In their August 2005 paper entitled “Imitation is the Sincerest Form of Flattery: Warren Buffett and Berkshire Hathaway”, Gerald Martin and John Puthenpurackal rigorously examine various possible explanations for Berkshire Hathaway’s superior investment performance. Is it luck? Is it reward-for-risk? Is it outstanding stock-picking skill? Using information on 261 common equity investments from Berkshire Hathaway’s SEC filings and market databases for 1980-2003, they conclude that:
- The mean (median) annualized returns for the stock investments in Berkshire’s portfolio from 1980 to 2003 are 39.38% (19.92%). The top five holdings often comprise over 70% of the total portfolio based on market value. The investment strategy is best characterized as big-growth.
- While beating the market in 20 out of 24 years from 1980-2003 is possibly due to randomness at a 5% significance level, the magnitude by which Berkshire beats the market (an average of 12.24% annually) makes “luck” an unlikely explanation.
- High levels of risk do not explain Berkshire’s high returns.
- Most likely, Warren Buffett is an investor with superior stock-picking skill that allows him to identify undervalued securities and thus obtain risk-adjusted positive abnormal returns.
- Stock price reactions suggest that the stock market views Berkshire’s purchases as positive signals. An investor who mimicked Berkshire Hathaway’s portfolio after public disclosure of such could have achieved positive abnormal annual returns of 7%-10%.
The paper includes an interesting literature review of luck versus skill in investment manager outperformance.
In summary, Warren Buffett’s consistently high level of outperformance challenges the Efficient Markets Hypothesis.
