Buffett in Foresight and Hindsight

Investors know the extraordinary performance of Warren Buffett with hindsight, but what did they know with foresight? Will Rogers said, “Don't gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don't go up, don't buy it.” Investors know today with perfect hindsight that the performance of Warren Buffett's Berkshire Hathaway Inc. has been extraordinary. But did they know it with foresight? We report that investors, as a group, did not see Buffett's performance with foresight, and we use our evidence to highlight the pitfalls of hindsight in investment analysis.A share of Berkshire Hathaway stock could have been bought for $18 on May 10, 1965, the day Warren Buffett took control of the company. That share could have been sold for $71,000 on December 31, 2000. The annualized return of Berkshire Hathaway's stock during the period was 26.18 percent, more than double the 11.69 percent of the S&P 500 Index.The $18 price of Berkshire Hathaway stock in 1965 was its “value-in-foresight”; that is, that price represents the sum of investors' wisdom in 1965 about the future performance of Berkshire Hathaway stock. Looking back in hindsight, from the vantage point of 2000, we know that the value of Berkshire Hathaway stock in 1965 was $1,383; that is, investors would have had to invest $1,383 in the S&P 500 in 1965 to earn the $71,000 accumulated by investors who bought shares of Berkshire Hathaway for $18 in 1965. So, Berkshire Hathaway's “value-in-hindsight” is almost 77 times higher than its value-in-foresight.If investors had foreseen in 1965 the wonderful future performance of Berkshire Hathaway, the company's stock price would have jumped from $18 to $1,383 right then. The fact that the price of Berkshire Hathaway shares increased only gradually over the years tells us that today's investors are fooled by hindsight to believe that they have seen Buffett's performance in foresight.Buffett himself understands well the distinction between foresight and hindsight. When the DJIA declined in the spring of 1966 after its climb beyond 1,000 earlier that year, some of Buffett's partners called to warn him that the market might decline further. Such calls, Buffett said, raise two questions: “If they knew in February that the Dow was going to 865 in May, why didn't they let me in on it then; and (2) if they didn't know what was going to happen during the ensuing three months back in February, how do they know in May?”The bias of hindsight that leads us to believe that we have seen Berkshire Hathaway's extraordinary performance with foresight also fools us into believing that we can identify the next Buffett and Berkshire Hathaway. We might identify, instead, the next WebVan, the next Enron, or any of the many stocks that peaked at tens or even hundreds of dollars before they were gone. Today more than ever, through 401(k) and other saving programs, investors hold their financial futures in their own hands. They cannot entirely avoid the risks in investing, but they cannot afford to let the confidence of hindsight ruin their financial well-being.