The Warren Buffett Way, + Website, 3rd Edition

Foreword: The Exception

What accounts for Warren Buffett’s exceptional investment success? That’s one of the questions I’m asked most often. It’s also the question I want to explore in this foreword.

When I studied for my MBA at the University of Chicago in the late 1960s, I was exposed to a new theory of finance that had been developed, largely there, in the preceding few years. One of the most important components of the “Chicago School” of thought was the Efficient Market Hypothesis. According to that hypothesis, the combined efforts of millions of intelligent, motivated, objective, and informed investors cause information to immediately be reflected in market prices such that assets will provide a fair risk-adjusted return, no more and no less. Prices are never so low or so high that they can be taken advantage of, and thus no investors can be capable of consistently identifying opportunities to benefit. It’s this hypothesis that gives rise to the Chicago School’s best-known dictum: You can’t beat the market.

The Efficient Market Hypothesis supplies the intellectual basis for that conclusion, and there are lots of empirical data showing that, despite all their efforts, most investors don’t beat the market. That’s a pretty strong case for the inability to outperform.

It’s not that no investors beat the market. Every once in a while some do, and just as many underperform; market efficiency isn’t so strong a force that it’s impossible for individual investors’ returns to deviate ...