Telstr would gener te somewh t sm ller "umul tive "ou$on th n the 2ond. (urther, unli*e the 2ond there w s no gu r ntee th t one would 2e 2le to redeem oneBs initi l investment t e> "tly Q/.23 %ter %ive ye rs. !a.le 2: A )im-le 32444 Vintage5 %valuation of !elstra &or-6 Ltd &ou-on .111 2333 233. 2332 2333 233C Q3.2H Q3.32 Q3.3H Q3.C3 Q3.4. Q3.41 &umulative &ou-on Q3.2H Q3.41 Q3.1; Q..31 Q..13 Q2.43 7ield on 896:; 3.3S 3.1S C.4S 4.2S ;.2S H.2S

'ven when ided 2y these very m2itious ssum$tions, in other words, nd reg rdless o% the ne rly0un nimous ssur n"es nd re"ommend tions o% 2ro*ers, %in n"i l $l nners, %unds m n gers nd "omment tors, the $ur"h se o% Telstr w s ris*ier th n the $ur"h se o% the 2ond< the 2ond, in other words, seemed to 2e more ttr "tive th n the sh re. He who $ur"h sed the Telstr sh re l te in .111 "ommitted himsel% to w it o% %ive ye rs 2e%ore its $ro6e"ted yield m t"hed the &gu r nteed+ yield v il 2le immedi tely %rom the 2ond. 7hether he re"ognised it or not @ nd in retros$e"t it is $$ rent th t very %ew re"ognised it @ Telstr Bs %ortunes h d to un%old e> "tly ""ording to these very rosy $ro6e"tions nd %or the %ull %ive0ye r $eriod in order in the %i%th ye r to $rovide "umul tive "ou$on th t would not e>"eed the "ou$on gu r nteed %rom the %irst d y o% ownershi$ 2y the %ive0ye r Commonwe lth 2ond. Cle rly, then, in .111 the results o% n investment in Telstr "ould not re son 2ly 2e e>$e"ted to sur$ ss 2y wide m rgin th t v il 2le %rom &ris* %ree+ Commonwe lth 2ond. To 5r h mite v lue investor, it there%ore m de little sense to $ur"h se Telstr sh res t $ri"es remotely "lose to Q/.23.C2 To 2uy t n e>u2er nt $ri"e 8i.e., one th t re%le"ts e>u2er nt ssum$tions9 is not to llo" te " $it l on the 2 sis o% so2er ssessment o% "om$ nyBs o$er tionsG it is to g m2le th t the m r*et $ri"e o% the sh res in ?uestion will "ontinue to in"re se nd 2e"ome even more det "hed %rom the "om$ nyBs o$er tions, nd th t it will 2e $ossi2le to sell them to n ever gre ter %ool t still more in%l ted $ri"e. To 2uy Telstr under .111 "onditions $rev iling in .111, in other words, w s "le rly to s$e"ul te r ther th n invest. 8!nd s$e"ul tion inevit 2ly ends in te rsG in Se$tem2er0F"to2er 233C, Telstr Bs ver ge "losing $ri"e w s QC./4. In"luding the dividends e rned during the ensuing %ive ye rs, the $ur"h se o% its sh res t Q/.23 in l te .111 gener ted %ive0ye r return on oneBs outl y o% " $it l o% minus 22.4S9.

42

Doti"e th t 5r h mites seldom tt "h s$e"i%i" num2er to their ssessment o% se"urityBs v lue. )u"h more "ommonly, s in this inst n"e, their n lysis le ds them to "on"lude th t r tion l v lue lies % r 2elow some re%eren"e $oint.

