The Snowball_ Warren Buffett and the Business of Life - Alice Schroeder [316]
Sitting in the first row alongside Buffett, the frail, aged David Dodd leaned over and whispered, “Take his pants off, Warren.”
Buffett had spent weeks preparing for this event. He’d anticipated the coin-flipping argument. When he got up for his turn, he said that while this might be so, the row of heads would not be random if all the successful coin-flippers came from the same town. For example, if all the coin-flippers who kept flipping heads came from the tiny village of Graham-and-Doddsville, something specific that they were doing must be making those coins flip heads.
He then pulled out a chart with the track record of nine money managers—Bill Ruane; Charlie Munger; Walter Schloss; Rick Guerin; Tom Knapp and Ed Anderson at Tweedy, Browne; the FMC pension fund; himself; and two others.44 Their portfolios were not similar; despite a certain amount of coattailing in the early years, they had largely invested on their own. All of them, he said, came from the village of Graham-and-Doddsville, had been flipping straight heads for more than twenty years, and for the most part had not retired and were still doing it. Such a concentration proved statistically that their success could not have come by random luck.
Since what Buffett said was obviously true on its face, the audience broke into applause and lobbed questions at him, which he answered gladly and at length. The random-walk theory was based on statistics and Greek-letter formulas. The existence of people like Buffett had been waved away using bafflemath. Now, to the Grahamites’ relief, Buffett had used numbers to disprove the absolutist version of the efficient-market hypothesis.
That fall, he wrote up “The Superinvestors of Graham-and-Doddsville” as an article for Hermes, the magazine of the Columbia Business School. Firing a flamethrower at the edifice of the EMH, this article did much to cement his reputation among investors. And over time, the random walkers revised their argument into “semi-strong” and “weak” forms that allowed for exceptions.45 The one great service EMH would have performed, if anybody listened, was to discourage the average person from believing they could outwit the market. Nobody except the toll-takers could object to that. But the tendencies of humankind being what they are, EMH became de rigueur in business school classrooms, yet the number of individual investors and professional money managers who assumed that they were smarter than average only grew, the toll-takers kept taking their cut, and the market went on as before. Thus the main effect of “The Superinvestors of Graham-and-Doddsville” was to add to the growing legend, even the cult, that was building around Warren Buffett.
Meanwhile, EMH and its underpinning, the capital asset pricing model, drove extraordinary and deep roots into the investing world; it launched a view of the stock market as an efficient statistical machine. In a reliably efficient market, a stock was risky not based on where it was trading versus its intrinsic value, but based on “volatility”—how likely it was to deviate from the market average. Using that information and newly unleashed computing power, economists and mathematicians started going to Wall Street to make more money than they ever could in academia.
Knowing every stock’s volatility allowed investment managers to shape and carve portfolios using stocks of greater and lesser volatility built around a core list of stocks that made up a near-replica of the market