In the acquisition arena, restructuring has been raised to an art form: Managements now frequently use mergers to dishonestly rearrange the value of assets and liabilities in ways that will allow them to both smooth and swell future earnings. Indeed, at deal time, major auditing firms sometimes point out the possibilities for a little accounting magic (or for a lot). Getting this push from the pulpit, first-class people will frequently stoop to third-class tactics. CEOs understandably do not find it easy to reject auditor-blessed strategies that lead to increased future “earnings".

Source:   Berkshire Hathaway Shareholder Letters

Clearly the attitude of disrespect that many executives have today for accurate reporting is a business disgrace. And auditors, as we have already suggested, have done little on the positive side. Though auditors should regard the investing public as their client, they tend to kowtow instead to the managers who choose them and dole out their pay. (“Whose bread I eat, his song I sing.”)

Source:   Berkshire Hathaway Shareholder Letters

There is only one combination of facts that makes it advisable for a company to repurchase its shares: First, the company has available funds — cash plus sensible borrowing capacity — beyond the near-term needs of the business and, second, finds its stock selling in the market below its intrinsic value, conservatively-calculated. To this we add a caveat: Shareholders should have been supplied all the information they need for estimating that value. Otherwise, insiders could take advantage of their uninformed partners and buy out their interests at a fraction of true worth. We have, on rare occasions, seen that happen. Usually, of course, chicanery is employed to drive stock prices up, not down...The business “needs” that I speak of are of two kinds: First, expenditures that a company must make to maintain its competitive position (e.g., the remodeling of stores at Helzberg’s) and, second, optional outlays, aimed at business growth, that management expects will produce more than a dollar of value for each dollar spent (R. C. Willey’s expansion into Idaho).

Source:   Berkshire Hathaway Shareholder Letters

But a pin lies in wait for every bubble. And when the two eventually meet, a new wave of investors learns some very old lessons: First, many in Wall Street a community in which quality control is not prized will sell investors anything they will buy. Second, speculation is most dangerous when it looks easiest.

Source:   Berkshire Hathaway Shareholder Letters

It’s fine for a CEO to have his own internal goals and, in our view, it’s even appropriate for the CEO to publicly express some hopes about the future, if these expectations are accompanied by sensible caveats. But for a major corporation to predict that its per-share earnings will grow over the long term at, say, 15% annually is to court trouble.

Source:   Berkshire Hathaway Shareholder Letters

The problem arising from lofty predictions is not just that they spread unwarranted optimism. Even more troublesome is the fact that they corrode CEO behavior. Over the years, Charlie and I have observed many instances in which CEOs engaged in uneconomic operating maneuvers so that they could meet earnings targets they had announced. Worse still, after exhausting all that operating acrobatics would do, they sometimes played a wide variety of accounting games to “make the numbers.” These accounting shenanigans have a way of snowballing: Once a company moves earnings from one period to another, operating shortfalls that occur thereafter require it to engage in further accounting maneuvers that must be even more “heroic.” These can turn fudging into fraud. (More money, it has been noted, has been stolen with the point of a pen than at the point of a gun.)

Source:   Berkshire Hathaway Shareholder Letters

Errors will usually be honest, reflecting only the human tendency to take an optimistic view of one’s commitments. But the parties to derivatives also have enormous incentives to cheat in accounting for them. Those who trade derivatives are usually paid (in whole or part) on “earnings” calculated by mark-to-market accounting. But often there is no real market (think about our contract involving twins) and “mark-to-model” is utilized. This substitution can bring on large-scale mischief. As a general rule, contracts involving multiple reference items and distant settlement dates increase the opportunities for counter-parties to use fanciful assumptions. In the twins scenario, for example, the two parties to the contract might well use differing models allowing both to show substantial profits for many years. In extreme cases, mark-to-model degenerates into what I would call mark-to-myth.

Source:   Berkshire Hathaway Shareholder Letters

I can assure you that the marking errors in the derivatives business have not been symmetrical. Almost invariably, they have favored either the trader who was eyeing a multi-million dollar bonus or the CEO who wanted to report impressive “earnings” (or both). The bonuses were paid, and the CEO profited from his options. Only much later did shareholders learn that the reported earnings were a sham.

