Berkshire Hathaway 1999 Annual Meeting Audience Question # 43

The market is generally fairly efficient

Warren Buffett:

Zone 2.

Audience Member:

Hello. I’m Murray Cass from Markham, Ontario. First off, Mr. Buffett, Mr. Munger, I’d like to thank you for being so generous with your time every year at these meetings.

Mr. Buffett, many in the academic community call you lucky, or a statistical outlier. Mr. Munger, I’m not sure what they call you.

Warren Buffett:

Well, you’re free to speculate on what they call him.

Audience Member:

I know you don’t like to forecast the equity markets, but maybe you would dare to forecast the evolution of the debate between proponents of the efficient market theory and value investors.

Do you think there will ever be a reconciliation? And I’m talking especially about what’s taught at the business schools.

And as an addendum, are your designated successors, are they outliers as well?

Warren Buffett:

Well, we like to think they are. And then, they may be more outliers than we are.

The market is generally… you know, I… to me, it’s almost self-evident if you’ve been around markets for any length of time, that the market is generally fairly efficient.

It’s fairly efficient at pricing between asset classes, it’s fairly efficient in terms of evaluating specific businesses.

But being fairly efficient does not make… does not suffice to support an efficient market theory approach to investing or to all of the offshoots that have come off of that in the academic world.

So, if you’d believed in efficient market theory, and been taught that and adapted… adopted it for your own 20 or 30 years ago, or 10 years ago… I think it probably hit its peak about 20 years ago… you know, it would have been a terrible, terrible mistake.

It would have been like learning the earth is flat. It just… you would have had the wrong start in life.

Now, it became terribly popular in the academic world. It almost became a required belief in order to hold a position.

It was what was taught in all the advanced courses. And a mathematical theory that involved other investment questions was built around it, so that, if you went to the center of it and destroyed that part of it, it really meant that people who’d spent years and years and years getting Ph.D found their whole world crashing around them.

I would say that it’s been discredited in a fairly significant way, over the last decade or two. I mean, you don’t hear people talking the same way about it as you did 15 or 20 years ago.

But the market generally is fairly efficient in most ways. I mean, it is hard to find securities that are inefficiently priced. There are times when it’s relatively easy. But right now, for example, it’s difficult.

There… I don’t know exactly how much it’s holy writ, still, in business schools.

I certainly get the impression, as I go around talking to business schools, that it is far less regarded as, you know, sort of unquestioned dogma that it… like it was 15 or 20 years ago.

The University of Florida now has some courses in valuing businesses. University of Missouri’s putting in one.

And I think the high priests of efficient market theory are probably not in the same demand for speaking engagements and seminars and all of that as they were a decade or two ago.

It’s hard, though… it’s very interesting. It’s hard to dislodge a belief that becomes sort of… becomes the dogma of a finance department.

It’s so challenging to them and, you know, they have to, at age 30 or 40, to go back and say, “What I’ve learned up to this point, and what I’ve been teaching students and all of that, is silly,” that doesn’t come easy to people.

Charlie?

Charlie Munger:

Well, you know, Max Planck, the great physicist, said that even in physics, the old guard really didn’t accept the new ideas. The new ideas prevail, in due course, because the old guard fades away, clinging to the asininities of the past.

And that’s what’s happened to the hard-form efficient market theorists. They’re an embarrassment to the scene and they will soon be gone. On the…

People who think the market is reasonably efficient, or roughly efficient, of course, are absolutely correct and that will stay with us for the long pull.

Warren Buffett:

Thinking it’s roughly efficient, though, does nothing for you in academia. You can’t build anything around it. I mean, that… what people want are what they call elegant theories. And it just… it doesn’t work.

You know, what investment is about is valuing businesses. I mean, that is all there is to investment. You sit around and you try to figure out what a business is worth. And if it’s selling below that figure you buy it.

That, to my… you can’t find a course virtually in the country on how to value businesses. You can find all kinds of courses on how to, you know, how to compute beta, or whatever it may be, because that’s something the instructor knows how to do. But he doesn’t know how to value a business. So, the important subject doesn’t get taught. And it’s tough to teach.

I think Ben Graham did a good job of teaching it at Columbia, and I was very fortunate to run into him many decades ago.

But if you take the average Ph.D. in finance and ask him to value a business, he’s got a problem.

And if he can’t value it, I don’t know how he can invest in it, so therefore, he… it’s much easier to take up efficient market theory and say it doesn’t make any difference because everybody knows everything about it, anyway.

And there’s no sense in trying to think about valuing businesses. If the market’s efficient, it’s valued them all perfectly.

I never known what you talk about on the second day in that course. I mean…

The first… you walk in, you say, you know, “Everything’s valued perfectly, and class dismissed.” So, it puzzles me. But I encourage you to look for the inefficiently priced.

Warren Buffett:

Zone 3. Berkshire, incidentally, was inefficiently priced for a long time. And it wasn’t on the radar screen of… if you asked an academic how to value it, they wouldn’t have known what to look at exactly. Yep.

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