Is Buffett’s Model Broken?

by | Apr 29, 2024

Is Buffett’s Model Broken?

For 70 years, we’ve been hearing about value investing from icons like Buffett. And you can’t exactly argue with the success of someone worth $130 billion… one of the richest humans on earth.

Buffett follows the Benjamin Graham school of thought when it comes to investing.

He looks for investments with prices that are unjustifiably low based on their intrinsic worth using traditional valuation metrics (meaning he is analyzing the company’s financials.) You can then derive what the value of the stock should be.

But in today’s day and age, what is value?

Value requires some standard… Some baseline… Some agreed upon common sense among market participants.

We don’t have that anymore.

Right now, we have companies reporting fantastic earnings and share prices dropping — And, at the same time, we have companies reporting terrible earnings and the stocks are rising double digits.

Traditional valuation metrics seem to have gone out the window.

Now, we could point to examples of insane valuations in the tech space like SMCI or ARM. Or how Tesla keeps ripping in spite of a pretty ugly balance sheet.

But it’s even deeper than that. We live in a society where almost every major enterprise is wildly political. Globally political!

Political maneuvers (and reactions to those maneuvers) end up having as much to do with the stock’s performance as its P&L…

Think about the airline industry for a moment.

Several of them have gone all-in on diversity as a key focus and metric for their multi-billion dollar enterprise.

Now, you can think that’s a good thing or a silly thing…But my point is that it’s not a typical fundamental factor to consider when you’re evaluating a stock.

The DEI (Diversity, Equity, and Inclusion) commitment from airlines and many other companies plays a huge role in changing the corporate landscape. It makes you take into account a whole slew of elements Buffett isn’t looking for in the financial statements.

Consider that the federal government just rejected a regulation that would allow pilots to retire at 67 instead of 65.

So we have confirmed in legislation that a pilot can’t be 67 years old even though they likely have 40 years of experience flying because that could open up unnecessary risks… At the same time, the field must be shifted to hire less qualified pilots to meet diversity quotas.

Whether you think that’s a good thing or not, the fact remains that it is inconsistent. And it’s a purely political adjustment that has nothing to do with the company’s real underlying value. 

Then There’s ESG

Now let’s think about environmental and social governance (ESG.) A recent study indicated that ESG initiatives are forfeiting 5% to 10% of shareholder value because the firms lose flexibility.

ESG is also causing companies to allocate funds that could be better spent internally or returned to shareholders. And what are they spending the funds on? Political agendas, campaigns, and donations to candidates…

That means companies are using money to position themselves favorably to political regimes rather than, say, pay a dividend or upgrade technology or invest internally to be more profitable.

Here’s the thing though… Maybe having sway over a politician does give them a ruling in the company’s favor. Maybe that is the best thing they can do for their profit… 

That wouldn’t shock me to be perfectly honest, but it sure is hard to account for that in any kind of “value” metric.

These initiatives are becoming increasingly commonplace. Investors who use ESG criteria and push companies towards ESG controlled over $8.4 trillion in US assets in 2022.

That means ESG accounted for $1 of every $8 of assets being managed professionally in the US and it’s only rising.

Where This Leaves Us

The fact of the matter is that the market has grown increasingly complex and bloated. Traditional representations of value, such as profitability metrics, cash flow, and earnings don’t seem to matter anymore to a broad group of investors.

Which is incredibly unfortunate. Because those are the things that should be the “make or break” of a company, not their diversity policy or ESG grade. (Which, by the way, isn’t a real objective standard that you could quantify even if you wanted. Just look at how Tesla’s ESG score tanked after Elon got on the wrong side of the political regime even though nothing about the company changed at all.)

We are now in an age where Buffett’s classic value investing approach doesn’t work as well anymore… Or, at the very least, is nearly impossible to measure. Because today, factors entirely outside the range of pure business fundamentals are acting as some of the biggest drivers of value.

Arbitrage opportunities tend not to make as much sense when we no longer have a unified system of assessing and determining what makes a company valuable.

And we can see this in the list of the wealthiest people across the world… For decades, Warren Buffett edged back and forth between first and second place as the richest man in the world. Now, year after year he’s edged down more and more (he’s at #7). We have the same story with Bill Gates as well (you probably recall it was Gates who often edged Buffett out as #1.)

Now, as valuations get messier and messier, they’ve lost some of their standing, and the top spots have been replaced by people who own companies whose valuations don’t entirely make sense. 

  • Bernard Arnault (Owner of most of the worlds luxury brands)
  • Jeff Bezos (Amazon Founder)
  • Elon Musk (Tesla, SpaceX, X)
  • Mark Zuckerberg (Facebook)

It’s because of this market chaos that you will hear me say again and again that I am mostly a momentum trader. It’s not that I don’t believe in value or wouldn’t jump at the opportunity for a great value investment…

It’s just that in today’s economy, there’s no confident measuring of value. Compare that to momentum where the market tells you the story in one simple baseline: Price.

You probably have heard me talk about the Automated Options strategy as well. The cool thing about that strategy is that it doesn’t require a single ticker to respond how I want. I don’t care about any individual assets DEI or ESG details. Instead, I focus on broad market momentum and then “hijack” the options to set myself up for success.

Because that’s the kind of trading I think makes sense in today’s world.

Luckily, there’s also a lot of benefits to the age we live in. That’s what I am here to explore and hopefully let you in on along the way!

For now, my advice is not trying to over-analyze value in a world that doesn’t recognize value.

To your success,

— Nate Tucci

P.S. I hope you were able to hop on and catch my Automated Options webinar this week! But for those of you that missed this opportunity, you can catch a recap of it right here.

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