Source:   Berkshire Hathaway Shareholder Letters

...beware of companies displaying weak accounting. If a company still does not expense options, or if its pension assumptions are fanciful, watch out. When managements take the low road in aspects that are visible, it is likely they are following a similar path behind the scenes. There is seldom just one cockroach in the kitchen. Trumpeting EBITDA (earnings before interest, taxes, depreciation and amortization) is a particularly pernicious practice. Doing so implies that depreciation is not truly an expense, given that it is a “non-cash” charge. That’s nonsense. In truth, depreciation is a particularly unattractive expense because the cash outlay it represents is paid up front, before the asset acquired has delivered any benefits to the business. Imagine, if you will, that at the beginning of this year a company paid all of its employees for the next ten years of their service (in the way they would lay out cash for a fixed asset to be useful for ten years). In the following nine years, compensation would be a “non-cash” expense – a reduction of a prepaid compensation asset established this year. Would anyone care to argue that the recording of the expense in years two through ten would be simply a bookkeeping formality?

Source:   Berkshire Hathaway Shareholder Letters

...unintelligible footnotes usually indicate untrustworthy management. If you can’t understand a footnote or other managerial explanation, it’s usually because the CEO doesn’t want you to. Enron’s descriptions of certain transactions still baffle me.

Source:   Berkshire Hathaway Shareholder Letters

Over the last 35 years, American business has delivered terrific results. It should therefore have been easy for investors to earn juicy returns: All they had to do was piggyback Corporate America in a diversified, low-expense way. An index fund that they never touched would have done the job. Instead many investors have had experiences ranging from mediocre to disastrous. There have been three primary causes: first, high costs, usually because investors traded excessively or spent far too much on investment management; second, portfolio decisions based on tips and fads rather than on thoughtful, quantified evaluation of businesses; and third, a start-and-stop approach to the market marked by untimely entries (after an advance has been long underway) and exits (after periods of stagnation or decline). Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful.

Source:   Berkshire Hathaway Shareholder Letters

Charlie and I love the idea of shareholders thinking and behaving like owners. Sometimes that requires them to be pro-active. And in this arena large institutional owners should lead the way. a. So far, however, the moves made by institutions have been less than awe-inspiring. Usually, they’ve focused on minutiae and ignored the three questions that truly count. First, does the company have the right CEO? Second, is he/she overreaching in terms of compensation? Third, are proposed acquisitions more likely to create or destroy per-share value?

Source:   Berkshire Hathaway Shareholder Letters

Too often, executive compensation in the U.S. is ridiculously out of line with performance. That won’t change, moreover, because the deck is stacked against investors when it comes to the CEO’s pay. The upshot is that a mediocre-or-worse CEO – aided by his handpicked VP of human relations and a consultant from the ever-accommodating firm of Ratchet, Ratchet and Bingo – all too often receives gobs of money from an ill-designed compensation arrangement.

Source:   Berkshire Hathaway Shareholder Letters

Take, for instance, ten year, fixed-price options (and who wouldn’t?). If Fred Futile, CEO of Stagnant, Inc., receives a bundle of these – let’s say enough to give him an option on 1% of the company – his self-interest is clear: He should skip dividends entirely and instead use all of the company’s earnings to repurchase stock.

Source:   Berkshire Hathaway Shareholder Letters

Huge severance payments, lavish perks and outsized payments for ho-hum performance often occur because comp committees have become slaves to comparative data. The drill is simple: Three or so directors – not chosen by chance – are bombarded for a few hours before a board meeting with pay statistics that perpetually ratchet upwards. Additionally, the committee is told about new perks that other managers are receiving. In this manner, outlandish “goodies” are showered upon CEOs simply because of a corporate version of the argument we all used when children: “But, Mom, all the other kids have one.” When comp committees follow this “logic,” yesterday’s most egregious excess becomes today’s baseline.

