Taleb: Buffett is Lucky

Taleb: Buffett is Lucky

Nassim Nicholas Taleb, author of The Black Swan, says Buffett is more luck than skill. Is the brilliant theorist and statistician correct?

Nassim Nicholas Taleb, author of the wonderful book The Black Swan and the less wonderful Fooled By Randomness, conducted an interview today with an online news site. In the interview Taleb is quoted as saying:

 “I don’t want to spend too much time on Buffett. George Soros has 2 million times more statistical evidence that his results are not chance than Buffett does. Soros is vastly more robust. I am not saying Buffett doesn’t have skill—I’m just saying we don’t have enough evidence to say Buffett isn’t doing it by chance.”

 Now I am a big fan of Taleb because I believe his work particularly concerning Black Swans is critical in investment analysis. His theory explains the existence and occurrence of high-impact, hard-to-predict, and rare events that are beyond the realm of normal expectations. In the case of Taleb, the Black Swan Theory refers only to unexpected events of large magnitude and consequence and their dominant role in history. Such events are considered extreme outliers.

Despite his obvious proficiency in statistical thought models and his contribution to investment and risk analysis, I have to admit he has dropped the ball on this one.

 Taleb’s statement is riddled with errors and it’s unclear how he drew that conclusion. Readers of his books should not be all too surprised by that statement because in The Black Swan, he spends a good few paragraphs playing down Buffett’s record and playing up his and that of Soros.

By its nature, George Soros’ record is easier to statistically “prove” than that of Buffett. Soros is a hypothesis investor – he generates a hypothesis in his mind and then tests that theory in the markets. He’s either right or he’s wrong. Buffett, on the other hand, is a long-term value investor. He forms no hypothesis but rather formulates the intrinsic value of a company and compares it to current market price. What’s more, he uses time as his friend. Therefore a statistical comparison as to whether he’s right or wrong on each investment is very difficult.

What is not in dispute is the fact that Buffett has one of the most outstanding investment records stretching over nearly 50 years. Each year since he took over Berkshire Hathaway in 1962, Buffett has generated a close on 20% annual compounded return. There are none in the business that can match that.

Every investment Buffett makes is a calculated bet based on expected outcome, a concept that Taleb advocates in his book, ironically. Buffett spends a lot of time working out the probabilities of each payoff and makes an investment only when the expected outcome is in his favor. This explains why Buffett has very few losing investments. There’s nothing lucky about this – it’s all in the calculations.

Taleb is in effect saying that Buffett is much like a roulette wheel, which has been spun 50 times and always ended on number 1. Every time. The probability of that event occurring, assuming a roulette table of 38 numbers, is so small that it’s as close to zero as my scientific calculator will go.

Markets are far too complex to reward luck on a continuous basis. It follows then that there is a tremendous amount of skill involved to successively compound money and avoid losses, in effect what Buffett has done. Any suggestion to the contrary that he has been “lucky” is just misled. Taleb was a trader himself once, but quit to publish books and put his ideas in writing. Most of his ideas are great and very worthwhile - just not this one!

 

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Comments

  • Gérard Lambert

    February 12, 2010

    How can you draw such a conclusion when you are even using his exact quote?

    ...we don’t have enough evidence to say Buffett isn’t doing it by chance.

    He's not saying Buffet IS lucky (1). He is saying he MIGHT be lucky(x). Hence, he might be skilled (1-x). Hence, you and Taleb probably agree.

    Your article would have had a better tone if you had explained that x=0, in your own opinion.

    Please be more thorough.

  • Some dumb guy

    May 21, 2010

    I read both Taleb's books. Considering that there are a lot of skilled value investors out there and yet only one Warren Buffet would tend to make one believe that Warren Buffet is lucky. But the world is a complex place and maybe a mixture of luck and skill play more into Warren Buffets success than we would like to admit.

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