vinod1
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Posts posted by vinod1
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Does anyone know of a site that shows historical valuations from different assets? By asset class I'm thinking US stocks vs emerging markets. And maybe something like a CAPE comparing US stocks to emerging markets to Developed International 10 years ago vs today? Or maybe small cap vs large cap US stocks in 1999?
Before you do compare, I would recommend reading Philosophical Economics blog on why CAPE for some countries is misleading - extremely so in some cases. You might find some data too in there. Do not have a link.
Vinod
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A lot of popular investors implicitly assume this 6.5% real return as the divine right of investors. This includes Montier, Hussman among others.
Vinod
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Philosophical economics has talked about why the costs, etc in historical context beautifully in one of the blog posts.
http://www.philosophicaleconomics.com/
Vinod
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You cannot talk about expected returns without factoring in required returns. It has a big impact on valuations.
Most just assume that since the realized returns were around 6.5% real over the last century or so, that is also what investors would/should require going forward.
Think back to the time around 1900, people started hearing about Dow Jones averages for 5 to 15 years at most. They had very little data on the stock market and not much information to form an opinion on what returns to expect.
Most importantly to put together a portfolio of 20 to 30 stocks would have been very expensive that consumed a significant portion of the expected returns.
So the 6.5% real returns that investors realized would have been more like 4% or 5% real, because of expenses (transaction costs, fraud, cost to physically secure the paper certificates, etc).
Now we have practically cut down on the expenses to zero and a widely diversified portfolio can be put together easily at the click of a button. I would think that probably reduced the actual cost paid by the investors by 2% or so compared to the 1900s.
In addition, I would also argue that the economic/political risks are much less than in the past. So that would require even less of required return.
If you put all of these together, I think the required real return for investors is going to be much less than in the past. I do not know how much, but 4% real does not seem to be too outlandish to me.
Put this into the valuation and you might get a much less scary picture of the valuation.
But the fact remains that we have less than 150 years of stock market data. If you believe long term to be 20 to 30 years, then we have non-overlapping sample size of 5 or 7.
Hardly the amount of data that you could use to draw conclusions. Maybe in another 1000 to 2000 years we would be a better position.
But to me, at this time with the data we have, to draw strong conclusions about market valuation based on such short data set seems to be unwise.
Vinod
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StubbleJumper makes very good points. However, I think shorting and CPI bets are better understood from the perspective of Mr. Watsa the individual.
Rewind back to the 2007-2009 period. Fairfax reported massive gains on the CDS portfolio, and many of us who have loaded up on Fairfax and its subs felt great at that time and patting ourselves on our backs for this.
How would this have felt for Prem? After all, we Fairfax investors were on a high just from taking advantage of Fairfax gains. He is one of the handful of investors who came out with billions of dollars of gains directly during the period. For 3 years book value exploded and it is hardly a stretch to think he must have felt like a genius, especially when every other company is wallowing in misery.
I can recall a period like that, when my LEAPS on BAC paid off big time, then after a couple of months of research on O&G companies, invested in Sandridge Energy LEAPS and they paid off like 5x in a few short months. I was on a high and contrary to my normal behavior invested in HP LEAPS with very little research. Fortunately, it is only 0.1% of portfolio and to make a long story short, the HP LEAPS went to zero the moment Leo Apotheker did a deal with Autonomy.
I think the "rush" from the 2007-2009 gains might have been a contributing factor. It was never about hedging.
If you are really concerned about Great Depression type scenario, do you invest in crappy companies like Blackberry, Sandridge Energy, Greek/Irish banks, restaurants?
Further look and what he has done on the business side, he went ahead and bought a bunch of other companies.
Is this what you expect when you are preparing another Great Depression?
(Hat tip to UCCMAL for pointing these out in one of the earlier discussions.)
One more thing. Even when you have hedged 100% of the equity portfolio, you promise to investors 15% annual returns? There is a snowball chance in hell that you would reach that objective without a major market crash.
