Graham, Buffett, Jensen, The Efficient Market and Investing

Those who have that have studied valuation analysis in any detail will know the name Ben Graham is fondly associated with "intelligent investing". The author of Security Analysis (1934 - now up to its 6th edition) along with David Dodd helped take what many saw as voodoo science of sorts to an art form people would become preoccupied with. One of the fundamental notions of the text was that the market is a pendulum that oscillates between overpricing and underpricing relative to some "true" fundamental and investors by recognising this departure from true value could profit from it. But is this really the case? What competitive advantage do individual (or other) investors have that would allow them to outstmart "Mr Market"?

In "Myth of the Rational Market" Justin Fox documents a conference attended by Michael Jensen and Warren Buffett to commemorate the 50th anniversary of Security Analysis. During this meeting Jensen had argued that a sizable  body of previous literature had shown that using publicly available data to "beat" the market was a fruitless exercise. In fact the returns generated by the droves of fund managers and self proclaimed experts over this time was for Jensen an indication that beating the market was a matter of luck and also support for the efficient market hypothesis. To quote Jensen, "If i survey a field of untalented analysts, all of whom are doing nothing but flipping coins, I would expect to see some who have tossed two heads in a row and even some who have tossed ten heads in a row." Jensen's point here is pretty clear. Try this enough times and what will emerge is a select few and a lot of losers.

Following on from this analogy, Buffett inquired, if those who remain as the winners after the coin toss possessed some common characteristic then would this change one's perception of investing as a game of chance. He suggested that if a good proportion of those that "won" the coin toss had ascribed to some methodology that allowed them to win, then this was not a fluke, but rather a discipline of skill. Buffett described, "I think you will find that a disproportionate number of successful coin flippers in the investment world came from a very small village that could be called Graham-and-Doddsville" and the continued "...there will continue to be wide discrepancies between price and value in the marketplace".

This debate still rages on today between those that believe the market proffers opportunities for successful investment to those who see it as a mugs game.