Even though many investors dote on Warren Buffetts every move, the market underreacts to trades of his company, Berkshire Hathaway Inc., leaving plenty of excess return available for other investors seeking to imitate its portfolio.
Even those investors who procrastinate in mimicking the Berkshire purchases and wait as long as 40 days after the initial announcement of a new Berkshire investment can enjoy returns nearly as high as those earned by the company. So as Mr. Buffett has trumped market efficiency, investors can do so, too.
Gerald S. Martin, visiting professor at American University, Washington, and Texas A&M University, College Station, and John Puthenpurackal, assistant professor in finance at the University of Nevada at Las Vegas, reached that conclusion in their research for a paper titled Imitation is the sincerest form of flattery: Warren Buffett and Berkshire Hathaway.
They plan to submit their 42-page paper for publication in an academic finance journal, as soon as they complete the final editing, Mr. Marin said in an interview.
Performance numbers demonstrate their findings.
Over a 31-year period, from 1976 through 2006, Berkshire Hathaways stock portfolio returned an annualized 24.97%, outperforming by 14.65 percentage points the 10.32% annualized of the Standard & Poors 500 over the same period.
The market appears to underreact to the news of a Berkshire Hathaway stock investment since a hypothetical portfolio that mimics the investments created the month after they are publicly disclosed, between 10 and 40 days, outperforms the S&P 500 by 14.26 percentage points a year, slightly less than Berkshire Hathaways performance, said Mr. Martin.
Thats a dilemma we dont understand, Mr. Martin said of the high returns of the mimicking portfolio. People claim to follow him. It may be people talk but dont do.
As one pension executive commented in Pensions & Investments in 1993, After (Mr. Buffett) has accumulated a stock, typically the investment community jumps on the bandwagon.
If investors followed Berkshire Hathaways move as closely as many people believe, the markets instant reaction would raise the price of the stocks, leaving no excess room for outperformance.
But because a portfolio that mimics Berkshire Hathaways investments after they are made public earns significantly large risk-adjusted returns over the S&P 500 and other benchmarks, it suggests this information does not get transmitted quickly into stock prices and would therefore be inconsistent with the predictions of the efficient market theory, Messrs. Martin and Puthenpurackal write in their paper,
The efficient market theory, depending on the strength of the hypothesis applied, contends stock prices generally correctly reflect all available public information. As a result, it is difficult for any investor, even a professional, to gain an advantage over other investors.
Mr. Martin and Mr. Puthenpurackal plan to send their paper to Berkshire Hathaway for possible reaction from Mr. Buffett or his colleagues at the company, Mr. Martin said.
Mr. Martin said he does consulting for hedge funds and mutual funds, which he wants to keep confidential. In part, they are trying to rely on me to interpret Buffetts style or anticipate his moves before he makes them.
But as the paper shows, there is no need to front-run Berkshire Hathaway. Just following along appears to earn a rich return.