Warren Buffett Dance Off
One reason I switched from public to private equity investing was my observation that technology was making investing in public stocks less fun. Thanks to algorithms, arbitrage, and automated trading, it was becoming more and more difficult to find an edge and generate excess return. After all, when you buy a stock, you can only take or leave the listed price. You can’t negotiate favorable terms or, absent being an enormous activist investor, influence management. So if the price is fairly efficient, that’s that. You should earn the market return.
When I met Brent (our CEO), I became fascinated by what he was doing because it seemed like private equity investing in the lower middle market was the better opportunity set. Not only might you find opportunities that were attractively priced, but you could also generate return through how you structured the investment and how you helped operate the business post-close.
And based on everything I know now, I think that point still stands to reason.
Yet here is Warren Buffett, the Oracle of Omaha, in his most recent annual letter expressing the exact opposite opinion:
Far be it from me to start a dance off with one of the most successful investors of all time (no one showed up to my annual meeting this past weekend), but while the stock market has certainly been volatile many times in the last 25 years, it probably hasn’t objectively achieved “panic-type” valuations since 1982, when it traded for less than eight times earnings.
Now, before you @ me, know that I recognize that there are all sorts of ways to measure stock market valuations, that individual stocks often trade well outside of average valuation bands, and that value investing has on average achieved very attractive long-term returns. But let’s just replace the phrase “selling at a panic-type valuation” with the phrase “selling at a valuation attractive to a buyer.” If we do that, then I think it is more common to find that among the universe of private businesses, particularly small ones.
See, it’s easy to find public stocks for sale. Just look up the price on your phone. Finding private businesses for sale is immeasurably harder. I was reminded of this at a conference I attended recently where potential buyers scheduled 20 minute slots of time with bankers representing handfuls of small business sellers. As a buyer, you didn’t know beforehand what the banker might have for sale. And as the banker, you had no idea ahead of time what the seller might be looking for. Some meetings were duds; others led to epiphanies. Yet there was no consistency, and if there’s no consistency, there can be no price discovery.
But back to Buffett’s statement. One could argue that if a seller does not receive an attractive offer from a buyer then that seller just won’t take it. This argument ignores the fact that there are lots of reasons beyond price that a seller might sell. They might want to retire or diversify or need help or be subject to a divorce settlement that requires liquidity. In that world, where there is limited price discovery and ample need, a private business might absolutely transact at a price attractive to a buyer.
Whenever you transact it can be worth asking who’s your counterparty and if that counterparty has more information than you do. In the public markets, whether you’re buying or selling, your counterparty likely absolutely has more information than you do and the price of the transaction is non-negotiable. In the private markets, your counterparty may still have more information than you, but it may not matter and you may be able to close the value of that knowledge gap by negotiating on details other than price.
I’m not saying Buffett is wrong, but that you should always think about where you want to take your chances and why.
– By Tim Hanson
