A Well Reasoned Response

By RandFan

"To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions." -- Warren Buffett, from "Buy American, I Am."

Buffett's message has never changed over the years...but market conditions have....

"Even if you agree that the 12 percent equity coupon is more or less immutable, you still may hope to do well with it in the years ahead. It's conceivable that you will. After all, a lot of investors did well with it for a long time. But your future results will be governed by three variable's: the relationship between book value and market value, the tax rate, and the inflation rate." Warren Buffett, from "How Inflation Swindles the Equity Investor"

The author of "Will the Real Mr. Buffett Please Stand Up" is either a very sloppy student or a Sophist trying to stir up controversy. To make this argument, you have to make two fatal assumptions: 1) For the equity investor, 1977 is functionally equivalent to 2008 and, 2)An "equity investor" is functionally equivalent to a "value investor." Regarding the first fatal assumption: Market value to book value for many excellent companies was much lower in late 2008 than it was in 1977, so the "investor's equation" produced a different signal. Tax rates were also much higher in 1977 (and may not reach that level again for some time because of today's political climate--a point Buffett made recently in a NYTimes OP-ED piece)which effects return on book value and, thus, the results of the investor's equation.

Throughout his career, Buffett has allowed his disciples an audience to his life-long process of learning. He carries on "out loud" mental discussions with himself as he incorporates new, conflicting data into his world view and through a process of creative destruction strengthens his understanding. His 1977 article is, I think, simply an academic exercise for him. He just so happens to be letting the world in on it. He's going about the process of reconciling information which contradicted truisms that he had learned earlier in life from sources such as John Burr Williams' "The Theory of Investment Value," a book which I highly recommend to anyone who is interested in understanding what Buffett means by "the investor's equation." At any rate, long story short, this is just another pseudo-controversy about Buffett that boosts web-hits and proves that age-old frailty of man: Envy.

Please revisit Dividend Inc. for editing and revisions to this post.