Source:   Berkshire Hathaway Shareholder Letters

If your adviser talks to you about double-digit returns from equities, explain this math to him – not that it will faze him. Many helpers are apparently direct descendants of the queen in Alice in Wonderland, who said: “Why, sometimes I’ve believed as many as six impossible things before breakfast.” Beware the glib helper who fills your head with fantasies while he fills his pockets with fees.

Source:   Berkshire Hathaway Shareholder Letters

I know of no reporting mechanism that would come close to describing and measuring the risks in a huge and complex portfolio of derivatives. Auditors can’t audit these contracts, and regulators can’t regulate them. When I read the pages of “disclosure” in 10-Ks of companies that are entangled with these instruments, all I end up knowing is that I don’t know what is going on in their portfolios (and then I reach for some aspirin).

Source:   Berkshire Hathaway Shareholder Letters

In evaluating a stock-for-stock offer, shareholders of the target company quite understandably focus on the market price of the acquirer’s shares that are to be given to them. But they also expect the transaction to deliver them the intrinsic value of their own shares – the ones they are giving up. If shares of a prospective acquirer are selling below their intrinsic value, it’s impossible for that buyer to make a sensible deal in an all-stock deal. You simply can’t exchange an undervalued stock for a fully-valued one without hurting your shareholders.

Source:   Berkshire Hathaway Shareholder Letters

If an acquirer’s stock is overvalued, it’s a different story: Using it as a currency works to the acquirer’s advantage. That’s why bubbles in various areas of the stock market have invariably led to serial issuances of stock by sly promoters. Going by the market value of their stock, they can afford to overpay because they are, in effect, using counterfeit money.

Source:   Berkshire Hathaway Shareholder Letters

I have been in dozens of board meetings in which acquisitions have been deliberated, often with the directors being instructed by high-priced investment bankers (are there any other kind?). Invariably, the bankers give the board a detailed assessment of the value of the company being purchased, with emphasis on why it is worth far more than its market price. In more than fifty years of board memberships, however, never have I heard the investment bankers (or management!) discuss the true value of what is being given. When a deal involved the issuance of the acquirer’s stock, they simply used market value to measure the cost. They did this even though they would have argued that the acquirer’s stock price was woefully inadequate – absolutely no indicator of its real value – had a takeover bid for the acquirer instead been the subject up for discussion.

Source:   Berkshire Hathaway Shareholder Letters

When stock is the currency being contemplated in an acquisition and when directors are hearing from an advisor, it appears to me that there is only one way to get a rational and balanced discussion. Directors should hire a second advisor to make the case against the proposed acquisition, with its fee contingent on the deal not going through. Absent this drastic remedy, our recommendation in respect to the use of advisors remains: “Don’t ask the barber whether you need a haircut.”

Source:   Berkshire Hathaway Shareholder Letters

Cultures self-propagate. Winston Churchill once said, “You shape your houses and then they shape you.” That wisdom applies to businesses as well. Bureaucratic procedures beget more bureaucracy, and imperial corporate palaces induce imperious behavior. (As one wag put it, “You know you’re no longer CEO when you get in the back seat of your car and it doesn’t move.”)

Source:   Berkshire Hathaway Shareholder Letters

The hedge-fund world has witnessed some terrible behavior by general partners who have received huge payouts on the upside and who then, when bad results occurred, have walked away rich, with their limited partners losing back their earlier gains. Sometimes these same general partners thereafter quickly started another fund so that they could immediately participate in future profits without having to overcome their past losses. Investors who put money with such managers should be labeled patsies, not partners.

Source:   Berkshire Hathaway Shareholder Letters

Every dime of depreciation expense we report, however, is a real cost. And that’s true at almost all other companies as well. When Wall Streeters tout EBITDA as a valuation guide, button your wallet.

Source:   Berkshire Hathaway Shareholder Letters

The reason we avoid the word “synergy” is because people generally claim more synergistic benefits than will come. Yes, it exists, but there are so many false promises.

Source:   Poor Charlie's Almanack

Mutual Funds charge two percent per year and then brokers switch between funds, costing another three to four percentage points. The poor guy in the general public is getting a terrible product from the professionals. I think it’s disgusting.  It’s much better to be part of a system that delivers value to the people who buy the product. But if it makes money, we tend to do it in this country.