The only logical explanation that fits the facts is that Prem is expected a market crash and the S&P 500 shorts and CPI portfolio is a market call. Pure and simple. It is a market call that did not work out.
All the explanations - avoiding 1-100 year event, hedging, etc. do not fit the facts.
Prem is a wonderful person from everything that I gather. He has build a multi billion dollar company from scratch. Nothing can take these things away from him.
But as investors we have to separate Prem the wonderful person from Prem the CEO. He got the market call wrong. It happens. The problem is not being able to acknowledge it. Calling it hedging is just plain wrong.
Vinod
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vinod1, I am curious if you use book value multiple for other stocks in your portfolio, if not why not?
I am curious to know as I see many people put an anchor with book value on BRK stock. However, they have no problems issuing buy recommendations for MSFT or AMZN which has lower earning yield and much higher P/B rations.
AdjustedEarnings, SwedishValue, khturbo, Jurgis & Lemsip - Great points.
Most reasonable people estimate future growth in total earnings power at Berkshire to grow at between 8% to 11% (my own range is 8-10% with 9% as my central expectation). To avoid confusion, I say total earnings power instead of IV, because IV is dependent on the growth rate.
When you take a growth rate of 10% or below, the only way it would be worth 1.5x BV or more is if we use a discount rate that is lower than that. Banal observation. But without specifying one's discount rate the justified BV multiple does not convey the full picture. I like how khturbo made it explicit.
Vinod
shalab,
I do not use Book Value much if at all. To me a business is worth some multiple of owners earnings.
The multiple is based on how fast and how long owners earnings grow which is a function of its competitive advantage and total addressable market size.
If I cannot estimate owner earnings, it is an automatic pass for me. I find it very difficult to wrap by head around valuation without owners earnings.
If I use book value, it is mostly as a shortcut once I estimated the IV using the owners earnings x multiple. So if I estimate BRK IV to be $200 and book value is $160, to keep track of it more easily in my head, I use the derived value of 1.25 BV multiple.
Vinod
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AdjustedEarnings, SwedishValue, khturbo, Jurgis & Lemsip - Great points.
Most reasonable people estimate future growth in total earnings power at Berkshire to grow at between 8% to 11% (my own range is 8-10% with 9% as my central expectation). To avoid confusion, I say total earnings power instead of IV, because IV is dependent on the growth rate.
When you take a growth rate of 10% or below, the only way it would be worth 1.5x BV or more is if we use a discount rate that is lower than that. Banal observation. But without specifying one's discount rate the justified BV multiple does not convey the full picture. I like how khturbo made it explicit.
Vinod
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It is a mystery to me as to why investors spend so much time on the question of buybacks both at Berkshire and many other companies.
Say Berkshire retires 20% of shares outstanding at 75% of IV over the next 5 years - a prospect I think that would seem to excite a lot of shareholders. This would result in about 6.25% increase in IV over the 5 years or about 1.25% annually.
Do shareholders really get that excited by the prospect of an extra 1.25% annual increase in IV? It is about the the volatility that the stock experiences intraday.
Of course, it is better to have that 1.25% rather than not having it. But is it really that big of a deal that so much attention gets paid?
There are cases where it makes a real difference. Like AIG in 2011/12 timeframe when a case could be made that it would be able to retire 30-40% of shares outstanding at 50-60% of IV in a relatively short period of time.
No disrespect meant to anyone. A lot of smart investors here and I might be missing something that I cannot wrap by head around.
Vinod
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Taking a quick look at my portfolio, there are only 3 businesses that I have researched in the last 15 months. Not one of the businesses that I researched in the last 6 months made it into my portfolio.
Vinod
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A bunch of problems would be solved if you can categorize your investments into buckets. Each bucket would have a different approach in terms of position sizing, how much margin of safety is needed, how much research is needed, how long you hold, etc.
The way I categorize is
1) Businesses with strong moats and which grow value above the broad stock market.
2) Businesses that either with weak moats or grow value at or below market rate.
3) Special situations: Spinoffs, Merger/Arb, etc.
