A f t e r w o r d
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demonstrate that what Buffett had taught and what I had written, if
followed, would allow an investor to generate market-beating returns.
The proof would be in the performance.
The new fund was established on April 17, 1995. Armed with the
knowledge gained by having studied Warren Buffett
for over ten years,
coupled with the experience of managing portfolios for seven of those
years, I felt we were in a great position to help our clients achieve
above-average results. Instead, what we got was two very mediocre
years of investment performance.
What happened?
As I analyzed the portfolio and the stock market during this pe-
riod, I discovered two important but separate explanations. First, when
I started the fund, I populated the portfolio mostly with Berkshire
Hathaway-type stocks:
newspapers, beverage companies, other con-
sumer nondurable businesses, and selected f inancial service companies.
I even bought shares of Berkshire Hathaway.
Because my fund was a laboratory example of Buffett’s teachings,
perhaps it was not surprising that many of the stocks in the portfolio
were stocks Buffett himself had purchased. But the difference between
Buffett’s stocks in the 1980s and those same stocks in 1997 was
striking. Many of the companies that
had consistently grown owner
earnings at a double-digit rate in the 1980s were slowing to a high single-
digit rate in the late 1990s. In addition, the stock prices of these com-
panies had steadily risen over the decade and so the discount to intrinsic
value was smaller compared with the earlier period. When the econom-
ics of your business slow and the discount to intrinsic value narrows, the
future opportunity for outsized investment returns diminishes.
If the f irst factor was lack of high growth
level inside the portfolio,
the second factor was what happening outside the portfolio. At the
same time that the economics of the businesses in the fund were
slowing, the economics of certain technology companies—telecommu-
nications, software, and Internet service providers—were sharply ac-
celerating. Because these new industries were taking a larger share of
the market capitalization of the Standard & Poor’s 500 Index, the stock
market itself was rising at a faster clip. What I soon discovered was that
the economics of what I owned in the
fund were no match for the
newer, more powerful technology-based companies then revving up in
the stock market.
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A F T E R W O R D
In 1997, my fund was at the crossroads. If I continued to invest in
the traditional Buffett-like stocks, it was likely I would continue to gen-
erate just average results. Even Buffett was telling Berkshire Hathaway
shareholders they could no longer expect to earn the above-average in-
vestment gains the company had achieved in the past.
I knew if I contin-
ued to own the same stocks Buffett owned in his portfolio at these
elevated prices, coupled with moderating economics, I was unlikely to
generate above-average investment results for my shareholders. And in
that case, what was the purpose? If a mutual fund cannot generate, over
time, investment results better than the broad market index, then its
shareholders would be better off in an index mutual fund.
Standing at the investment crossroads
during this period was dra-
matic. There were questions about whether the fund should continue.
There were questions about whether Buffett could compete against the
newer industries and still provide above-average results. And there was
the meta-question of whether the whole philosophy of thinking about
stocks as businesses was a relevant approach when analyzing the newer
technology-oriented industries.
I knew in my heart that the Buffett approach to investing was still
valid. I knew without question that this business-analytical approach
would still provide the opportunity for investors to spot mispricing and
thus prof it from the market’s narrower view. I knew all these things
and more, yet I momentarily hesitated at the shoreline,
unable to cross
into the new economic landscape.
I was fortunate to become friends with Bill Miller when I f irst
began my career at Legg Mason. At the time, Bill was comanaging a
value fund with Ernie Kiehne. Bill periodically spent time with the
newer investment brokers sharing his thoughts about the stock market,
about companies, and ideas from the countless books he had read. After
I left Legg Mason to become a portfolio manager,
Bill and I remained
friends. After
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