Source:   Poor Charlie's Almanack

To me it’s obvious that the winner has to be bet very selectively. It’s been obvious to me since very early in life. I don’t know why it’s not obvious to many other people. I think the reason why we got into such idiocy in the investment management business is best illustrated by a story that I tell about the guy who sold fishing tackle. I asked him, “My God, they’re purple and green. Do fish really take these lures?” And he said “Mister, I don’t sell to fish”.

Source:   Poor Charlie's Almanack

In Investment Management today, everybody wants not only to win, but to have the path never diverge very much from a standard path except on the upside. Well, that is a very artificial, crazy construct…It’s the equivalent of what Nietzsche meant when he criticized the man who had a lame leg and was proud of it. That is really hobbling yourself. Now, investment managers would say, “We have to be that way. That’s how we’re measured.” And they may be right in terms of the way the business is now constructed. But from the viewpoint of a rational consumer, the whole system’s bonkers and draws a lot of talented people into a socially useless activity.

Source:   Poor Charlie's Almanack

Trying to minimize taxes too much is on the great standard causes of really dumb mistakes.

Source:   Poor Charlie's Almanack

If you invested Berkshire Hathaway-style, it would be hard to get paid as an investment manager as well as they're currently paid - because you'd be holding a block of Wal-Mart aand a block of Coca-Cola and a block of something else. You'd be sitting on your ass. And the client would be getting rich. And, after a while, the client would think, "why am I paying this guy half-a-percent a year on my wonderful passive holdings?" So what makes sense for the investor is different from what makes sense for the manager. And, as usual in human affairs, what determines the behavior are incentives for the decision maker.

Source:   Poor Charlie's Almanack

As a matter of business practice, or perhaps of thorough-going conviction, the stock brokers and the investment services seem wedded to the principle that both investors and speculators in common stocks should devote careful attention to market forecasts. The farther one gets from Wall Street the more skepticism one will find, we believe, as to the pretensions of stock-market forecasting or timing. The investor can scarcely take seriously the innumerable predictions which appear almost daily and are his for the asking. Yet in many cases he pays attention to them and even acts upon them. Why? Because he has been persuaded that it is important for him to form some opinion of the future course of the stock market, and because he feels that the brokerage or service forecast is at least more dependable that his own. This attitude will bring the typical investor nothing but regrets.

Source:   The Intelligent Investor

For years the financial services have been making stock-market forecasts without anyone taking this activity seriously. Like everyone else in the field they are sometimes right and sometimes wrong. Wherever possible they hedge their opinions so as to avoid the risk of being proved completely wrong. (There is a well-developed art of Delphic phrasing which adjusts itself successfully to whatever the future brings.) In our view – perhaps a prejudiced one – this segment of work has no real significance except for the light it throws on human nature in the securities markets. Nearly every-one interested in common stocks wants to be told by someone else what he thinks the market is going to do. The demand being there, it must be supplied.

Source:   The Intelligent Investor

The analysts hired by brokerage houses, we are convinced, are greatly handicapped by the general feeling that they are supposed to be market analysts as well. When they are asked whether a given stock is “sound”, the question often means, “Is this stock likely to advance during the next few months?” As a result may of them are compelled to analyze with one eye on the stock ticker – a pose not conducive to sound thinking or worth-while conclusions.

Source:   The Intelligent Investor

We once likened the activities of the host of stock market-analysts to a tournament of bridge experts. Everyone is very brilliant indeed, but scarcely anyone is so superior to the rest as to be certain of winning a prize. An added quirk on Wall Street is that the prominent market analysts freely communicate and exchange their view almost from day to day. The result is somewhat as if all the participants in a bridge tournament, while each hand was being played out, gathered around and argued about proper strategy.

