The Superinvestors of Graham-and-Doddsville
Encyclopedia
"The Superinvestors of Graham-and-Doddsville" is an article by Warren Buffett
promoting value investing
, published in the Fall, 1984 issue of Hermes, Columbia Business School
magazine. It was based on a speech given on May 17, 1984 at the Columbia University
School of Business in honor of the 50th anniversary of the publication of Benjamin Graham
and David Dodd
's book Security Analysis. The speech and article challenged the idea that equity markets are efficient
through a study of nine successful investment funds generating long-term returns above the market index. All these funds were managed by Benjamin Graham's alumni, pursuing different investment tactics but following the same "Graham-and-Doddsville" value investing strategy.
The article has been reprinted in books on Buffett (e.g. Miles, 2004).
, a University of Rochester
professor and a proponent of efficient market theory, and Buffett, who was known to oppose it. Jensen argued that a simple coin tossing experiment among a large number of investors would generate a few successive winners, and the same happens in real financial markets. Buffett grabbed Jensen's metaphor
and started his own speech with the same coin tossing experiment. There was one difference, he noted: somehow, a statistically significant share of the winning minority belongs to the same league. They follow value investing
rules set up by Graham and Dodd.
Buffett then proceeds to present nine successful investment funds. One is his own Buffett Partnership, liquidated in 1969. Two are pension fund
s with three and eight portfolio managers; Buffett asserts that he had influence in selecting value-minded managers and the overall strategy of the funds. The other six funds were managed by Buffett's business associates or people otherwise well known to Buffett. Seven investment partnerships have demonstrated average long-term returns with a double-digit lead over market average. Pension funds, bound to more conservative portfolio mix, showed 5% and 8% lead.
Buffett takes special care to explain that the nine funds have little in common except the value strategy and personal connections to himself. Even when there are no striking differences in stock portfolio, individual mixes and timing of purchases are substantially different. The managers were indeed independent of each other.
Buffett made three side notes concerning value investment theory. First, he underscored Graham-Dodds postulate: the higher the margin between price of undervalued stock and its value, the lower is investors' risk. On the opposite, as margin gets thinner, risks increase. Second, potential returns diminish with increasing size of the fund, as the number of available undervalued stocks decreases. Finally, analyzing the backgrounds of seven successful managers, he makes a conclusion that an individual either accepts value investing strategy at first sight, or never accepts it, regardless of training and other people's examples. "There seems to be a perverse human characteristic that likes to make easy things difficult... it's likely to continue this way. Ships will sail around the world, but the Flat Earth Society will flourish... and those who read their Graham and Dodd will continue to prosper".
's 1991 Margin of Safety and was cited by Klarman as a principal source; "Buffett's argument has never, to my knowledge, been addressed by the efficient-market theorists; they evidently prefer to continue to prove in theory what was refuted in practice". In 2000s Klarman's book, never reprinted since 1991, achieved a cult status and sells for four-digit prices.
Buffett's article was a "titular subject" of 2001 Value Investing: From Graham to Buffett and Beyond.
In 2005 Louis Lowenstein compiled Graham-and-Doddsville Revisited – a review of the changes in mutual fund
economics, comparing the Goldfarb Ten funds against Buffett's value investing standard. Lowenstein pointed out that "value investing requires not just patient managers but also patient investors", since value investing managers have also demonstrated regular drops in portfolio values (offset by subsequent profits).
(1995) called him "a three-sigma
event" (1 in 370), Michael Lewis
(1989) a "big winner produced by a random game".
Warren Buffett
Warren Edward Buffett is an American business magnate, investor, and philanthropist. He is widely regarded as one of the most successful investors in the world. Often introduced as "legendary investor, Warren Buffett", he is the primary shareholder, chairman and CEO of Berkshire Hathaway. He is...
promoting value investing
Value investing
Value investing is an investment paradigm that derives from the ideas on investment and speculation that Ben Graham and David Dodd began teaching at Columbia Business School in 1928 and subsequently developed in their 1934 text Security Analysis...
, published in the Fall, 1984 issue of Hermes, Columbia Business School
Columbia Business School
Columbia Business School is the business school of Columbia University in Manhattan, New York City. It was established in 1916 to provide business training and professional preparation for undergraduate and graduate Columbia University students...
magazine. It was based on a speech given on May 17, 1984 at the Columbia University
Columbia University
Columbia University in the City of New York is a private, Ivy League university in Manhattan, New York City. Columbia is the oldest institution of higher learning in the state of New York, the fifth oldest in the United States, and one of the country's nine Colonial Colleges founded before the...
