In 1952, Warren Buffett made a concentrated bet on Western Insurance Securities. At two times earnings and half of book value, the stock had tremendous upside and no downside. An enterprising investor could easily find opportunities with similar mathematical expectation ((probability of loss x size of loss) + (probability of gain x size of gain)).

By 1967 Buffett realized that the situation had changed:

“Statistical bargains have tended to disappear over the years. This may be due to the constant combing and re-combing of investments that has occurred during the past twenty years, without an economic convulsion such as that of the ’30s to create a negative bias toward equities and spawn hundreds of new bargain securities. It may be due to the new growing social acceptance and usage of takeover bids which have a natural tendency to focus on bargain issues. It may be due to the exploding ranks of security analysts bringing forth an intensified scrutiny of issues far beyond what existed some years ago. Whatever the cause, the result has been the virtual disappearance of the bargain issue as determined quantitatively - and thereby of our bread and butter.”

I would add that the emergence of leveraged buyout funds has contributed to the dearth of bargains. Because these funds use large amounts of operating leverage to increase return on equity, they are willing to pay control premiums that would otherwise be foolish. Manifestly cheap stocks (such as Western Insurance circa 1952) are non-existent. Virtually all companies selling below NCAV have large operating losses, indifferent management and/or excessive fixed charges. The mathematical expectation of such issues is usually equal to the expectation of the general market; prices are more efficient than ever.

NOTE: My preference for special situation/distressed investing is an admission that stock prices are intensely efficient. On this site, the ratio of arbitrages to long-term holdings is 5 to 1; it will probably surpass 50 to 1 by year-end. These arbitrages provide superior risk-adjusted returns because the small dollar gain is unattractive to most professionals.