Source:   The Intelligent Investor

Efficiency of Management: The attitude of the financial world toward good and bad management to this writer seems to be utterly childish. First, we have the solemn assurance that quality of management is the most important consideration in selecting an investment. Second, we have the complete absence of any serious effort to determine the quality of management by any rational tests? It is all a matter of hearsay and obvious deductions from the degree of success of the company. Third, we find no interest of any kind in the common-sense objective of improving or replacing weak managements – even though their existence is freely admitted. The first and last word of wisdom [given by the financial world] to owners of American business is: “if you don’t like the management, sell your stock.”

Source:   The Intelligent Investor

It is time now to say a word about the role of boards of directors in the determination of managerial ability. One reason why stockholders have largely ignored this question is their belief that the directors they elect are the ones who have both the duty and opportunity to pass critical judgement on the executive staff. Since the stockholders are much farther removed from the scene than are the directors, their traditional inertia is reinforced by a certain logic, which limits their expression of ownership to voting for the directors whose names appear on the official proxy statement. The rest is then up to the directors. The trouble with this idea is that the directions are rarely independent of management. They should be, of course, but it does not work out that way. Our observation is that the officers choose the directors more often than the directors choose the officers. In many cases, the executives actually constitute a majority of the board. Where this occurs, the notion that the directors serve as a check on management is patently incorrect. But in most of the other cases the situation is not really different, for even the non-officer directors are generally bound closely to the executives by ties of friendship and often of business dealings. When a president has outlived his usefulness, or fails to measure up to the growing requirements of his job, he is not going to be removed by his personal friends.

Source:   The Intelligent Investor

From standpoint of an institution, the existence of a risk manager has less to do with actual risk reduction than it has to do with the impression of risk reduction.

Source:   Fooled By Randomness

When you look at the past, the past will always be deterministic, since only one single observation took place…A mistake is not something to be determined after the fact, but in light of the information until that point. A more vicious effect of [hindsight bias] is that those who are very good at 'predicting' the past will think of themselves as good at predicting the future, and feel confident in their ability to do so.

Source:   Fooled By Randomness

…the category of entertainers called Wall Street "economists" or "strategists" who make pronouncements on the fate of the markets, but do not engage in any form of risk taking, thus having their success dependent on rhetoric rather than actually testable facts.

Source:   Fooled By Randomness

Professionals forget the following reality: It is not the estimate or the forecast that matters as the degree of confidence with the opinion.

Source:   Fooled By Randomness

Technical Analysis studies market patterns and the demand and supply of stocks. It has undoubted merit in predicting probabilities but not the actual course of events…it has little theoretical foundation other than the assertions that stock prices are determined by their supply and demand and that past experience is relevant in predicting the future.

Source:   The Alchemy of Finance

Fisher's Research Questions: POINT 13. In the foreseeable future will the growth of the company require sufficient equity financing so that the larger number of shares then outstanding will largely cancel the existing stockholders' benefit from this anticipated growth?

Source:   Common Stocks and Uncommon Profits

One of the most widespread and least accurate of such ideas is the popular conception of what traits are needed to be an investment wizard. If a public opinion poll were taken on this subject, I suspect John Q. Public's composite picture of such an expert would be an introverted, bookish individual with an accounting-type mind. This scholastic-like investment expert would sit all day in undisturbed isolation poring over vast quantities of balance sheets, corporate earning statements, and trade statistics. From these, his superior intellect and deep understanding of figures would glean information not available to the ordinary mortal. This type of cloistered study would yield invaluable knowledge about the location of magnificent investments. Like so many other widespread misconceptions, this mental picture has just enough accuracy to make it highly dangerous for anyone wanting to get the greatest long-range benefit from common stocks.

Source:   Common Stocks and Uncommon Profits

There are not as yet the barriers to weed out the ignorant and the incompetent in the financial field that exist, for example, in the fields of law or medicine. Even among some of the so-called authorities on investment, there is still enough lack of agreement on the basic principles involved that it is as yet impossible to have schools for training investment experts comparable to the recognized schools for teaching law or medicine.