School of Business in honor of the 50th anniversary of the publication of Benjamin Graham
Benjamin Graham
Benjamin Graham was an American economist and professional investor. Graham is considered the first proponent of value investing, an investment approach he began teaching at Columbia Business School in 1928 and subsequently refined with David Dodd through various editions of their famous book...
and David Dodd
David Dodd
David LeFevre Dodd was an American educator, financial analyst, author, economist, professional investor, and in his student years, a of, and as a postgraduate, close colleague of Benjamin Graham at Columbia Business School.The Wall Street Crash of 1929 almost wiped out Graham, who had started...
's book Security Analysis. The speech and article challenged the idea that equity markets are efficient
Efficiency (economics)
In economics, the term economic efficiency refers to the use of resources so as to maximize the production of goods and services. An economic system is said to be more efficient than another if it can provide more goods and services for society without using more resources...
through a study of nine successful investment funds generating long-term returns above the market index. All these funds were managed by Benjamin Graham's alumni, pursuing different investment tactics but following the same "Graham-and-Doddsville" value investing strategy.
The article has been reprinted in books on Buffett (e.g. Miles, 2004).
The speech
Columbia Business School arranged celebration of Graham–Dodd's jubilee as a contest between Michael JensenMichael Jensen
Michael Cole "Mike" Jensen is an American economist working in the area of financial economics. He is currently the managing director in charge of organizational strategy at Monitor Group, a strategy consulting firm, and the Jesse Isidor Straus Professor of Business Administration, Emeritus at...
, a University of Rochester
University of Rochester
The University of Rochester is a private, nonsectarian, research university in Rochester, New York, United States. The university grants undergraduate and graduate degrees, including doctoral and professional degrees. The university has six schools and various interdisciplinary programs.The...
professor and a proponent of efficient market theory, and Buffett, who was known to oppose it. Jensen argued that a simple coin tossing experiment among a large number of investors would generate a few successive winners, and the same happens in real financial markets. Buffett grabbed Jensen's metaphor
Metaphor
A metaphor is a literary figure of speech that uses an image, story or tangible thing to represent a less tangible thing or some intangible quality or idea; e.g., "Her eyes were glistening jewels." Metaphor may also be used for any rhetorical figures of speech that achieve their effects via...
and started his own speech with the same coin tossing experiment. There was one difference, he noted: somehow, a statistically significant share of the winning minority belongs to the same league. They follow value investing
Value investing
Value investing is an investment paradigm that derives from the ideas on investment and speculation that Ben Graham and David Dodd began teaching at Columbia Business School in 1928 and subsequently developed in their 1934 text Security Analysis...
rules set up by Graham and Dodd.
The statement
Buffett starts the article with a rebuttal of a popular academic opinion that Graham and Dodd's approach ("look for values with a significant margin of safety relative to [stock] prices") had been made obsolete by improvements in market analysis and information technology. If the markets are efficient, then no one can beat the market in the long run; an apparent long-term success can happen by pure chance only. However, argues Buffett, if a substantial share of these long-term winners belong to a group of value investing adherents, and they operate independently of each other then their success is more than a lottery win; it is a triumph of the right strategy.Buffett then proceeds to present nine successful investment funds. One is his own Buffett Partnership, liquidated in 1969. Two are pension fund
Pension fund
A pension fund is any plan, fund, or scheme which provides retirement income.Pension funds are important shareholders of listed and private companies. They are especially important to the stock market where large institutional investors dominate. The largest 300 pension funds collectively hold...
s with three and eight portfolio managers; Buffett asserts that he had influence in selecting value-minded managers and the overall strategy of the funds. The other six funds were managed by Buffett's business associates or people otherwise well known to Buffett. Seven investment partnerships have demonstrated average long-term returns with a double-digit lead over market average. Pension funds, bound to more conservative portfolio mix, showed 5% and 8% lead.
