Beating A Wildly Efficient Stock Market

Since 1950, the number of buildings in the United States that catch on fire has decreased by 92%. This reduction in property loss is the result of fire-resistant building materials, major improvements in heating devices like space heaters, and even the addition of smoke detectors and sprinkler systems to middle-class homes.

When I recommend that people recognize reality as it is rather than how they wish it would be, the investor insights usually involve grudging acceptance of the foibles of human nature. People may not like smoking or drinking, but the data shows that the consumption of cigarettes and beer remains strong in spite of government regulations aimed at deterrence—harsher DWI consequences, restrictions on smoking-permitted locations, advertising bans and curtailments, and even excise taxes.

Recognizing reality—that a meaningful subset of the population will do anything to take the edge off the hardships of their daily life—explains why beer barons are the wealthiest families in nearly every country and Altria/Philip Morris investors have gotten richer than any other investor in the American stock market since 1956 save for the doctor, roommate, and family members of Warren Buffett that invested in the partnership that preceded Berkshire Hathaway.

For a long time, I have searched for a more salutary example. When has recognizing reality that is more pleasant than most people think resulted in the accumulation of inordinate wealth?

I’ll offer you this. From 1943 through 1982, investors in fire insurance companies generated 16.5% annual returns. Everyone talks about “Be like Warren Buffett”—fire insurance investing during this time period is how you could have emulated the man from Omaha. Buffett, in part, built his fortune on GEICO because it was the Government Employee Insurance Company and he surmised correctly that people who chose to work in government were more risk-averse than workers in private industry and would therefore be more careful drivers as well.

Similarly, people were paying premiums for fire insurance companies that were much higher than the amount that the insurance company paid out since America’s mid-20th century advancements were hitting the pockets of fire insurance companies before the typical market price readjusted to reflect the lower risk.

Over time, fire can be a peril covered by a typical homeowner’s insurance policy rather than a separate purchase in its own right.

Investors that want to have a few business holdings that compound at 15-20% over long periods of time need to adopt this mindset. What is a business where people still think about the “cost” side in 1990s-era terms but the reality is that the contemplated downside is not as bad as it used to be? Or, conversely, what is something that is something that is going to need to be bought in amounts far in excess of historical norms and therefore the P/E multiple is not as high as it deserves to be?

Personally, I suspect the answer is going to involve the accumulation, storage, and protection of personal information, such as medical and credit data. For most of American history, this type of data was kept in an office file that would need to be physically broken into or did not have far-reaching implications (e.g. when credit scores were first being introduced, the idea of using them to accept or reject job candidates was absurd).

The field of data storage and protection largely developed without government oversight or fear of steep penalties (the only penalty was the marketplace, where data breaches and failures would presumably lead to loss of customers). I suspect over the coming years you will see extensive tort and regulatory penalties for companies that do not adequately store and protect data, and therefore, companies that can reliably provide these services stand to make quite a mint.