Source:   Common Stocks and Uncommon Profits

My objection to [macro forecasting] is not that it is unreasonable in theory. It is that in the current state of human knowledge about the economics which deal with forecasting future business trends, it is impossible to apply this method in practice. The chances of being right are not good enough to warrant such methods being used as a basis for risking the investment of savings. This may not always be the case. It might not even be the case five or ten years from now. At present, able men are attempting to harness electronic computers to establish “input-output” series of sufficient intricacy that perhaps at some future date it may be possible to know with a fair degree of precision what the coming business trends will be. When, if ever, such developments occur, the art of common stock investment may have to be radically revised. Until they occur, however, I believe that the economics which deal with forecasting business trends may be considered to be about as far along as was the science of chemistry during the days of alchemy in the Middle Ages. In chemistry then, as in business forecasting now, basic principles were just beginning to emerge from a mysterious mass of mumbo-jumbo. However, chemistry had not reached a point where such principles could be safely used as a basis for choosing a course of action.

Source:   Common Stocks and Uncommon Profits

The amount of mental effort the financial community puts into this constant attempt to guess the economic future from a random and probably incomplete series of facts makes one wonder what might have been accomplished if only a fraction of such mental effort had been applied to something with a better chance of proving useful.

Source:   Common Stocks and Uncommon Profits

The fact that a stock has or has not risen in the last several years is of no significance whatsoever in determining whether it should be bought now. What does matter is whether enough improvement has taken place or is likely to take place in the future to justify importantly higher prices than those now prevailing.

Source:   Common Stocks and Uncommon Profits

...many investors will give heavy weight to the per-share earnings of the past five years in trying to decide whether a stock should be bought. To look at the per-share earnings by themselves and give the earnings of four or five years ago any significance is like trying to get useful work from an engine which is unconnected to any device to which that engine's power is supposed to be applied. Just knowing, by itself, that four or five years ago a company's per-share earnings were either four times or a quarter of this year's earnings has almost no significance in indicating whether a particular stock should be bought or sold.

Source:   Common Stocks and Uncommon Profits

A worthwhile clue is available to all investors as to whether a management is predominantly one man or a smoothly working team (this clue throws no light, however, on how good that team may be). The annual salaries of top management of all publicly owned companies are made public in the proxy statements. If the salary of the number-one man is very much larger than that of the next two or three, a warning flag is flying. If the compensation scale goes down rather gradually, it isn't.

Source:   Common Stocks and Uncommon Profits

The only true test of whether a stock is “cheap” or “high” is not its current price in relation to some former price, no matter how accustomed we may have become to that former price, but whether the company's fundamentals are significantly more or less favorable than the current financial-community appraisal of that stock.

Source:   Common Stocks and Uncommon Profits

Security analysts in those pre-crash days were called statisticians. It was three successive years of sensationally falling stock prices that were to occur just a short time ahead that caused the work of Wall Street's statisticians to fall into such disrepute that the name was changed to security analysts.

Source:   Common Stocks and Uncommon Profits

It is vastly more difficult to forecast what a particular stock is going to do in the next six months. Estimates of short-term performance start with economic estimates of the coming level of general business. Yet the forecasting record of seers predicting changes in the business cycle has generally been abysmal.

Source:   Common Stocks and Uncommon Profits

A company with poor economic returns, excess cash, and a low stock price will attract corporate raiders, which is the beginning of the end of current management tenure. To protect themselves, executives frequently choose the second option instead: purchasing growth by acquiring another company.

Source:   The Warren Buffett Way

When management repurchases stock, Buffett feels that the reward is twofold. If the stock is selling below its intrinsic value, then purchasing shares makes good business sense. If a company’s stock price is $50 and its intrinsic value is $100, then each time management buys its stock, it is acquiring $2 of intrinsic value for every $1 spent. Transactions of this nature can be very profitable for the remaining shareholders.

Source:   The Warren Buffett Way

Buffett believes that the institutional imperative is responsible for several serious, but distressingly common, conditions: “(1) [The organization] resists any change in its current direction; (2) just as work expands to fill available time, corporate projects or acquisitions will materialize to soak up available funds; (3) any business craving of the leader, however foolish, will quickly be supported by detailed rate-of-return and strategic studies prepared by his troops; and (4) the behavior of peer companies, whether they are expanding, acquiring, setting executive compensation or whatever, will be mindlessly imitated.”