| Fund | Manager | Investment approach and constraints | Fund Period | Fund Return | Market return |
|---|---|---|---|---|---|
| WJS Limited Partners | Walter J. Schloss Walter Schloss Walter J. Schloss is a well-regarded value investor, as well as a notable disciple of the Benjamin Graham school of investing.-Biography:... |
Diversified small portfolio (over 100 stocks, US$ 45M), second-tier stock | 1956–1984 | 21.3% / 16.1% | 8.4% (S&P) |
| TBK Limited Partners | Tom Knapp | Mix of passive investments and strategic control in small public companies | 1968–1983 | 20.0% / 16.0% | 7.0% (DJIA) |
| Buffett Partnership, Ltd. | Warren Buffett | 1957–1969 | 29.5% / 23.8% | 7.4% (DJIA) | |
| Sequoia Fund, Inc. | William J. Ruane William J. Ruane William J. Ruane was a Wall Street investment manager and philanthropist.... |
Preference for blue chips stock | 1970–1984 | 18.2% | 10.0% |
| Charles Munger, Ltd. | Charles Munger | Concentration on a small number of undervalued stock | 1962–1975 | 19.8% / 13.7% | 5.0% (DJIA) |
| Pacific Partners, Ltd. | Rick Guerin | 1965–1983 | 32.9% / 23.6% | 7.8% (S&P) | |
| Perlmeter Investments, Ltd | Stan Perlmeter | 1965–1983 | 23.0% / 19.0% | 7.0% (DJIA) | |
| Washington Post Master Trust | 3 different managers | Must keep 25% in fixed interest instruments | 1978–1983 | 21.8% | 7.0% (DJIA) |
| FMC Pension Fund | 8 different managers | 1975–1983 | 17.1% | 12.6% (Becker Avg.) | |
Buffett takes special care to explain that the nine funds have little in common except the value strategy and personal connections to himself. Even when there are no striking differences in stock portfolio, individual mixes and timing of purchases are substantially different. The managers were indeed independent of each other.
Buffett made three side notes concerning value investment theory. First, he underscored Graham-Dodds postulate: the higher the margin between price of undervalued stock and its value, the lower is investors' risk. On the opposite, as margin gets thinner, risks increase. Second, potential returns diminish with increasing size of the fund, as the number of available undervalued stocks decreases. Finally, analyzing the backgrounds of seven successful managers, he makes a conclusion that an individual either accepts value investing strategy at first sight, or never accepts it, regardless of training and other people's examples. "There seems to be a perverse human characteristic that likes to make easy things difficult... it's likely to continue this way. Ships will sail around the world, but the Flat Earth Society will flourish... and those who read their Graham and Dodd will continue to prosper".
Influence
Graham-and-Doddsville influenced Seth KlarmanSeth Klarman
Seth Klarman is the founder and president of the Baupost Group, a Boston-based private investment partnership, and the author of a book on value investing.-Career:...
's 1991 Margin of Safety and was cited by Klarman as a principal source; "Buffett's argument has never, to my knowledge, been addressed by the efficient-market theorists; they evidently prefer to continue to prove in theory what was refuted in practice". In 2000s Klarman's book, never reprinted since 1991, achieved a cult status and sells for four-digit prices.
Buffett's article was a "titular subject" of 2001 Value Investing: From Graham to Buffett and Beyond.
In 2005 Louis Lowenstein compiled Graham-and-Doddsville Revisited – a review of the changes in mutual fund
Mutual fund
A mutual fund is a professionally managed type of collective investment scheme that pools money from many investors to buy stocks, bonds, short-term money market instruments, and/or other securities.- Overview :...
economics, comparing the Goldfarb Ten funds against Buffett's value investing standard. Lowenstein pointed out that "value investing requires not just patient managers but also patient investors", since value investing managers have also demonstrated regular drops in portfolio values (offset by subsequent profits).
Rebuttal
Buffett, despite his untarnished reputation in mainstream business press, remains rarely cited within traditional academia. A 2004 search of 23,000 papers on economics revealed only 20 references to any publication by Buffett. A significant share of references simply rebutt Buffett's statements or reduce his own success to pure luck and probability theory. William SharpeWilliam Forsyth Sharpe
William Forsyth Sharpe is the STANCO 25 Professor of Finance, Emeritus at Stanford University's Graduate School of Business and the winner of the 1990 Nobel Memorial Prize in Economic Sciences....
(1995) called him "a three-sigma
68-95-99.7 rule
In statistics, the 68-95-99.7 rule, or three-sigma rule, or empirical rule, states that for a normal distribution, nearly all values lie within 3 standard deviations of the mean....
event" (1 in 370), Michael Lewis
Michael Lewis (author)
Michael Lewis is an American non-fiction author and financial journalist. His bestselling books include The Big Short: Inside the Doomsday Machine, Liar's Poker, The New New Thing, Moneyball: The Art of Winning an Unfair Game, The Blind Side: Evolution of a Game, Panic and Home Game: An...
(1989) a "big winner produced by a random game".