Wednesday, September 29, 2010

Warren Buffett and Sherlock Holmes?

Professor  John Price is recognized as a leading international authority on Warren Buffett's secretive investment strategies. He had appeared in Bloomberg Radio, Fox News, and Bloomberg Television. He was interviewed by Wall Street Journal, The Australian Financial Review and many other well known financial journal. He has written five books, and write may articles and journals. He has developing it called Conscious Investor. Here is one of his article:

Price on Value
September 2000
 Sherlock Holmes and the Sciences of Investing
John Price , Ph.D.
Dedicated to Warren Buffett, the Sherlock Holmes of stock market, on his 70th birthday

What has Sherlock Holmes got to do with investing? Most people, including myself up to few a years ago, would probably answer nothing. But something happened 1997 that made me change my mind.

Source: wn
At the time I was mulling over a talk I was to give at a conference on the mathematics of options. My mind went from thinking of the pricing of options as paradoxical to thinking of them as mysterious. From there I went to Sherlock Holmes who was created by Sir Arthur Conan Doyle as the world's greatest detective, the pre-eminent person solve any mysteries.

This led to two outcomes. The first was that I prepared a talk entitled the "The Case of the Missing Ten Pounds." It described the arcana of the theory of pricing futures and options in the setting of a Sherlock Holmes mystery. this talk become an article that you can read on my website.

The second outcome was that I reread all Sherlock Holmes books and articles on the lookout for quotations that could be interpreted as sound advice for long-term strategies for the stock market. All right, we all do weird things from time to time. The important thing is that I came across a lot of pithy comments that can be directly applied to the stock market.
As this is the occasion of the second anniversary of  The Price on Value articles, I thought that I would gives you some quotes. most of the quotes are from the conversations that Holmes has with his friend and biographer, Dr. John Watson. Just let your imagination go and think of Holmes as expounding on principles of long-term investing in quality companies. 


            You know my methods in such cases, Watson: I put myself  in the man's place, and having first   
            gauged the man's intelligence, I try to imagine how I should  myself have proceeded under the same  
            circumstances. (The Musgrave Ritual.)

           You'll get results, inspector, by always putting yourself in the other fellow's place, and thinking what  
           you would do yourself. It takes some imagination, but it pays. (The Adventurers of the Retired  

This quotes reminds me of Warren Buffett's many comments stating that he tries to think as an owner of any company that he might invest in. "I always picture myself as owning the whole place," he once said.

Ask your self  question such as, "What could go wrong?" and "Who are the competitors?"

           It is the highest importance in the art of detection to be able to to recognize out of numbers of facts  
           which are incidental and which are vital. Otherwise your energy and attention must be dissipated 
           instead of being concentrated. (The Reigate Squires.)

           we approached the cases, you remember, with absolutely blank mind, which is always an advantage. 
           We had formed no theories. We were simply there to observe and to draw inferences from our 
           observations. (The Cardboard Box.)
           The difficulty is to detach the framework of fact-of  absolute, undeniable fact-from the embellishments 
           of theorists and reporters. (Silver Blaze.)

           I has long been an axiom of mine that the little things are infinitely the most important. (A Case of 

When analyzing a company, focus on what is important and don't get stuck in side issues. Buffett started his career in New York but move back to Omaha, Nebraska, where he found it "much easier to think." On Wall Street everyone has an opinion, a hot tip, but ultimate success depend on separating the facts from, as Holmes said, "the embellishments of theorists and reporters." Here we might add, "and stocks analysts."


          You know a conjurer gets no credit when once he has explained his trick; and if I show you  too much
          of my method of  working, you will come to the conclusion that I am a very ordinary individual after
          all. (A Study in Scarlet.)

          One of  Sherlock Holmes' defect-if, indeed, one may call it defect-was that he was exceedingly loath
          to communicate his full plans to any person until the instant of their fulfillment. Partly it came, no doubt
          from his own masterful nature, which loved to dominate and surprise those who were around him.
          Partly also from his professional caution, which urged him never to take any chances. (The Hound
          of the Baskervilles.)

We know just how secretive Buffett is regarding his investments decisions. He once said that he is lucky to have one good idea each year." Good investment ideas are rare, valuable and subject to competitive appropriation just as good product or business acquisition ideas are," he wrote in the Berkshire Hathaway Owner's Manual. By keeping ideas a secret and at the same time acting on them with sizeable investments, Buffett ensures the Berkshire Hathaway profit the most every time his mental light bulb lights up.

Present Value

          To determine its exact meaning I have been obliged to work out the present prices of the investments
          with which it is concerned. (The Adventure of the Speckled Band.)

