The following article was written in
September 2000 and appeared in The Investor Journal.
It included the dedication: "Dedicated to Warren
Buffett, the Sherlock Holmes of the stock market,
on his 70th birthday."
Warren Buffett replied stating, "I
enjoyed the Sherlock Holmes piece. Thanks for the
dedication; I'm flattered."
What has Sherlock Holmes got to do with investing?
Most people, including myself up to a few years ago, would
probably answer nothing. But something happened in 1997
that made me change my mind.
At the time I was mulling over a talk I was
to give at a conference on the mathematics of options. My
mind went from thinking of the pricing of options as paradoxical
to thinking of them as mysterious. From there I went to
Sherlock Holmes who was created by Sir Arthur Conan Doyle
as the world's greatest detective, the pre-eminent person
to solve any mysteries.
This led to two outcomes. The first was that
I prepared a talk entitled the "The Case of the Missing
Ten Pounds." It described the arcana of the theory
of pricing futures and options in the setting of a Sherlock
Holmes mystery. This talk became an article published in
The second outcome was that I reread all the
Sherlock Holmes books and articles on the lookout for quotations
that could be interpreted as sound advice for long-term
strategies for the stock market. All right, we all do weird
things from time to time. The important thing is that I
came across a lot of pithy comments that can be directly
applied to the stock market.
As this is the occasion of the second anniversary
of writing the Price on Value articles, I thought that I
would give you some of the quotes. Most of the quotes are
from conversations that Holmes has with his friend and biographer,
Dr. John Watson. Just let your imagination go and think
of Holmes as expounding on principles of long-term investing
in quality companies.
You know my methods in such cases, Watson:
I put myself in the man's place, and having first gauged
the man's intelligence, I try to imagine how I should myself
have proceeded under the same circumstances. The Musgrave
You'll get results, Inspector, by always putting
yourself in the other fellow's place, and thinking what
you would do yourself. It takes some imagination, but it
pays. The Adventures of the Retired Colourman
These quotes reminds me of Warren Buffett's
many comments stating that he tries to think as an owner
of any company that he might invest in. "I always picture
myself as owning the whole place," he once said.
Ask your self questions such as, "What
could go wrong?" and "Who are the competitors?"
It is of the highest importance in the art
of detection to be able to recognize out of a number of
facts which are incidental and which are vital. Otherwise
your energy and attention must be dissipated instead of
being concentrated. The Reigate Squires
We approached the case, you remember, with
an absolutely blank mind, which is always an advantage.
We had formed no theories. We were simply there to observe
and to draw inferences from our observations. The Cardboard
The difficulty is to detach the framework
of fact-of absolute, undeniable fact-from the embellishments
of theorists and reporters. Silver Blaze
It has long been an axiom of mine that the
little things are infinitely the most important. A Case
When analyzing a company, focus on what is
important and don't get stuck in side issues. Buffett started
his career in New York but moved back to Omaha, Nebraska,
where he found it "much easier to think." On Wall
Street everyone has an opinion, a hot tip, but ultimate
success depends on separating the facts from, as Holmes
said, "the embellishments of theorists and reporters."
Here we might add, "and stock analysts."
You know a conjurer gets no credit when once
he has explained his trick; and if I show you too much of
my method of working, you will come to the conclusion that
I am a very ordinary individual after all. A Study in
One of Sherlock Holmes' defects-if, indeed,
one may call it a defect-was that he was exceedingly loath
to communicate his full plans to any person until the instant
of their fulfillment. Partly it came, no doubt from his
own masterful nature, which loved to dominate and surprise
those who were around him. Partly also from his professional
caution, which urged him never to take any chances. The
Hound of the Baskervilles
We know just how secretive Buffett is regarding
his investment decisions. He once said that he is lucky
to have one good idea each year. "Good investment ideas
are rare, valuable and subject to competitive appropriation
just as good product or business acquisition ideas are,"
he wrote in the Berkshire Hathaway Owner's Manual. By keeping
ideas a secret and at the same time acting on them with
sizeable investments, Buffett ensures that Berkshire Hathaway
profit the most every time his mental light bulb lights
To determine its exact meaning I have been
obliged to work out the present prices of the investments
with which it is concerned. The Adventure of the Speckled
Here we have it. Perhaps the first statement
anywhere that the important calculation when valuing an
investment is to determine the present or discounted value
of its financial rewards. As Buffett has said, intrinsic
value is "the discounted value of the cash that can
be taken out of a business during its remaining life."