18 But did the $ur"h se o% the 2ond "onstitute n investmentN In .111, this $ rti"ul r 2ond w s more ttr "tive th n the single given ltern tive. 7 s it more ttr "tive in gener l senseN Hitherto very little h s 2een s id 2out 5r h mitesB " l"ul tion o% investment returns. Dow, however, mu"h " n 2e s id. Dot sur$risingly, little or none o% it reson tes with the m instre m. I% time is money, s Ben (r n*lin ?ui$$ed, nd i% l "* o% time is de rth o% " $it l, s )ises demonstr ted, then we lth is time. The return on n investment, in other words, " n @ indeed, should @ 2e me sured in terms o% time. The degree o% investment ris* th t inheres in given sset v ries not only with the v ri 2ility o% its "ou$onsG it di%%ers s well ""ording to the length o% time one must w it 8i.e., the &$ y2 "* $eriod+9 in order to re"ou$ the initi l investment. The $ y2 "* $eriod o% the Telstr sh re n lysed in T 2le . is $$ro>im tely .2 ye rs, nd th t o% the Commonwe lth 5overnment 2ond to whi"h it w s "om$ red is slightly more th n .; ye rs. T 2le 2 shows why. 5iven our ssum$tions 8i.e., Telstr Bs $ur"h se $ri"e o% Q/.23, "ou$ons grow t .HS $er ye r9, .2 ye rs is re?uired %or the "umul tive "ou$ons to meet or e>"eed the ssetBs $ur"h se $ri"e. Twelve ye rs, in other words, is re?uired @ assumin# that the coupons e%entuate accordin# to this trajectory @ %or the Telstr sh re to &$ y %or itsel%.+ !n logously, the 2ond re?uires slightly more th n .; ye rs to do so. !a.le :: &om-aring Pa1.a+, Periods of the /24440 )to+, and Bond Telstr Sh re t Q/.23 7ith .HS 5rowth o% Cou$on Cou$on Cumul tive Cou$on Q3.2H Q3.2H .32 .41 .3H .1; .C3 ..31 .4. ..13 .41 2.C1 .;1 3../ ./. 3.11 .14 C.1C .... ;.34 ..21 H.3C Q..42 8969< ;.34S 5overnment Bond 7ith (i>ed Cou$on Cou$on Cumul tive Cou$on Q3.4. Q3.4. .4. ..32 .4. ..43 .4. 2.3C .4. 2.44 .4. 3.34 .4. 3.4; .4. C.3H .4. C.4/ .4. 4.31 .4. 4.;3 .4. ;... .4. ;.;2 .4. H..3 .4. H.;C Q3.4. 8962=

Ee r . Ee r 2 Ee r 3 Ee r C Ee r 4 Ee r ; Ee r H Ee r / Ee r 1 Ee r .3 Ee r .. 7ear 2: Ee r .3 Ee r .C Ee r .4 7ear 2<

7h t is n $$ro$ri te $ y2 "* $eriodN The nswer de$ends u$on oneBs time $re%eren"e< nd th t, in turn, will v ry %rom one investor to nother. But %ew gener l $oints " n 2e m de. (irst, shorter $ y2 "* $eriod 8i.e., higher r te o% return9 is $re%er 2le to longer one 8i.e., lower r te o% return9. This is 2e" use the longer the time re?uired in order to re"ou$ n investment, the ris*ier th t investment 2e"omes. The longer the $ y2 "* $eriod, the more de"ision to invest de$ends u$on the ver "ity o% its underlying ssum$tions, i.e., the more im$er tive it 2e"omes th t those ssum$tions "orres$ond to re lity. 7ith e "h ddition l ye r o% w iting, the "h n"es in"re se th t

