Buffet’s Value Investing Strategy and Berkshire Hathaway: A Strategy Past its Prime?

Bullshitting a client, my coworker claimed that “our (wealth management) firm takes the Warren Buffet approach to stock picking; we look for underpriced stocks with strong fundamentals and hold them for several years.”

To many, Warren Buffet is synonymous with astute investing decisions, outperforming the market, and a “self-made” ideal. Who wouldn’t want to be associated with Warren Buffet?

Me.

Buffet’s shrewd style of investing is increasingly difficult and less productive. Since 2000, Warren Buffet’s Berkshire Hathaway outperformed the S&P 500 by only a small margin.

Returns on Berkshire Hathaway shares may become even less significant in the coming years. With analysts projecting equity values to increase by a paltry 3-6% in 2015 and 2016, a purely value-driven approach to investing is hard to justify.

Many investors are looking abroad, particularly to troubled countries like Russia, Greece, Brazil and Europe for better returns. Personally, I am embracing riskier investment alternatives such as oil futures, emerging market ETFs and hedging to bolster performance.

Let’s consider Warren Buffet’s investing vehicle, Berkshire Hathaway, and three key limitations to its performance: company size, prevailing market conditions, and investment strategy.

Berkshire Hathaway’s performance is limited by its sheer size. Economics theorists believe that large capitalization stocks underperform small capitalization stocks because of distanced management and operational inefficiencies. By adopting a minimalist managerial structure, Berkshire Hathaway has managed to mitigate this problem in the parent company. However, many of the companies that it owns may be faced with this problem. Similarly, pursuing lucrative becomes increasing difficult for Berkshire Hathaway because the investment may be to small to have a sizeable impact on Berkshire Hathaway’s net worth. In essence, its size may “crowd out” many smaller but beneficial investments.

In the past, Warren Buffet has used his size beneficially by garnering large premiums for financing mergers and protecting companies from hostile takeovers. However, the M&A world may experience a “cooling-off” period when the treasury yields inevitably rise. (Treasury Yields Up → Corporate Bond Yields Up → Cost of Financing M&A Up → Number of M&A Transactions Down)

Several of Warren Buffet’s recent investments have taken a beating; American Express and IBM have faced declining revenues and worsening profit margins. While these may be exceptions to Buffet’s historical success, the meager equity market outlook and recent value investing failures make Berkshire Hathaway’s outlook less than appealing.