The Buffett Way: Time for a Rethink?

The value investing style championed by Berkshire Hathaway chief Warren Buffett often excels in bear markets, but not this time. Is the strategy still sound?

By Ben Steverman

The past year has sometimes looked like a practical joke that the stock market is playing on value investors.

Disciples of the value strategy, like Berkshire Hathaway's (BRKA) Warren Buffett, focus on the long-term intrinsic value of a company, hoping to buy shares in good companies at reasonable prices. By focusing on value, they avoid fast-growing firms with expensive stocks, and, by thinking long term, they try not to worry about the fickle gyrations of the market from month to month or day to day.

But amid a severe recession and financial crisis, true value has proven to be a slippery concept. "It's only a value if you can accurately assess today what the future profits will be," says Richard Sparks of Schaeffer's Investment Research. Particularly for financial stocks—some of which haven't or won't survive the crisis—it's nearly impossible to identify the long-term value, whether through profits, cash flow, or other measures.

Value investors might think long term, but that's a problem when the stock market is moving very quickly. Stocks lost a third of their value in one month last fall, and jumped 20% higher in three weeks this March. Buy or sell a position too early or too late and the effect on your portfolio could be disastrous.

Big Disparity in Performance

Every investing style has had its problems in the bear market of 2008 and 2009, and, depending on your measure and time frame, value managers' results have been remarkably similar to those with other styles, says Morningstar (MORN) fund analyst Michael Breen.

In the past year, for example, Morningstar data show that large-cap value funds have fallen 37.5%, while large-cap growth funds are off 34.5% and large-cap blend funds lost 36.4%.

There are two surprises, however. The first is that value managers often do better than growth managers or others during bear markets. The classic example is the tech bust in the early 2000s. Value managers had avoided expensive, high-flying technology stocks, while many growth managers were burned by the sector's implosion. "Traditional value strategies did so well in the last bear market," says Jeff Layman, director of investment services for BKD Wealth Advisors.

Burned by Bank Stocks

The second surprise is the very wide range of results among value managers, Breen says. "Everybody's gotten hit," he says. But, "Some have gotten killed. It's the biggest disparity I've ever seen."

One explanation for the poor performance of many value investors in the past year is financial stocks. In late 2007 and 2008, beaten-down banks and other financial firms looked like great deals.

The world's most famous value investor, Buffett, held onto shares of U.S. Bancorp (USB), down 53% in the past year; Wells Fargo (WFC), off 49%; and American Express (AXP), which plunged 68%. He also made fixed-income investments in investment bank Goldman Sachs (GS) and General Electric (1 2 Next Page