'The New Buffettology': A Long-Term Wolf Among Shortsighted Sheep

In chapter two of “The New Buffettology,” authors Mary Buffett and David Clark looked more deeply into the concept of a “selective contrarian investment strategy.”

A plain contrarian is an investor interested in stocks with falling prices. Like Warren Buffett (TradesPortfolio), they are buying when mainstream investors are selling; it’s a standard part of value investing. The authors say this strategy emerged from the research of Eugene Fama and Kenneth French (also known as Fama and French); they discovered that stocks that had been undervalued in the previous two years could generate above-average returns in the following two years.

Buffett, though, sees a falling price and lack of popularity as only a starting point. He insists the company must have “exceptional” business economics, as well as a contrarian price.

As pointed out in chapter one, contrarian prices arise out of shortsightedness among 95% of all investors; because of these shortsighted perspectives, bad news embedded in the daily noise can be enough to scare investors out of their low-conviction holdings:

“Warren is the ultimate exploiter of the foolishness that results from other investors’ pessimism and shortsightedness. You see, most people and financial institutions (like mutual funds) play the stock market in search of quick profits. They want the fast buck, the easy dollar, and as a result they have developed investment methods and philosophies that are controlled by shortsightedness.”

In addition to a contrarian price and exceptional business case, Buffett also demands that target companies have a “durable” competitive advantage. In other words, the company needs to have price protection of some kind; examples include proprietary technology, such as Apple (NASDAQ:AAPL), and strong brands, such as Walmart (NYSE:WMT).

There is one more explanatory thread: Buffett looks at potential buys as a private business person would. He approaches a potential

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