Source:   The Warren Buffett Way

Buffett isolates three factors as being most influential in management’s behavior. 1. Most managers cannot control their lust for activity. Such hyperactivity often finds its outlet in business takeovers. 2. Most managers are constantly comparing their business’s sales, earnings, and executive compensation to other companies within and beyond their industry. These comparisons invariably invite corporate hyperactivity. 3. Most managers have an exaggerated sense of their own capabilities.

Source:   The Warren Buffett Way

Wall Street’s method of using accounting ratios to determine value may capture the here and now but does a woefully poor job of calculating sustainable long-term growth. Or, put differently, more often than not, sustainable long-term growth is mispriced by the market.

Source:   The Warren Buffett Way

Interestingly, Cremers reports that in 1980, 50 percent of large-cap mutual funds had an active share score of 80 percent or more. That is, half the mutual funds had a portfolio that was significantly different from their benchmark. Today, just 25 percent of mutual funds are considered truly active. “Both investors and fund managers have become more benchmark-aware,” says Cremers. “As a manager, you want to avoid being in the bottom 20% or 40% (of your peer group). The safest way to do that, especially when you’re evaluated over the shorter time periods, is to hug the index.”

Source:   The Warren Buffett Way

The financial writer Joseph Nocera has pointed out the inconsistencies between what mutual fund managers recommend shareholders do—namely, “buy and hold”—and what managers actually do with their own portfolios—namely, buy-sell, buy-sell, buy-sell. Reinforcing his own observations of this double standard, Nocera quoted Morningstar’s Don Phillips: “There is huge disconnect between what the fund industry does and what it tells investors to do.”

Source:   The Warren Buffett Way

Today, there is substantial pressure on portfolio managers to generate eye-catching short-term performance numbers. These numbers attract a lot of attention. Every three months, leading publications such as the Wall Street Journal and Barron’s publish quarterly performance rankings of mutual funds. The funds that have done the best in the past three months move to the top of the list, are praised by financial commentators on television and in newspapers, rush to put out self-congratulatory advertising and promotional pieces, and attract a flurry of new deposits. Investors, who have been waiting to see which fund manager has the so-called hot hand, pounce on these rankings. Indeed, quarterly performance rankings are increasingly used to separate those managers deemed gifted from those who are mediocre.

Source:   The Warren Buffett Way

Buffett’s problem with the efficient market theory rests on one central point: It makes no provision for investors who analyze all the available information and gain a competitive advantage by doing so. “Observing correctly that the market is frequently efficient, they went on to conclude incorrectly that it was always efficient. The difference between these propositions is night and day.”...Nonetheless, the efficient market theory is still religiously taught in business schools, a fact that gives Warren Buffett no end of satisfaction. “Naturally, the disservice done students and gullible investment professionals who have swallowed EMT has been an extraordinary service to us and other followers of Graham,” he wryly observed. “In any sort of a contest—financial, mental or physical—it’s an enormous advantage to have opponents who have been taught it’s useless to even try. From a selfish standpoint, we should probably endow chairs to ensure the perpetual teaching of EMT.”

Source:   The Warren Buffett Way

The sad truth is that incentives have diluted the importance of investment philosophy in recent decades. While well intentioned and hard working, corporate executives and money managers too frequently prioritize growing the business over delivering superior results for shareholders. Increasingly, hired managers get paid to play, not to win.

Source:   More Than You Know

Portfolio managers who underperform the market risk losing assets, and ultimately their jobs. So their natural reaction is to minimize tracking error versus a benchmark. Many portfolio managers won’t buy a controversial stock that they think will be attractive over a three-year horizon because they have no idea whether or not the stock will perform well over a three-month horizon. This may explain some of the overreaction we see in markets and shows why myopic loss aversion may be an important source of inefficiency.

Source:   More Than You Know

Ivo Welch shows that a buy or sell recommendation of a sell-side analyst has a significantly positive influence on the recommendations of the next two analysts. Analysts often look to the left and to the right before they make their recommendations.

Source:   More Than You Know