Megan McArdle Sep 1 2009, 12:00 PM ET

Ben Baker/Redux

F or Warren Buffett’s most devoted followers, a meal at Gorat’s Steak House is near the apex of the visit to Omaha for the Berkshire Hathaway annual meeting, second only to seeing Buffett onstage at the Qwest Center. You do not eat at Gorat’s for the food, which is the apotheosis of indifferent midwestern cooking. You eat at Gorat’s because it is Warren Buffett’s favorite restaurant. Really serious Buffett devotees order the T-bone and hash browns, because that is what “Warren” is rumored to eat.

After five days in Omaha, I still don’t understand what Buffett’s disciples hope to learn by copycatting his food choices. I do have a better sense, though, of why some 30,000 people now make what amounts to an annual pilgrimage to Omaha, from places as far-flung as Singapore and South Africa.

More like the early Christians in pagan Rome than the millions of Muslims thronging Mecca, Buffett’s hard-core “value investors” are few, and in many ways, their entire lives run against the grain of the dominant culture. Only here in Omaha, for one weekend a year, are they a majority. The meeting, with its quasi-ritual speeches, canonical stories and jokes, and the fellowship of other value investors, helps to brace them against a society that almost actively rejects their austere financial philosophy.

And, of course, there is Buffett himself. It is his achievements that give value investing a good name. But while many popularizers who become the public face of a discipline reap the scorn of their colleagues, Buffett epitomizes value investing for insiders as much as for those on the outside. He seems to be the very reason why most value investors are value investors. Much of the writing on the arcane craft eventually comes around to a central question: What Would Warren Do? Which of course makes one wonder: What happens to the value-investing community once he is gone?

I wasn’t the only one wondering about this. During the Q&A, Buffett was asked, once again, why he hasn’t started to give some control of Berkshire Hathaway to a successor. Buffett’s response: “If we had a good way to inject someone into some role that would make them a better CEO of Berkshire, we’d do it, but the candidates we have right now are running businesses, making decisions, getting experience. To bring them into the Berkshire offices while I’m sitting there reading would be a waste of talent.”

Beyond a certain point, what Warren Buffett does can’t be taught. That’s why, as the British financial writer Merryn Somerset Webb once drily pointed out. despite all the self-proclaimed value investors in the world, “Buffett is certainly the only money manager around in a position to give £20 billion to charity.”

But if Buffett is such a hard act to follow, then why were we all spending a beautiful spring day in the Omaha convention center trying to drink in his wisdom, not to mention eat his brain food?

I spent much of my time in Omaha trying to answer that question, a task complicated by the difficulty of defining what, exactly, value investing is. When Benjamin Graham and David L. Dodd wrote the value-investing urtext, Security Analysis . in 1934, the rules were more hard-and-fast. Graham and Dodd looked for companies whose price was less than their intrinsic value, and offered various formulas for divining this value.

Buying stock in firms where the intrinsic value of the assets is higher than the market capitalization worked well in the depths of the Great Depression, when investors were wary of holding equity. Between 1929 and 1932, the Dow lost just about 90 percent of its value, bottoming out at 41.22. What economists call the “equity premium”—the extra return that investors demand to compensate for the risk of holding stocks—has never since been so high. That’s why Graham and Dodd could find companies whose liquidation value offered a substantial “margin of safety” for people who bought their equity.

Moreover, book value and other balance-sheet-based metrics have become less useful, as the market, and the economy, have changed. Persistent inflation means that the historical cost of the assets on the balance sheet in many cases bears only passing resemblance to their actual worth. Meanwhile, firms get more and more of their value from intangible assets, like intellectual property or strong brands, that don’t show up in the financial statements. Geico, one of Buffett’s crown jewels, gets much of its value not from physical equipment or even investment savvy, but from a sterling brand name built on relentless advertising.

Much of what Graham and Dodd did so well was simply hard coolie labor. In an era before spreadsheets or financial databases, they looked at company reports and painstakingly did the arithmetic to see where a company stood. That effort offers no competitive advantage in today’s information-saturated market. So while value investors still hew to the core notion of determining a company’s intrinsic value, waiting for the market to misprice the stock, and then buying on the cheap, nowadays that determination has much more of a subjective skill element.

Buffett is the one who has, more than anyone else, refined and redefined value investing for a new era. He is the one who stopped hunting for superbargains and started buying exceptional companies, even if they weren’t available at fire-sale prices. But what makes a company “exceptional” is idiosyncratic. Warren Buffett is exceptionally good at asking the right questions; the speech he gave in 1999 explaining why he wasn’t investing in the tech boom is astonishing for its foresight. But teaching someone to ask the right questions is much easier said than done.

When Buffett lectures on his craft, his precepts often sound less like investing rules than like the distilled essence of bourgeois virtue. Don’t speculate. Don’t risk money you can’t afford to lose. Don’t try to ride market trends. Don’t try to get rich quick. Don’t panic when the price drops. If there are no good buys, don’t buy anything. Above all, ignore what other people are saying. If everyone jumped off a bridge, would you jump too?

