You’ve probably heard all of the arguments before:
“Warren Buffett is washed up.”
“He’s past his prime.”
“He manages too much money to find good deals anymore.”
And with Berkshire Hathaway underperforming the S&P 500 by 17% halfway into 2020, I understand the sentiment. However, this isn’t the first time that people have questioned Warren Buffett’s competence as an investor.
In December 1999, during the height of the dot-com bubble, Barron’s released an article titled, “What’s Wrong, Warren?” that questioned whether Buffett (then 69) had become an old man who was out of touch with the shiny new internet economy, in contrast to VCs who were more than exuberant and pumped nearly 40% of their investments into internet startups before the dawn of Y2K. And it wasn’t just the professionals who wanted in: Between the mid-to-late-’90s amateur investors day-traded their way to becoming overnight millionaires via rampant speculation on explosive tech stocks.
If you had purchased Berkshire stock on December 27, 2002 you would have underperformed the S&P 500 by 2% annually through today.
This was the era in which companies like Pets.com, Webvan (today’s version of Instacart), and Boo.com (aspiring to be like the trendy online retailer ASOS) were immortalized for their failures of being too ahead of their time, and the era when a new generation of tech upstarts came onto the scene, including then-private companies Netflix and Google in ’97 and ’98, respectively. And with Berkshire trailing the S&P 500 by 43% at the time “What’s Wrong, Warren?” was published in late ’99, the theory seemed not only plausible, but convincing:
But it was Buffett who would go on to have the last laugh as the bubble popped and wiped out nearly 80% of the Nasdaq’s value, resulting in the loss of billions of dollars of equity. In the three years after “What’s Wrong, Warren?” was published, Berkshire went on to gain 36% while the S&P 500 lost 37%:
It was quite a fitting end to the debate over who was the greatest investor of all time — or was it? Because just as Buffett’s devout followers were taking victory laps, the tide had already started turning for the Oracle of Omaha. In fact, if you had purchased Berkshire stock on December 27, 2002, you would have underperformed the S&P 500 by 2% annually through today:
As it turns out, the internet bubble bursting wasn’t the end of the story for critics who claimed Buffett lost his touch — it actually marked the start of the gradual, but inevitable, decline of the investment community’s luminary. And I can prove it.
How much has Buffett underperformed by?
From 1965 to 2002, Berkshire underperformed the S&P 500 in only four of those 38 years (roughly 10% of the time) and outperformed the S&P 500 by double digits in over half of the others (53% of the time). But in the 17 years since then from 2003 to 2019, Berkshire has underperformed the S&P 500 in eight years (47% of the time) and has outperformed by double digits on only four occasions (24% of the time).
Since the dot-com bubble burst, Berkshire has been four times more likely to underperform and half as likely to outperform (by double digits) the S&P 500. Additionally, Berkshire has lagged the market over basically every time scale for the last 15 years:
No matter how you slice it, Buffett has struggled to keep pace with the rest of the market since the dot-com crash. The more important question though is: why?
Why did Buffett lose his touch?
While many theories abound as to why Buffett hasn’t been able to outperform the broader market — including his focus on undervalued opportunities over investing in growth businesses — the main culprit seems to be driven by Buffett’s failure to invest in companies that have become central to the digital economy, a strange twist of irony given the current market’s strong reliance on e-commerce. If you’ve been an astute student of Buffett’s investment philosophy like myself, this theory makes perfect sense.
It’s like Buffett’s portfolio got upgraded to first class on the Titanic. Things looked good initially, but, in the long run, it couldn’t be saved.
Historically, Buffett has made his money by betting on things that never change — things like the addictiveness of sugar (for example, Coke, See’s Candy, Dairy Queen), risk aversion (for example, insurance companies like Geico), and the supremacy of traditional banking. And these bets paid off for decades, as reflected in his market returns when tracking the first four decades of his career. But then the internet came along and transformed our modern-day economic infrastructure — the effects of which we are seeing play out in real time today. Just take a look at how fintech and SaaS companies like Stripe, Square, and Shopify are undergirding our current digital economy.
