Once upon a time a couple of enterprising university professors got together and proclaimed that the stock market was efficient, meaning that on any given day a stock was accurately priced given the information available to the public. They also concluded that because of this efficiency, it would be impossible to develop an investment strategy that could do better than the market did as a whole. Because of the market's efficiency, they concluded, the most profitable approach to investing would be through index funds that go up and down with the rest of the market. (This type of fund buys a basket of stocks, without regard to price, representing the stock market as a whole.)
Warren Buffett recognizes that because 95% of all investors are hell-bent on trying to beat each other out of the quick buck, the stock market is very efficient. He sees that it is impossible to beat these people at their short-term game. He also realizes that the shortsighted investment mind-set that dominates the stock market is completely devoid of any true long-term investment strategy. You only have to look to the options market to see hard evidence of this.
- Short-term options trading, up to 6 months out, is a fully developed market with multiple exchanges, writing tens of thousands of option contracts, on hundreds of different companies, each and every day the stock market is open.
- The so-called long-term options market, up to 2 years out, is tiny and deals in fewer than fifty stocks. From Warren's investment perspective, 2 years out is still short-term.
- No exchange has an active options market writing contracts 5 to 10 years out. It simply doesn't exist.
Warren's great discovery is that, from a short-term perspective, the stock market is very efficient, but from a long-term perspective, it is grossly inefficient. He had only to develop an investment strategy to exploit the shortsighted market's inefficient long-term pricing mistakes. To this end, he developed selective contrarian investing.
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