Wednesday, December 26, 2007

Reflecting Times – Day One

(Note: This week is one of those two weeks per year when the Sectors and Styles Strategy Report is not produced. There are no changes to the Model Growth Portfolio. The next report will be published Monday, December 31st.)

This holiday shortened week presents a good time to reflect and review some of the key principles of investment decision making. Accordingly, with the Sage of Omaha in the news today, the following thoughts from Warren Buffet on risk (as expressed in the single factor – beta) are worth considering:

“In assessing risk, a beta purist will disdain examining what a company produces, what its competitors are doing, or how much borrowed money the company employs. He may even prefer not to know the company’s name. What he treasures is the price history of its stock. In contrast, we’ll happily forgo knowing the price history of its stock and instead will seek whatever information will further our understanding of a company’s business. …

The theoretician bred on beta has no mechanism for differentiating the risk in, say, a single-product toy company selling pet rocks or hula hoops from that of another toy company whose sole product is Monopoly or Barbie. But it’s quite possible for ordinary investors to make that distinction if they have a reasonable understanding of consumer behavior and the factors that create long-term competitive strength or weakness. Obviously, every investor will make mistakes. But by confining himself to a relatively few, easy-to-understand cases, a reasonably intelligent, informed and diligent person can judge investment risks with a useful degree of accuracy.”

The Essays of Warren Buffett: Lessons for Corporate America
(2001), pp. 77-79

Quote is contained within the Morgan Stanley "Investment Perspectives" report of December 12, 2007

1 comment:

Valueman said...

Morgan Stanley has selected a Buffet quote which, while insightful, really misses the point about why beta is not an appropriate risk metric when seeking alpha going forward...something that Warren knows all to well. Beta is a backward looking measure of price volatility versus the market. This is only a measure of risk if your main goal is preservation of value (a market return)with immediate liquidity. This describes the investment goals of few who invest in the stock market. For most, risk is better defined and the probability that a particular stock is going to under or out-perform over an intermediate or longer term. Volatility isn't as important as trend. And relative price trends are the result of the fundamentals that Buffet concerns himself with.