Why Warren Buffett Rocks

(Photo: Insider Monkey)

(Photo: Insider Monkey)

A new NBER working paper (abstract; PDF) analyzes Warren Buffett‘s Berkshire Hathaway and the drivers of its stock market success. Beyond benefiting from Buffett’s ability to buy low and sell high, Berkshire has also been able to borrow cheaply

Berkshire Hathaway has realized a Sharpe ratio of 0.76, higher than any other stock or mutual fund with a history of more than 30 years, and Berkshire has a significant alpha to traditional risk factors. However, we find that the alpha becomes insignificant when controlling for exposures to Betting-Against-Beta and Quality-Minus-Junk factors. Further, we estimate that Buffett’s leverage is about 1.6-to-1 on average. Buffett’s returns appear to be neither luck nor magic, but, rather, reward for the use of leverage combined with a focus on cheap, safe, quality stocks. Decomposing Berkshires’ portfolio into ownership in publicly traded stocks versus wholly-owned private companies, we find that the former performs the best, suggesting that Buffett’s returns are more due to stock selection than to his effect on management. These results have broad implications for market efficiency and the implementability of academic factors.

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COMMENTS: 16


  1. Chad says:

    Hidden due to low comment rating. Click here to see.

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    • Michael says:

      Hi, I believe the key word in Warren Buffett’s comment was ‘rate’. He mostly likely pays more taxes but the ‘rate’ at which he is taxed is lower than his secretary. The reason (I think, and undoubtedly I will be corrected if I’m wrong) is that the majority of his income is in the form of dividends (and similar) which are taxed at a lower rate than regular income, e.g. 10% versus 28%. I’m sure he has good tax advice nonetheless.

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      • Ray says:

        Chad’s point was not that Buffet pays more total taxes than his secretary. Chad’s point is the so-called “double taxation” of dividends. The idea is that since dividends are paid out of a corporations profit and the corporation has already paid taxes on the profit, why should the receiver of dividends have to pay taxes on the dividends?

        Personally I do not agree with those that push the double taxation issue; the “extra” taxes are the price you pay for the convenience of incorporation and all the advantages it confers.

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      • Enter your name... says:

        I’m with you, Ray. Those “extra” taxes are owed for a reason.

        Also, having part of the tax depend on the owner’s income protects lower-income individuals. If we only taxed the corporation’s profits, and not the owner’s, then the corporate taxes would be higher to make up the difference. This would help billionaires (whose dividend income is now taxed at 20%) but hurt elderly people (whose dividend income is taxed at 10%, or even often not taxed at all, because there isn’t much of it).

        Finally, Chad seems to have forgotten that most publicly traded corporations don’t pay out much, or anything, of their profit in dividends anyway, and stable companies of the sort that Buffett invests in tend to produce a stable dividend, regardless of typical fluctuations in tax rates and other expenses. Retaining that post-tax income results in Buffet receiving a lot of unrealized and untaxed income from rising stock prices.

        And that, finally, is the big difference between Buffett and his secretary: his actual net worth may go up by hundreds of millions of dollars in a year, but his taxable income is nowhere near that amount.

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      • James says:

        Also the secretary almost certainly pays a lower rate on his/her dividend & CG income, perhaps even 0% if the secretary is underpaid.

        I’ve also never quite understood the problem with lower rates. After all, if I buy a big box of say breakfast cereal, I’ll pay less per ounce than if I bought a small box, and no one seems to have a problem with that.

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  2. Caleb B says:

    Oh, i thought this was going to be a link to the GEICO commercial where Buffett plays Axel Rose.

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  3. Voice of Reason says:

    Ray,

    The issue isn’t whether or not C Corporations deserve to pay higher taxes or whether or not passive income should be taxed at a higher rate than other forms of income, the issue that I have with double taxation is transparancy. It gives all of the 99%ers and liberal politicians the ability to tee off on those who choose to invest their income in equities without giving the true nature of their taxation.

    Essentially a 35% C corp rate on income at the corporate level, and a 15% rate on the individual level is about 44% (1-[.65*.85]) and then tack on another 10% or so depending on which state you’re in. Why can’t people call a spade a spade, and refer to the actual rate when having debates and discussions?

