Track Record Is Everything
Track Record Is Everything.
Warren E. Buffett
I've often felt there might be more to be gained by studying business failures than business successes. In my business, we try to study where people go astray, and why things don't work. We try to avoid mistakes. If my job was to pick a group of 10 stocks in the Dow Jones average that would outperform the average itself, I would probably not start by trying to pick the 10 best. Instead, I would try to pick the 10 or 15 worst performers and take them out of the sample, and work with the residual. It's an inversion process. Albert Einstein said, "Invert, always invert, in mathematics and physics," and it's a very good idea in business, too. Start out with failure, and then engineer its removal.
In Berkshire Hathaway Inc.'s 1989 annual report, I wrote about something I called the "institutional imperative." I didn't learn about it in business school, but it tends to have an enormous impact on how businesses are actually run. One of its main tenets is a copycat mechanism that decrees that any craving of a leader, however foolish, will be quickly supported by detailed rate-of- return and strategic studies prepared by his troops.
For example, every time it becomes fashionable to expand into some new line of business, some companies will expand into it. Then they get out of it about five years later, licking their wounds. It's very human; people do the same thing with their stocks.
To illustrate, let me tell you the story of the oil prospector who met St. Peter at the Pearly Gates. When told his occupation, St. Peter said, "Oh, I'm really sorry. You seem to meet all the tests to get into heaven. But we've got a terrible problem. See that pen over there? That's where we keep the oil prospectors waiting to get into heaven. And it's filled-we haven't got room for even one more." The oil prospector thought for a minute and said, "Would you mind if I just said four words to those folks?" "I can't see any harm in that," said St. Pete. So the old-timer cupped his hands and yelled out, "Oil discovered in hell!" Immediately, the oil prospectors wrenched the lock off the door of the pen and out they flew, flapping their wings as hard as they could for the lower regions. "You know, that's a pretty good trick," St. Pete said. "Move in. The place is yours. You've got plenty of room." The old fellow scratched his head and said, "No. If you don't mind, I think I'll go along with the rest of 'em. There may be some truth to that rumor after all."
That, unfortunately, is what happens in business and investments. People know better, but when they hear a rumor-particularly when they hear it from a high place-they just can't resist the temptation to go along.
It happens on Wall Street periodically, where you get what are, in effect, manias. Looking back no one can quite understand how everyone could have gotten so swept up in the moment. A group of lemmings looks like a pack of individualists compared with Wall Street when it gets a concept in its teeth.
When I was a graduate student at Columbia University, I got a piece of advice from Ben Graham, the founding father of security analysis, that I've never forgotten: You're neither right nor wrong because other people agree with you. You're right because your facts are right and your reasoning is right-and that's the only thing that makes you right.
And if your facts and reasoning are right, you don't have to worry about anybody else. Watch that track record. The best judgment we can make about managerial competence does not depend on what people say, but simply what the record shows. At Berkshire Hathaway, when we buy a business we usually keep whoever has been running it, so we already have a batting average. Take the case of Mrs. B, who ran our Furniture Mart. Over a 50-year period, we'd seen her take $500 and turn it into a business that made $18 million pretax. So we knew she was competent. She's also 97 years old. In fact, now she's competing with us; she started a new business two years ago. Who would think you'd have to get a noncompete agreement with a 95-year-old? Clearly, the lesson here is that the past record is the best single guide.
A group of lemmings looks like a pack of individualists compared with Wall Street when it gets a concept in its teeth. Then you run into the problem of the 14-year-old horse. Let's say you buy The Daily Racing Form and it shows that the horse won the Kentucky Derby as a four- year-old. Based on past performance, you know this was one hell of a horse. But now he's 14 and can barely move. So you have to ask yourself, "Is there anything about the past record that makes it a poor guideline as a forecaster of the future?"
The situation may also arise in which there is no clear past record. Let's say that when you left college they gave you a little bonus: You got to pick out anybody in your class and you'd get 10 percent of his or her future earnings. All of a sudden you look at the whole group in a different way. You've seen them in class; you know their grades and their leadership capabilities. Taking these factors into account, you ask yourself, "Who do I pick?" But how good a choice do you think you could make? It would be a lot easier if you could make that decision at your tenth class reunion, after you've seen their actual business performance, wouldn't it?
These are the judgments that Berkshire Hathaway makes about management all the time. We try to find businesses that we really feel good about owning. What a company's stock sells for today, tomorrow, next week, or next year doesn't matter. What counts is how the company does over a five- or 10-year period. It has nothing to do with charts or numbers. It has to do with businesses and management.
Another thing I learned in business school was that it doesn't help to be smarter than even your dumbest competitor. The trick is to have no competitors. That means having a product that truly differentiates itself.
Say a customer goes into a drugstore and asks for a Hershey's bar. The clerk says, "We don't have any, but why don't you take this other chocolate bar instead; it's a nickel cheaper." And the customer says, "I'll go across the street." "It's when the customer will go across the street that you've got a great business.
Extract from The Book of Investing Wisdom Classic Writings by Great Stock Pickers and Legends of Wall Street
