Yale made 93% a year on venture capital in the past two decades. Warren Buffett is buying entire companies instead of investing in common shares. Are two of the world’s best investors saying something with their actions?
Information on individual companies is now free and abundant, transaction costs have fallen to virtually nil, and changes in the way stocks are traded has led to a more efficient market. We can debate how efficient the market is according to the Efficient Market Hypothesis, but suffice it to say that overall it’s very difficult to consistently outperform by investing in common stocks on the public exchanges.
Why have David Swensen and Warren Buffett decided that it is better to invest away from the public markets than to be at the whim of Mr. Market’s mood swings? Is it that the constant focus on quarterly outcomes doesn’t add to our long-term returns? Is it because with all information public and freely available there are no more of Mr. Buffet’s “cigar butts” laying around?
If you buy a stock at a sufficiently low price, there will usually be some hiccup in the fortunes of the business that gives you a chance to unload at a decent profit, even though the long- term performance of the business may be terrible. I call this the "cigar butt" approach to investing. A cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the "bargain purchase" will make that puff all profit. -Berkshire Hathaway Chairman's Letter 1989
(Mr. Buffett also points out in his 1989 letter that while he employed this type of investing early in his career, it is a foolish approach to buying a business.)
The takeaway for most investors should be that investing in low cost passively managed index funds is the best way to earn their fair share of market returns and participate in the long-term success of the US economy. If these two great investors understand that in the long-run it is very difficult to outperform the market, then the average investor with less experience and focus should realize that they can’t either.