19 un%orseen or un"ontroll 2le % "tors @ re"ession, de"re se o% the $ur"h sing $ower o% the "urren"y, new "om$etition, the loss o% *ey "ontr "ts, em$loyees nd other innumer 2le nd $erh $s unim gin 2le % "tors @ will de"re se 8or h lt the r te o% in"re se o%9 the siOe o% the ye rly "ou$on nd hen"e $rolong %urther the $ y2 "* $eriod. 7h t, %or e> m$le, re the "h n"es th t during the ne>t doOen ye rs the !ustr li n tele"ommuni" tions industry will "h nge signi%i" ntly in some un%oresee 2le w yN Se"ond, high n tur l r te o% interest im$lies l rge re?uired r te o% return nd more stringent hurdle %or $otenti l investments to surmount. (or e> m$le, n tur l r te o% .20 .4S 8whi"h Leithner & Co. uses to "ondu"t its investment o$er tions9 nd "onst nt stre m o% "ou$ons im$ly $ y2 "* $eriod o% ;0/ ye rs. By th t "riterion, 2oth the Telstr sto"*Bs nd the Commonwe lth 2ondBs $ y2 "* $eriod is un ""e$t 2ly long< nd 2y this 2solute, more "h llenging @ nd, to m instre m investors, virtu lly un*nown @ y rdsti"*, neither o% these se"urities re "om$elling. Sin"e the l te .113s, in other words, wide sw ths o% the investment universe 8i.e., most e?uities, 2onds nd re l est te9 h ve 2een un ""e$t 2ly de r< nd the %ive0ye r investment results o% most m instre m investors "on%irm the s d "onse?uen"es o% 2uying se"urities t in%l ted $ri"es. )r Bu%%ett "on"urs. !t Ber*shire H th w yBs 2333 !5) he st ted &in our view, the s me "on"lusion %its sto"*s gener lly. Aes$ite three ye rs o% % lling $ri"es, whi"h h ve signi%i" ntly im$roved the ttr "tiveness o% "ommon sto"*s, we still %ind very %ew th t even mildly interest us. Th t dism l % "t is testimony to the ins nity o% v lu tions re "hed during The 5re t Bu22le. =n%ortun tely, the h ngover m y $rove to 2e $ro$ortion l to the 2inge. The version to e?uities th t Ch rlie nd I e>hi2it tod y is % r %rom "ongenit l. 7e love owning "ommon sto"*s @ i% they " n 2e $ur"h sed t ttr "tive $ri"es. In my ;. ye rs o% investing, 43 or so ye rs h ve o%%ered th t *ind o% o$$ortunity. There will 2e ye rs li*e th t g in. K=ntil thenL we will sit on the sidelines. 7ith short0term money returning less th n .S %ter0t >, sitting it out is no %un. But o"" sion lly su""ess%ul investing re?uires in "tivity.+ &on+lusion ) instre m e"onomi"s h s not only 2e"ome esoteri", in"oherent nd uselessG it is "re ting in"re sing num2ers o% vi"tims. It is there%ore unsur$rising th t its re$ut tion @ whi"h is 2uilt u$on unre listi" nd o%ten 2surd ssum$tions, r" ne m them ti"s nd d t , $rivileges e>tended 2y governments nd $oli"ies whose destru"tive "onse?uen"es h ve 2e"ome $$ rent to m ny mem2ers o% the $u2li" @ is su%%ering. ) instre m %in n"e, whi"h is e%%e"tively su20%ield o% m instre m e"onomi"s, %inds itsel% in simil r $i"*le.C3 In sh r$ "ontr st, !ustri n S"hool e"onomists use re listi" $remises, sim$le 82ut not sim$listi"9 ver2 l logi" nd "ommonsensi" l eviden"e to e>$l in the "tions o% re l, %lesh0
43

!meri" ns, !ustr li ns nd Britons whose investments in mutu l %unds su%%ered siO 2le losses during The 5re t Bu22le re "orre"t to %eel ggrievedG %unds m n gers r ther th n &the m r*et+ were res$onsi2le %or the loss. Tim Poller nd J ne 7illi ms o% )"Pinsey & Co. drew these "on"lusions in $ $er entitled &!n tomy o% Be r ) r*et.+ !""ording to -o2ert 5ottli2sen 8+he 0ustralian H ) y 23339, &the )"Pinsey rese r"h doesnBt m *e 6udgements on the %unds m n gers. But it is "le r th t m ny I were sim$ly " ught in mire o% short0term %ore" sts nd inde> worshi$. They 2lew their "ustomersB money.+ !l s, this un$ l t 2le result is not tem$or ry 2err tionG it $$lies to most $oints in time nd to m 6or institution l investors who "ondu"t investment o$er tions in "onvention l m nner. (or det ils, see Ch $. > o% +he 9ortune 5ellers: +he -i# -usiness of -uyin# and 5ellin# 8redictions.

