Berkshire Hathaway
Phenomenon
In the Context of Modern
Finance Theory

Septtember
2013

Berkshire Hathaway Phenomenon
In the Context of Modern Finance Theory

Introduction
Over the 46 years ending December 2012, Warren Buffett (Berkshire Hathaway) has achieved a compound, after-tax, rate of return in excess of 20% p.a. Such consistent, long term, out performance might be viewed as incompatible with modern finance theory.

This essay discusses the Berkshire Hathaway phenomenon in the context of modern finance theory. Part 1 Modern Portfolio Theory
Berkshire Hathaway’s investing strategies mainly differ with modern portfolio theory on two aspects. The first one is the attitude towards the undesirable thing in …show more content…

He once said, (Banchuenvijit, 2006)”investing in a market where people believe in efficiency is like playing bridge with someone who has been told it does not do any good to look at the cards.”
Also in his speech at Columbia University in 1984, he mentioned, “ships will sail around the world but the Flat Earth Society will flourish. There will continue to be wide discrepancies between price and value in the marketplace, and those who read their Graham & Dodd will continue to prosper.”

(Roberg G, 2005)To illustrate, we can take Berkshire Hathaway’s acquisition of Burlington
Northern Santa Fe Corp. in 2009 for example. At the time, shares of Burlington Northern had dropped 13 percent in 12 months. Also, the market was soft during GFC, so the possibility of competitive bids was low according to Tony Russo, a partner at Gardner Russo & Gardner, which holds Berkshire shares. If efficient market hypothesis does stand, the market would rebound quickly when GFC took place, and such opportunity of relatively low-priced acquisition would not exist. Even if it exists, other investor should anticipate quick upward adjustment of price and participate in bidding when they find out about this opportunity.

However, this does not prove that fundamental analysis is superior, because intrinsic value is not yet clear defined, and how does Mr Buffet calculate the intrinsic value is still a mystery.

Part 3 Capital Asset Pricing