    Personally, I’d like to see a very modest corporate rate, maybe 15%, to still allow for incentives for corporations if the government chooses, but then treat capital gains and dividends at the ordinary rate. It would essentially be the same treatment as it is now, but the system would be a little more transparent, easier to understand, and would allow for different income levels to pay different rates, as capital gains and dividends are pretty horribly regressive right now.

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    • Enter your name... says:

      People can’t call a spade a spade because it’s more complicated than that.

      For example:

      Apple, Inc. made hundreds of millions of dollars between 1996 and 2011. Do you know how much dividend-related taxes were paid? Zero. They didn’t issue dividends for fifteen years.

      Your profit—or loss—on buying and selling the stock depended on your timing. To know how much tax revenue was created by that company, you would literally have to parse every single stock transaction, figure out which tax rate the person paid, and add it up. And then you’d have to guess how much of the stock price was due to the corporation’s income rather than due to hype or sector inflation or other factors.

      Your proposal, in practice, amounts to “I want corporations to stop issuing dividends.” That’s what happens when tax rates are low for the corporations but high for the institutions receiving the dividends.

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      • Voice of Reason says:

        First of all, you’re talking about one corporation. Any argument based upon one company when there are thousands and thousands of C Corps is doomed to fail. But you’re also forgetting that there are captial gains taxes, which are taxed at the same rate as dividends or even higher if they are short-term. So I’m not entirely sure what your argument is.

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  4. Jabari says:

    I think the problem with the argument about “double taxation” on dividends is that all transactions are taxed. So I could say that if Warren Buffet paid a lower tax rate, then he might pay his driver more, so his driver is triple taxed. And if the driver was paid more, then his babysitter might be paid more, so she is quadruple taxed. But if she buys Quaker Oats, they could have charged more to her, plus she is paying a sales tax, so Quaker is hextuple (sextuple) taxed. So if Quaker pays a dividend, its owners are septuple taxed! It’s really an infinite loop.

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  5. Steve Cebalt says:

    When a thread in taxes is this complex, I think it says something about the real problem. Complexity in taxes. Nothing this complicated can be managed in any meaningful way. By anyone.

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  6. Required says:

    “Warren Buffett: Baptist and Bootlegger
    How America’s favorite billionaire plays politics to make money”
    by
    Peter Schweizer
    “During the financial crisis in the fall of 2008, Buffett became an important symbol on television. He filled the role of fiscal adult, a responsible father figure in the midst of irresponsible Wall Street speculators. While pushing for calm and advocating specific market interventions in both public and private, however, he was also investing (sometimes quietly) so he could profit once his policy advice was implemented. “

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  7. Sal's Dad says:

    So far, the comments have absolutely nothing to do with the original post. Buffett’s opinions and observations on our absurd tax system have nothing to do with his success as an investor.

    I have not read the complete paper, and my analytical finance skills are apparently out-of -date (“Betting-Against-Beta”???) .

    But I read this as “Buffett’s stockpicking skills are pretty good (‘a focus on cheap safe quality stocks’!!!), but he has leveraged this with a remarkable ability to find low-cost sources of long-term money, such as insurance float, deferred taxes, and cheap (even negative-interest!) borrowing”.

    So there is nothing supernatural about Buffett’s success. Just good investment choices, smart unconventional financing approaches, and discipline in sticking to what he knows.

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  8. Nate says:

    Another example of how inflation & centrally planned interest rates benefit those already with assets and those, like Buffet, with first access to the basically free printed money of the federal reserve.

    Price inflation is killing the poor – wage inflation is not keeping up. In the meantime, the wealthy continue to push for more free FED money.

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    • Voice of Reason says:

      The wage gap between the top 1% and the rest keeps expanding, and the liberal governments of the country keep figuring out ways to give those who refuse to earn an income all that they need to live, and the middle class gets more and more screwed.

      People like Obama and Buffett are basically telling us: “You can either sit back and we’ll take care of you, you can be blessed with the ability to make millions, or you can work your finger to the bones so that we can light cigars with $100 bills with your money.”

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  9. Robert says:

    Warren Buffett is perhaps the biggest and most iconic name on Wall Street, and his high-return investment portfolio reflects his genius and financial acumen.

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