How Buffett Beats the Market

Warren Buffett is so much more than just a good investor. One economic study found that he is the best investor the world has ever known.

Based on an index that measures returns adjusted by price fluctuations, we learned that the CEO and chairman of Berkshire Hathaway, billionaire investor Warren Buffett, has beaten every mutual fund and long-standing US stock based on a set of certain parameters.

When closely looking at the US stock market between 1926 and 2011, mainly focusing on stocks that have traded for 30 years or more, the National Bureau of Economic Research published a paper recently that said Buffett’s Sharpe ratio is 0.76 since the year 1976. That’s roughly twice the stock market’s ratio at 0.39.

Buffett’s ratio is also bigger than 196 United States mutual funds that have existed for over 30 years. Their median Sharpe ratio is 0.37.

By reviewing Buffett’s investments, they were able to conclude that his use of leverage, plus buying low cost quality shares, were the main reasons for his big rewards.

The study proves that Buffett is willing to borrow in order to finance his investments, and then he buys cheap, low volatility stocks – with low price-to-book ratios – as well as high-quality businesses that have high payouts and are profitable.

After breaking down the Berkshire Hathaway portfolio into private companies and publicly traded stocks, the authors of the study found that the tradable equities are the best performers. This fact also suggests that Buffett’s monstrous returns are more because of his stock picking ability then the added pressure Warren Buffett puts on businesses to improve management when he has a stake in the company.

“Buffett’s performance appears not to be luck, but an expression that value and quality investing can be implemented,” said David Kabiller and Andrea Frazzini, of AQR Capital and Copenhagen Business School’s Lasse H. Pedersen. “If you travel back in time and pick one stock in 1976, Berkshire Hathaway would be your pick.”