Doubts over value-investing

March 3rd, 2009

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Warren Buffett’s latest dismal performance had many fans of value-investing taken note (see this Bloomberg article). In his latest shareholder letter, he confessed that

During 2008 I did some dumb things in investments. I made at least one major mistake of commission and several lesser ones that also hurt. I will tell you more about these later. Furthermore, I made some errors of omission, sucking my thumb when new facts came in that should have caused me to re-examine my thinking and promptly take action.

Some of his fans are even questioning the whole philosophy of value investing. One of Australia’s value-investing tip-sheet (which we will not name here) confessed that

Ben Graham began his seminal piece on value investing with that quote, and several of his disciples built impressive records over many decades using it as their guiding principal. Buy established businesses when their share prices have fallen substantially and are out of favour, the theory goes, and sell them when the world comes to its senses. It worked for the best part of 70 years. Then, in 2008, it stopped working.

I wouldn?t go that far but it?s clear this financial and economic crisis is different to anything Warren Buffett has experienced. Unless you?re an octogenarian, that makes it different to anything you or I have seen either. It?s time to tread extremely carefully.

Today’s Global Financial Crisis (GFC) is something that we warned our readers. As recent as last month, we wrote in Should you follow Buffett and be greedy now? that

Finally, take note of this: Warren Buffett has never experienced the Great Depression for himself. Neither has he experienced hyperinflation of Weimar Germany. All his life, he lives in America as an American. Today?s America is at a turning point and there?s no guarantee that it will return to the America that Buffett experienced all his life.

In December last year, we reported in Is the Warren Buffett way dead? that Marc Faber said that

I think The Warren Buffett approach is dead, and it?s been dead for ten years, and it?s going to be dead for another ten years.

In July last year, we wrote in Should value investors be ?bullish? in a bear market?,

Here, we see a potential trap for the unwary value investor.

But this is where the Achilles? heel of value-oriented stock research lies. Because they hold a neutral view on the macroeconomic big picture and business cycle, they can severely underestimate the effects of a protracted downturn in the earnings of businesses.

If the global economy falls into a Greater Depression, many of today’s ‘bargain’ stocks will still turn out to be value-traps. For us, we are not buying stocks yet.

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