20 nd02lood $eo$le. So too do 5r h mite v lue investors,CC nd the results o% this "l nBs most $rominent mem2ers demonstr te the $$li" 2ility o% 5r h mBs ide s over the de" des nd in m ny "ountries.C4 Hen"e 8%rom m instre m $oint o% view9 $ r do>G there e>ists $hiloso$hy nd $r "ti" l $$ro "h to investment th t is 2oth un$o$ul r nd $ro%it 2le. In his &Su$erinvestors o% 5r h m0 nd0Aoddsville+ s$ee"h, )r Bu%%ett "on"luded &the se"ret h s 2een out %or %i%ty ye rs ever sin"e Ben 5r h m nd A ve Aodd wrote 5ecurity 0nalysis, yet I h ve seen no trend tow rd v lue investing in the thirty0%ive ye rs IBve $r "tised it. There seems to 2e some $erverse hum n "h r "teristi" th t li*es to m *e e sy things di%%i"ult. The " demi" world, i% nything, h s "tu lly 2 "*ed w y %rom the te "hing o% v lue investing over the l st 33 ye rs. ItBs li*ely to "ontinue th t w y. Shi$s will s il round the world 2ut the (l t ' rth So"iety will %lourish. There will "ontinue to 2e wide dis"re$ n"ies 2etween $ri"e nd v lue in the m r*et$l "e nd those who re d their 5r h m nd Aodd will "ontinue to $ros$er.+ To v lue investors, !ustri n e"onomi"s is 8or should 2e9 "om$elling 2e" use it su2sumes re l e"onomi" nd %in n"i l events within 6usti%i 2le l ws o% hum n "tion. =nli*e m instre m e"onomi" nd %in n"e, !ustri ns not only "*nowledge 2ut lso em$h sise the im$ort n"e o% entre$reneurshi$< indeed, !ustri ns "*nowledge th t sust ined entre$reneuri l "umen, whilst h rdly wides$re d, is nonetheless li*ely to e>ist. In turn, v lue investing nd the results "hieved 2y $rominent v lue investors m y interest !ustri ns 2e" use 5r h mites hold ?u si0!ustri n views @ or, t ny r te, views th t re "om$ ti2le to !ustri n views @ with res$e"t to im$ort nt e"onomi" nd %in n"i l $rin"i$les. , lue investors lso illustr te the $ositive results th t entre$reneuri l "tion " n "hieve. Aes$ite the m ny %ollies o% governments nd m instre m e"onomists nd investors, whi"h o%ten $rom$t v lue investors nd !ustri ns li*e to do$t r ther dour short0term outloo*s, 2oth 5r h mites nd )isesi ns re long0term o$timists. To do$t their $$ro "hes to e"onomi"s nd investment is ultim tely to %%irm 2 si" % ith in hum n n ture, " $it lism, oneBs "ountry nd %uture th t will 2e t le st s $ros$erous s the $resent. The %uture envis ged 2y these e"onomists nd gener ted $ rtly 2y these investors hel$s to vindi" te this % ith.

44

45

!s the $re% "e to the %irst edition o% 5ecurity 0nalysis $ut it, &we re "on"erned "hie%ly with "on"e$ts, methods, st nd rds, $rin"i$les, nd, 2ove ll, with logi" l re soning. 7e h ve stressed theory not %or itsel% lone 2ut %or its v lue in $r "ti"e. 7e h ve tried to void $res"ri2ing st nd rds whi"h re too stringent to %ollow, or te"hni" l methods whi"h re more trou2le th n they re worth.+ Both 5r h m nd Bu%%ett re rightly noted %or the $resent tion o% $ower%ul ide s in $l in nd sim$le l ngu ge. See lso Bu%%ettBs $re% "e to ! Pl in 'nglish H nd2oo*G How to Cre te Cle r S'C Ais"losure Ao"uments 87 shington, ACG Se"urities nd '>"h nge Commission, .11/9, &Bu%%ett Ae"odes (und Pros$e"tus+ 8@50 +oday, .C F"to2er .11C9 nd The Leithner Letter 8Do. CC, 2; !ugust 23339. !n overview o% the results "hieved 2y 5r h mBs most $rominent %ollowers, whom 7 rren Bu%%ett h s du22ed &the Su$erinvestors o% 5r h m0 nd0Aoddsville,+ $$e rs s !$$endi> . in +he Intelli#ent In%estor. 7h t H s 7or*ed In Investing 2y Tweedy, Brown LLC sets out the results "hieved 2y 5r h mite $$ro "h to investing in "ountries outside the =.S.