Simply put, the internet provided a completely new way of doing business. Unfortunately, investors during the heyday of the ’90s went wild with anticipation over just how much things would change, which led to a boom-and-bust cycle and the subsequent internet crash. While it’s easy to say that this bubble was a foolish mania, I don’t think that’s quite accurate. As Marc Andreessen pointed out in his interview with Barry Ritholtz, the dot-com bubble wasn’t wrong, it was just early:
The dotcom crash hit in 2000, and all these ideas that were viewed as genius in 1998 were viewed as complete lunacy and idiocy in 2000. Pets.com being the classic example. So, it’s actually really striking. All of those ideas are working today. I cannot think of a single idea that isn’t working today. The kicker for the Pets.com story is that there is a company, Chewy, that just got bought for $3 billion.
If you agree with Andreessen’s theory, then this suggests that Buffett’s “victory” following the dot-com crash wasn’t a victory at all. He was merely delaying the inevitable. It’s like Buffett’s portfolio got upgraded to first class on the Titanic. Things looked good initially, but, in the long run, it couldn’t be saved.
You might think that this take is too harsh, but consider this: If you compare the investment holdings of Berkshire Hathaway from year-end 2018 to year-end 2019, you will see that roughly half the gain in market value of Berkshire’s investment portfolio came from one company — Apple. This was also in a year where Berkshire returned 11% for shareholders compared to 31.5% for the S&P 500.
So, just imagine how much worse Berkshire would have performed had it not started acquiring its Apple position in 2016:
Berkshire’s stake in Apple represents 21% of its current market capitalization. One-fifth of Buffett’s empire came from one technology investment that was brought into Berkshire’s portfolio only four years ago. The Oracle of Ohama essentially missed the proverbial boat (perhaps yacht is more fitting in this case) on high-growth technology stocks. He committed this grave oversight by following his own rules a little too well. As the investor who popularized the term “circle of competence,” Buffett prides himself on not investing in things he doesn’t understand. This quote from “What’s Wrong, Warren?” has aged particularly well:
Absent from Berkshire’s portfolio is technology. Asked at Berkshire’s annual meeting in May why he hadn’t bought Microsoft, Buffett replied: “If I had to bet on anybody [in technology], I’d certainly bet on Microsoft-and heavily. But I don’t have to bet. And I don’t see that world as clearly as I see the soft-drink world.” Buffett recently told a group of Nebraska high-school students that he once told Bill Gates that explaining technology to him was a waste, that Gates would have “better luck with chimps.”
Unfortunately, the cumulative effects of this lack of understanding around technology eventually caught up with him. Keep in mind that Buffett was approaching 70 back in 1999. And since then, the world has only continued to change at a relentless pace — Silicon Valley’s success, digital consumer habits, and the growth-obsessed model for VC-backed unicorns have rapidly taken shape and evolved.
Despite not being able to accurately predict technology’s dominance over the modern economy, you still have to marvel at what Buffett has been able to achieve in his decades-long career. There’s no doubt that he is an incredible manager of money to keep pace with the S&P 500 all these years. Today, Berkshire Hathaway has a market cap of $433.5 billion and Buffett’s $43 billion cash on hand puts him in a strong position to ride out this pandemic-induced recession — a fact that has not gone unnoticed recently by analysts wondering why the Fed is assisting Berkshire by buying its bonds.
But as Buffett’s portfolio performance over the past 15 years has shown, his investing edge — his alpha — has been on the wane since the dot-com crash and has flickered even more today in the era of monolithic tech giants. Still, no one has quite the track record of beating the market as long and as consistently as Buffett has, and no one likely ever will.
Has Warren Buffet Lost His Touch? was originally published on Marker.
The views represented in this commentary are those of its author and do not reflect the opinion of Traders Magazine, Markets Media Group or its staff. Traders Magazine welcomes reader feedback on this column and on all issues relevant to the institutional trading community.