Putting it together
When Watson said that he thought that Holmes
had seen more in the rooms than was visible to him, Holmes
replied, "No, but I fancy that I may have deduced a
little more. I imagine that you saw all that I did."
The Adventure of the Speckled Band
A similar idea is expressed in "A Case
of Identity" in which Watson remarked that Holmes had
seen things that were invisible to him to which Holmes replied,
"Not invisible, but unnoticed, Watson."
Another time Watson complains that he cannot
see anything unusual about what Holmes was showing him.
Holmes responds, "On the contrary, Watson, you can
see everything. You fail, however, to reason from what you
see. You are too timid in drawing your inferences."
The Adventure of the Blue Carbuncle
I see no more than you, but I have trained
myself to notice what I see. The Adventure of the Blanched
Isn't this the secret core of investing? The
ability to see what everyone else sees, the company reports,
the products, the competitors, and so on, but to see it
in a new way so that you can tell whether it is a superior
investment or just another ho-hum stock. Buffett, for example,
said that when he made his major purchase of Coca Cola stock
that he only used the same information and material that
was available to everyone else. The difference was that
he deduced more than everyone else to arrive at the conclusion
in 1988 that this was an excellent investment. He was right;
the stock quadrupled in value over the next four years.
Stay with the facts
It is a capital mistake to theorize in advance
of the facts. The Adventure of the Second Stain
No, no: I never guess. It is a shocking habit,
destructive to the logical faculty. What seems strange to
you is only so because you do not follow my rain of thought
or observe the small facts upon which large inferences may
depend. The Sign of Four
The temptation to form premature theories
upon insufficient data is the bane of our profession. The
Valley of Fear
In 1934, Benjamin Graham wrote in Security
Analysis that the intrinsic value of a stock is that value
which is justified by the facts, e.g., the assets, earnings,
dividends, definite prospects, as distinct, let us say,
from market quotations established by artificial manipulation
or distorted by psychological excesses."
Doyle/Holmes in 1890 and Graham in 1934 could
have been referring to the wild speculations that are put
out by market commentators and analysts regarding dot com
companies and that are dressed up as reasoned reports.
Knowledge and experience
He possesses two out of the three qualities
necessary for the ideal detective. He has the power of observation
and that of deduction. He is only wanting in knowledge,
and that may come in time. The Sign of Four
It is better to learn wisdom late, than never
to learn it at all. The Man with the Twisted Lip
Learn from your mistakes
If it should ever strike you that I am getting
a little over-confident in my powers, or giving less pains
to a case than it deserves, kindly whisper 'Norbury' in
my ear, and I shall be infinitely obliged to you. The
Norbury was one of the rare cases when Holmes
was not at his best. He asked Watson to use this as a reminder
to make sure that he did not become over-confident in the
This reminds me of Buffett after his investment
in USAir in 1989. Within a few years the airline was in
such difficulty that Buffett wrote down the investment by
75 percent while trying to sell the shares at 50 cents on
the dollar. Fortunately for stockholders in Berkshire Hathaway,
Buffett was unsuccessful in finding a buyer for within a
year or two USAir returned to profitability. In the end,
Buffett's action brought a healthy profit to Berkshire Hathaway.
On a personal level, Buffett admitted that
the purchase was a result of sloppy analysis that may have
been caused by hubris. To guard against a similar lapse
in the future, he once joked, "So now I have this 800
number, and if I ever have the urge to buy an airline stock,
I dial this number and I say my name is Warren Buffett and
I'm an airoholic. Then this guy talks me down on the other
There were no 800 numbers in the late nineteenth
century so Holmes had to rely on Watson to "talk him
Check and double check
I have forged and tested every link of my
chain, Professor Coram, and I am sure that it is sound.
The Adventure of the Golden Pince-Nez
These are just a small sampling of quotes
from Sherlock Holmes that have an investing flavor. In fact,
some of them seem to have been written as if their main
purpose was to provide sound principles of investment, rather
than as methods of criminal investigation. But perhaps we
should not be surprised at this. After all, patience, tenacity,
clarity of mind, a willingness to sift though the facts,
resistance to unnecessary or premature speculation are surely
traits of the best detectives as they are of the best investors.