21

APP%(DI> 2 Leithner & Com$ ny Pty. Ltd. is $riv te investment "om$ ny nd not m n ged %und 8unit trust9. This stru"ture h s im$ort nt im$li" tions %or its o$er tions nd the me surement o% its results. !n investor e>its 8&" shes out+9 m n ged %und 2y selling its units 2 "* to the %und @ whi"h in e>treme " ses m y o2lige the %und to sell ssets in order to meet re?uests %or redem$tion. Fne " n ty$i" lly e>it n !ustr li n m n ged %und within %ew wor*ing d ys. In sh r$ "ontr st, the sh reholder o% $riv te "om$ ny sells his sh res not to the "om$ ny 2ut to third $ rty th t grees to 2uy them. Li*e selling re l est te, this $ro"ess " n t *e n e>tended $eriod o% time. !s "om$ ny, Leithner & Co.Bs results derive %rom dividends nd interest re"eived nd " $it l g ins re lised @ nd not %rom the %lu"tu tions o% the m r*et $ri"es o% the 2usinesses in its $ort%olio. ! m n ged %undBs results, on the other h nd, derive %rom dividends, interest nd " $it l g ins nd losses @ whether re lised or unre lised. 5iven identi" l $ort%olios, over time "om$ nyBs results would tend to 2e ste dier nd the %undBs results more su26e"t to the m r*etBs u$ nd downs. !""ordingly, Leithner & Co.Bs results, whi"h re summ rised in T 2le 3, h ve everything to do with the in"ome re"eived %rom the 2usinesses o% whi"h it is $ rt0owner @ nd nothing to do with either the $ri"e vol tility o% these sh res, 2onds, et"., or their $ri"e level t given $oint in time. 8Sin"e in"e$tion, the "om$ nyBs $ort%olio h s tended to "onsist in roughly 43043 s$lit 2etween " sh, "ommer"i l $ $er nd %lo ting r te notes on the one h nd nd the sh res o% !ustr li n nd Dew Je l nd "om$ nies on the other.9 !a.le ?: Leithner @ &o6As &umulative Results $alfB7earl1 Re-orting Periods )in+e In+e-tion !otal Benefi+ial %arnings Per )hare Q3.3H1 Q3.3/H Q3.3/4 Q3.314 Q3.3/; Q3.31H Q3.3;3 Q3...4 Q3.314V Q3.31/V Grossed #Dividend Per &lass % )hare Q3.3;/ Q3.3H. Q3.3H. Q3.3H. Q3.3H. Q3.3H. Q3.3C2 Q3.3H3 Q3.3H.V Q3.3H.V .;.;S .H.2S ./.3S ./..S ./.3S .4.HS .H.4S 2..3SV .1.3SV .3.1S .C.2S .C.2S .C.2S .C.2S ...3S ...2S .C..SV .C.2SV Annualised Return 3&om-an15 Annualised Return 3&lass % )hareB holders5

inan+ial 7ear .11102333 23330233. 233.02332 233202333 23330233C 233C02334

$alf

: n0:un :ul0Ae" : n0:un :ul0Ae" : n0:un :ul0Ae" : n0:un :ul0Ae" : n0:un :ul0Ae"

The steris*s denote " utious estim tes o% results 8whose degree o% %r n*ing will 2e "on%irmed nd %in lised 2y F"to2er 23349. =nder the Commonwe lthBs &Sim$li%ied

22 Im$ut tion System+ e%%e"tive . :uly 2332, "h nges were m de to the w y !ustr li n $riv te "om$ nies distri2ute dividend im$ut tion 8i.e., "or$or te t >9 "redits to their sh reholders. )ost im$ort ntly, they " n %r n* retros$e"tively 2ut must %r n* t "onst nt r te. This me ns th t "om$ ny h s the entire %in n"i l ye r nd u$ to %our months %ter the end o% th t ye r to m *e de"ision on the e>tent to whi"h it %r n*s distri2utions m de during the ye r. It is there%ore e>$e"ted th t de"ision 2out the %r n*ing o% dividends %or the 233C02334 %in n"i l ye r will 2e t *en 2y F"to2er 2334. In the t 2leBs third "olumn, +otal -eneficial 1arnin#s 8er 5hare me ns ll investment in"ome $er sh re. It is "onserv tive nd &2usinessli*e+ me sure in the sense th t it does not in"lude unre lised " $it l g ins nd is there%ore not in%luen"ed 2y %lu"tu tions in the m r*et $ri"es o% investments< it lso in"ludes the %r n*ing "redits sso"i ted with this in"ome. In the %ourth "olumn, *rossed @p 4i%idend 8er Class 1 5hare me ns the dividend 8in"luding %r n*ing "redits9 $ id $er Cl ss ' sh re. In the %i%th "olumn, 0nnualised (eturn 'Company) e>$resses the sum o% T.B.'.P.S. %or the "urrent nd immedi tely $re"eding h l%0ye r s $er"ent ge o% the Com$ nyBs ssets. !nd in the l st "olumn, 0nnualised (eturn 'Class 1 5hareholders) e>$resses the sum o% the 5.=.A. $er Cl ss ' sh re %or the "urrent nd immedi tely $re"eding h l%0ye r s $er"ent ge o% the Com$ nyBs ssets. '>$ressed in more "onvention l terms, e "h doll r invested on 33 :une .111, i% reinvested in the Com$ nyBs Cl ss ' sh res, would 2y 33 F"to2er 233C h ve grown to Q..;3, gener ted Q3..1H o% %r n*ing "redits nd $ossessed unre lised " $it l g ins o% more th n Q3.23 $er sh re. This e?u tes to tot l g in o% 11.HS nd "om$ound r te o% growth o% .C./S $er nnum.