A glimpse at my book...

Perhaps most gallingly of all, Buffett even joked about sponsoring more academic studies and endowing chairs of finance departments to prove the market is efficient. After all, he argued, it is a lot easier to win the game when you're playing against foolish people who believe a bunch of nonsense.

I wrote this book because I believe Buffett discovered a way to consistently beat the market. I believe his method is simple enough that almost anyone who is willing to learn the basics of finance and investing can understand it. As Buffett proves, you don't have to go to Harvard to get rich in the stock market. (Harvard rejected Buffett in 1952.)

I also wrote this book because I believe investors can dramatically improve their investment performance and radically reduce their investment fees and taxes by adopting Buffett's approach. Happily, even if I'm wrong – even if Jensen is exactly right and the markets are perfectly efficient – there's no harm in trying to do better than average. After all, if you invest for a long enough period, Jensen's theory suggests you'll at least earn average returns. Ergo, there's no downside to trying to learn from Buffett.

And no matter what Jensen says, there can be no doubt about what Buffett achieved as an investor.

Since 1965, the book value of Berkshire Hathaway has compounded at almost 20% a year. That's more than twice the pre-tax return of the S&P 500 in the same period.

Buffett accomplished these market-beating investment returns while exposing his investors to very little risk. Berkshire has never borrowed much money, nor has it ever invested in risky stocks. And Buffett almost never lost money... between 1965 and 2000, Buffett didn't experience a single losing year. During this period, the S&P 500 beat the growth in Berkshire's book value just four times.

In short, for 35 years, Buffett trounced the market, earning returns far in excess of what the academic theory suggests is possible. And he did it without borrowing money or taking excessive risks. Jensen and his colleagues from the University of Chicago believe such a performance over such a long period of time is impossible.

However, a 2013 academic study proves what these numbers suggest: Buffett's investment performance was the very best that exists out of all individual stocks and mutual funds that have existed for at least 30 years, even when you carefully adjust for the amount of risk-taking involved in his investment strategy.

A word of caution, though. As we'll examine in this book, Buffett's investment results since 2000 haven't been this good. Berkshire Hathaway has seen its book value decline annually on two different occasions since 2000. And Buffett's investment portfolio returns have fallen far below that of the indexes.

The primary purpose of this book is to examine how Buffett's investments from 1965 to 2000 were different from the ones he has made since 2000. By studying Buffett's mistakes – both the few he made before 2000 and the several he has made since then – I believe you can best come to fully understand and appreciate his approach to investing, an approach that defies the conventional wisdom about what's possible for individual investors to achieve.

But maybe you shouldn't read this book. Maybe Jensen is right. Maybe it is just a waste of a lot of time (and a little bit of money). What did Jensen say about Buffett's success? How did he explain an investor who could beat the averages by so much, year-after-year, while taking almost no risk?

In 1984, Jensen was asked to explain how Buffett's results were possible, given the limits described to individual investors by the efficient-market hypothesis. The venue was Columbia University in New York City. The event was the 50th anniversary the publishing of Securities Analysis, the book written by Buffett's mentor Ben Graham and by David Dodd, a professor at Columbia.

Securities Analysis represents the antithesis of the efficient-market hypothesis. It was this book that put Buffett on his path to wealth and investment greatness.

In the book, Graham's secrets to systematically beating the market are spelled out in black and white. Graham taught readers to evaluate each share of a company as though you were buying the entire firm... Always get more in value than you pay in price... Understand Mr. Market is manic-depressive, and wait until he offers you an asking price that's cheap because he's under duress or during a depressive stage... And most important, don't buy until you have a firm margin of safety.

Jensen thought all of this was hocus-pocus. Other market participants would have this information, too, he argued. As a result, these factors would already be "priced in" to the stock market. There was no way any individual investor could gain a systematic edge – not even Buffett. Jensen explained Buffett's success as mere luck.

Jensen used a story to illustrate his point. Imagine, he said, if everyone in America picked up a quarter once each evening and picked heads or tails and then flipped the coin, recording the result. Even if everyone was honest, by the end of the year, there would be a small number of people who had "predicted" every coin flip correctly, or nearly every coin flip correctly. The media and the celebrity hounds would fete these individuals. They would be asked for their opinions on a wide range of topics, most of which they know nothing about. And they would be asked to make predictions on a wide range of other random events, some of which they would get right. Soon people would be referring to these lucky coin flippers as "oracles."

But Jensen reminded the audience, no amount of correct coin flipping would ever convince a scientist that people could gain a lasting advantage in a coin-flipping contest. Buffett's results were random. He was merely an incredibly lucky coin flipper.

Then it was Buffett's turn to talk. His reply was the most famous intellectual smack-down in financial history.

First, Buffett showed the audience the incredible investment performance of nine fellow value investors, all of whom he knew personally and who had adopted their style of investing from work of Graham and Dodd. They were all from the same intellectual town "Graham-and-Doddsville."

All of these investors beat the market over a 20-year period or longer, using the same approach, working independently of each other and buying completely different investments. This wasn't coin flipping. All of these investors beat the market by a wide margin. There were no losers. They were all from the same intellectual place. That meant it couldn't be random chance or luck. After all, lucky people don't all come from the same place.

As Buffett explained...

So these are the nine "coin flippers" from Graham-and-Doddsville. I haven't selected them with hindsight from among thousands. It's not like I am reciting to you the names of a bunch of lottery winners – people I had never heard of before they won the lottery. I selected these men years ago based upon their framework for investment decision-making. I knew what they had been taught and additionally I had some personal knowledge of their intellect, character, and temperament. It's very important to understand that this group has assumed far less risk than average. Note their record in years when the general market was weak. While they differ greatly in style, these investors are, mentally, always buying the business, not buying the stock. A few of them sometimes buy whole businesses. Far more often they simply buy small pieces of businesses. Their attitude, whether buying all or a tiny piece of a business, is the same. Some of them hold portfolios with dozens of stocks; others concentrate on a handful. But all exploit the difference between the market price of a business and its intrinsic value. I'm convinced that there is much inefficiency in the market. These Graham-and-Doddsville investors have successfully exploited gaps between price and value. When the price of a stock can be influenced by a herd on Wall Street with prices set at the margin by the most emotional person or the greediest person or the most depressed person it is hard to argue that the market always prices rationally. In fact, market prices are frequently nonsensical.