These are admirable traits in any investor. But they are hard to uphold, even in the best of times. And for value investors, the past few decades have not been the best of times. They have spent those years fighting not only their own human instincts, but also a broader financial culture that expected maximum returns for minimum effort. Many hedge funds piled up fortunes with abstruse mathematical trading strategies that paid little attention to the individuals or companies underlying their trades. Consumers bet wildly on stocks they knew little about, or passively stowed their net worth in index funds that required no mental effort—and either way, they expected double-digit annual returns.

Meanwhile, everyone discovered the magic of using more leverage to make money faster. What consumers were doing with no-money-down mortgages, financial firms were doing by investing borrowed money. In a booming market, this is an easy way to make big returns: for a small annual interest payment, you can bank any increase in the value of your house or portfolio. The less of your own money you put in, the better the return you get on your initial investment.

Bull markets can hide the downside of leverage for years. But as John Kenneth Galbraith noted in The Great Crash, 1929 . “Geometric series are equally dramatic in reverse.” Millions of underwater homeowners can now attest to leverage’s downside, with graphs and profanity. So can any number of laid-off bankers: one of the few uncontested causes of the current crisis is the 2004 decision by the Securities and Exchange Commission to let the largest investment banks increase their leverage ratio from about 12-to-1 to 30-to-1, or even higher.

Even the most committed professional value managers felt a lot of pressure to participate in the madness. During boom times, when value-investing strategies underperform lunatic gambles, clients get tempted by funds that deliver outsize returns by assuming a lot of hidden risk. And what about now, when value investors should theoretically be in a position to clean up? Well, for starters, the market still hasn’t fallen to Graham-and-Dodd levels; most of the managers I talked to groused that they were finding few real bargains. The market was irrational enough to drag down their investment results, but too rational to offer stocks at deep discounts from intrinsic value. Meanwhile, many of their potential investors had just lost half their money.

Value investors love to deride academics and the efficient-market hypothesis, but they can’t deny that stock-screening tools and other analytics have taken away many of the best bargains. At least some managers have lost the will to wait patiently for superdeals and have taken on more risk to get more return. As we walked to dinner through the soft Omaha twilight, a fund manager I had encountered at a “meet and greet” suddenly said, “The only way to make money these days is leverage.”

We had been discussing Mohnish Pabrai, a famous value-fund manager and author, whose portfolio had reportedly declined severely in 2008. Pabrai’s apparent willingness to invest in leveraged situations where a major loss is possible has caused some to argue that he isn’t really a value investor. But here was another Buffett follower essentially defending leveraged investing, because only leverage generates the kind of returns we’ve all come to expect. Investing in a highly leveraged company, or in a bunch of them, exposes you to many of the same risks as taking on leverage yourself. And my dinner companion seemed to be saying that value managers couldn’t compete with other funds without taking at least some of those bets.

This is a controversial position. Yet arguably, even Warren Buffett himself profits from substantial financial leverage. Like banking, insurance is in some sense a leveraged bet. Companies take on large deferred liabilities, in the form of future claims or account withdrawals, in exchange for payment now. They make their money by investing most of the proceeds from the deposits or premiums and keeping a moderate cash reserve, relying on the pooling of many accounts to ensure that at any one time, the demands on their assets will be smaller than the reserves set aside to cover them. Like banks, insurance companies are therefore vulnerable to a sudden mismatch between claims and underlying assets. Many analysts are now anxiously eyeing life insurers.

Warren Buffett’s insurers are run more conservatively than most. But despite all that, he, too, has taken a beating in the downturn. The answer to “What Would Warren Do?” seems, these days, to be “lose money.” His acolytes had taken a beating, too—at least the ones I met. Most private-fund managers are cagey about their returns, but everyone at my table at Gorat’s readily admitted to having had a very, very bad year. “I’m down 25 percent,” said one friend I ran into at a “meet and greet.” He runs a tiny hedge fund mostly composed of his own money. But he quickly added, with some cheer, “I’m still outperforming other funds!”

In the coming years, we’ll find out if rising above the madness is enough of a success. In many ways, it’s not even clear that Buffett could replicate his own success if he started out today. He built his reputation as an investor in an era when there were more opportunities for easy money, and these days, the news that Buffett has bought a stock is often enough to help support, or even boost, its price.

But I’m not brave enough to second-guess the Sage of Omaha—certainly not while seated at Gorat’s, cramming myself full of investment advice and moderately priced midwestern beef. And even if none of the value investors I ate with are likely to replicate his outlandish success, they will still have an edge over competitors, and the rest of us, because one Warren-like trait they do share is his commitment to thrift and prudence. Just as Warren still famously lives in the same modest house he purchased in the 1950s, almost everyone I met seemed more interested in building wealth and security than in spending riches. During my five days in Omaha, I had at least three conversations about the best way to save money on rental cars. I’m pretty sure that at least one of the people enthusiastically pitching me an off-brand vendor half an hour from the airport was there on an expense account.

Right now, the academic literature suggests that value investing has a modest advantage over a broader market strategy. Better information, more widely available, may continue to erode that edge. But the principles of prudence, patience, and thrift will always, in the end, offer a better chance at outsize returns. The question is whether, once Saint Warren passes, his followers will find the courage to stick to them.