Presumably Santa, Rudolph and the rest of the gang flying around delivering presents this weekend are not among his targets but, over the years, Warren Buffett has been pretty rude about the aviation sector. As the Sage of Omaha unambiguously put it in a 2002 interview: “If a capitalist had been present at Kitty Hawk back in the early 1900s, he should have shot Orville Wright. He would have saved his progeny money.”
Buffett went on to describe the airline business as “extraordinary” – and not in a good way – pointing to its huge fixed costs, strong unions, vulnerability to commodity prices and, especially, the way it ate up capital. “This is not a great recipe for success,” he noted before joking that, whenever he had an urge to buy an airline stock, he would call a Freephone number, admit to being an “aeroholic” – “and then they talk me down”.
Which makes it all the more remarkable Buffett’s investment vehicle Berkshire Hathaway should recently have been buying airlines. In and of itself, this is not a terribly controversial move – over the last few years, the sector has become more concentrated following some significant merger and acquisition activity and a number of businesses within it have actually started making a profit.
As a result, Buffett and Berkshire Hathaway are by no means the only investors to have concluded airlines now look a much better prospect than they once did and that “aeroholism” is no longer the vice they once thought. The questions of whether or not they will be proved right and whether or not they will make money are not, however, the ones that will concern us for the rest of this article.
No – what interests us today, here on The Value Perspective, are not the consequences of Buffett’s apparent change of heart but what that says about him as an investor. In all likelihood, Buffett did not buy the airline shares himself but he has allowed his name to be associated with a sector about which he has been very critical in the past, which leads us first towards the world of behavioural finance and assorted cognitive biases.
Most obviously, there is the ‘endowment effect’ – the idea that once you hold a view, you become very attached to it and find it hard to change your position, even if new facts suggest you should. Also coming into the mix is ‘confirmation bias’ – the natural inclination to interpret any new evidence as confirmation of your existing beliefs or ideas.
These are two cognitive biases or behavioural finance sins to which most investors are prone. But of course Buffett is not ‘most investors’ and the fact he has been able to overcome such human frailties – having his name associated with buying into an industry he has so assiduously and publicly avoided in the past – is a good illustration of why he is considered one of the investment greats.
Here on The Value Perspective, we would also interpret his change of heart on airlines as a nod towards his investing past. One of our favourite books this year has been Warren Buffett’s Ground Rules. Here, rather than analysing the Berkshire Hathaway policy of buying big-brand consumer goods businesses such as Coca Cola, its author Jeremy Miller focuses on Buffett’s investment approach in the late 1950s and 1960s.
This was the period when he was running the Buffett Partnership and posting some remarkable returns. Between 1957 and 1969, when the Dow Jones index rose 153%, or 7.4% a year, the Buffett Partnership rose 2,794% – or 29.5% a year. Strikingly, rather than pursuing the ‘big brands’ approach for which he is now so well-known, these years saw Buffett adopting a more Graham & Dodd style of investment.
He was, in other words, buying businesses on historically cheap valuations – and, as we said, he did very well indeed out of it until he teamed up with his long-term Berkshire Hathaway partner Charlie Munger. The pair then dismissed this approach as ‘cigar-butt investing’, with Buffett later explaining his concern was that it was not scalable and thus would not work with the enormous sums of money Berkshire Hathaway now invests.
For our part, here on The Value Perspective, we are quite content to continue investing in statistically cheap businesses, secure in the knowledge that when you do so, good things tend to happen – and we will take this opportunity to point you back to our conclusion in Sage Advice II – that “investors would be much better served by tracking down Buffett’s shareholder letters – particularly his older ones.
“These were written when he had far fewer assets under management than he does today and thus far greater leeway to invest as he wanted. Reading these, to mangle the well-known phrase, you will teach yourself how to catch manageable fish rather than merely watching Buffett land his sea-monsters or, even less productively, setting sail to try and catch them yourself.”