Here we have it. Perhaps the first statement anywhere that the important calculation when valuing an investment is to determine the present or discounted value of  its financial rewards. As Buffett has said, intrinsic value "the discounted value of  the cash that can be taken out of a business during its remaining life."

Putting it together

          When Watson said that he thought that Holmes had seen more in the rooms than was visible to him,
          Holmes replied, " No, but I fancy that I may have deduced a little more. I imagine that you saw all that
          I did." ( The Adventure of the Speckled Band.)

          A similar Idea is expressed in "A Case of Identity" in which Watson remarked that Holmes had seen
          things that were invisible to him to which Holmes replied, "Not invisible, but unnoticed, Watson."

          Another time Watson complains that he cannot see anything unusual about what Holmes was showing
          him. Holmes responds, "On the contrary, Watson, you can see everything, You fail, however, to
          reason from what you see. You are to timid in drawing your inferences." (The Adventure of the Blue

          I see no more than you, but I have trained myself to notice what I see. (The Adventure of  the
          Blanched  Soldier.)

Isn't this the secret core of  investing? The ability to see what everyone else sees, the company reports, the products, the competitors, and so on, but to see it in a new way so that you can tell whether it is a superior investment or just another ho-hum stock. Buffett, for example, said that when he made his major purchase of Coca Cola stock that he only used the same information and material that was available to everyone else. The difference was that he deduced more than everyone else to arrive at the conclusion in1988 that this was an excellent investment. He was right; the stock quadrupled in value over the next four years.

Stay with the facts

          It is a capital mistake to theorize in advance of  the facts. (The Adventure of the Second Stain.)

          No, no:I never guess.It is a shocking habit 3/4 destructive to the logical faculty. What seem strange to
          you is only so because you do not follow my rain of  thought or observe the small facts upon which
          large inferences may depend. (The Valley of Fear.)
          The temptation to form premature theories upon insufficient data is the bane of our profession. (The
          Valley of Fear)

In 1934, Benjamin Graham wrote in Security Analysis that the intrinsic value of a stock is that value which is justified by the facts, e.g., the assets, earnings, dividends, definite prospects, as distinct, let us say, from market quotations established by artificial manipulation or distorted by psychological excesses."

Doyle/Holmes in 1890 and Graham in 1934 could have been referring to the wild speculation that are put out by market commentators and analysts regarding dot com companies and that are dressed up as reasoned reports.  

Knowledge and experience

           He possesses two out of the three qualities necessary for the ideal detective. He has the power of
           observation and that of deduction. He is only wanting in knowledge, and that may come in time. (The
           Sing of four.)

           It is better to learn wisdom late, than never to learn it all. (The Man with the Twisted Lip.)

Learn from your mistakes

           If it should ever strike you that I am getting a little over-confident in my powers, or giving less pains to
           a case than it deserves, kindly whisper 'Norbury' in my ear, and I shall be infinitely obliged to you .
           (The Yellow Face.)

Norbury was one the rare cases when Holmes was not at his best. He asked Watson to use this as a reminder to make sure that he did not become over-confident in the future.

This reminds me of Buffett after his investment in USAir in 1989. Within a few years the airline was in such difficulty that Buffett wrote down the investment by 75 percent while trying to sell the shares at 50 cents on the dollar. Fortunately for stockholder in Berkshire Hathaway, Buffett  was unsuccessful in finding  a buyer for within a year or two USAir returned to profitability. In the end, Buffett's action brought a healthy profit to Berkshire Hathaway.

On a personal level, Buffett admitted that the purchase was a result of sloppy analysis that may have been caused by hubris. To guard against a similar lapse in the future, he once joked, "So now I have this 800 number, and if I ever have the urge to buy an airline stock, I dial this number and I say my name iis Warren Buffett and I'm an airoholic. Then this guy talks me down on the other hand."

There were no 800 numbers in the late nineteenth century so Holmes had to rely on watson to 'yalk him down."

Check and double check  

           I have forged and tested every link of my chain, Professor Coram, and I am sure that it is sound.
           (The Adventure of Golden Pince-Nez.)

These are just small sampling of quotes from Sherlock Holmes that have an investing flavor. In fact, some of them seem to have been written as if their main purpose was to provide sound principles of investment, rather than as methods of criminal investigation. but perhaps we should not be surprised at this. After all, patience, tenacity, clarity of mind, a willingness to sift though the facts, resistance to necessary or premature speculation  are surely traits of the best detectives as they are of  the best investors.


I sent a copy this article to Warren Buffett and he replied:

Dear John:
      I enjoyed the Sherlock Holmes piece. Thanks for the dedication; I'm flattered.
                   (signed) Warren E. Buffett


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