For 1), you can identify the business upfront and research them at your convenience. Then update them every 6 months. The advantage is that, these business change infrequently and your knowledge is cumulative. In addition, market throws a fit at least for a couple of these stocks each year for some odd reason. Since you already did your research you just need to do a quick update and make a decision. This is a pretty good area for me personally. Less bias due to the issues you mention, as I have already researched them a long time back and I have a price point in mind. I have about 80 stocks in this bucket and own about 12 of them. No sunk cost fallacy here as I have several dozens that I have researched already and waiting to be replaced as needed.
For 2) and 3) you pick your spots. You lean about a few industries and if a business happens to fall under them, it would not take too long to get up to speed. If it is not an industry you are competent in, I do not think I have the time to get up to speed on the industry and the business in quick enough time to make a buy decision. The key being picking your spots and not going after those you have little idea about.
For example, energy is probably a productive area for investment now, but it is not an industry that I am competent in. So I do not bother researching it now, since it would take me too long and by that time the opportunity would have disappeared.
Chasing after ideas is tough, it is better to let them come to you. Avoids a whole bunch of issues, including sunk cost fallacy.
Vinod
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Admire the way you are intellectually honest and looking at performance in a rational manner. It is a rare quality and I think would serve you very well in whatever you choose to do.
I think Gregmal hit it in the head. The problems you mentioned have little to do with value investing. Even if you take up indexing you would face the same problems. I think with indexing, it might be even more of a problem. When you take an individual company, you might have some insight, right or wrong about that company, which might give you some confidence in your decision making. With indexing you have less insight and the things that are going to determine the value tend to be macro variables. Which are even more uncertain which basically causes investors to let their emotions dictate.
The very first thing you need to check is your behavior when an investment goes down 50% or more in value after you bought it upon no news.
1) If you can honestly see yourself saying "Meh!" and increasing the allocation, then you are a viable candidate for investing. You can think more about how to go about addressing the behavioral issues.
2) If that is going to cause you to lose sleep, then you need to think of something very different. Something where you would have little insight into the investments. Use DFA funds which slice and dice into a dozens of index funds with an advisor to boot who can talk you down from making radical changes. Or buy Target date funds, which hide all the fluctuations due to them being a mix of stocks and bonds, etc which reduces volatility. End result is you see your overall portfolio value change only modestly. This way you can stick with an allocation for the long term.
Vinod
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One of the few Buffett pearls of wisdom that I question is his comment about how when a business with a bad reputation meets management with a good one, it's the reputation of the business that survives.
I'm sceptical because as a rule I think management is absolutely key in business success. In my experience very few businesses are so good that they can do well under bad management, yet very average businesses can do well under good management. Ironically Buffett's two main businesses, insurance and investing, are excellent examples of this, and his emphasis on the people who run his businesses suggests to me that even he doesn't really believe the quote.
Clearly if a business is in secular decline the best management in the world won't save it. But as a rule I tend to think smart management make all the difference in the world.
Thoughts? Examples?
I think you are misinterpreting Buffett. I believe Buffett is pretty close to your line of thought.
His point is in a terrible business, even great management would not be able to do much. Here is a quote you are probably familiar with:
Time is the friend of the wonderful business, the enemy of the mediocre. You might think this principle is obvious, but I had to learn it the hard way… It is far better to buy a wonderful company at a fair price than a fair company at a wonderful price. Charlie understood this early; I was a slow learner. But now, when buying companies or common stocks, we look for first-class businesses accompanied by first class managements. That leads right into a related lesson: Good jockeys will do well on good horses but not on broken down nags.
So the idea is to avoid really bad businesses. Since as soon as one problem is fixed another problem turns up.
Generally the idea is to avoid both really bad businesses and really bad management.
Take Stericycle as an example. It has a wonderful moat, but poor management is lighting up IV for the past few years.
Vinod
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For those of us who have memory of the 2000 tech bubble, it is easy to imagine a bubble whenever you see tech or other companies sporting high multiples.
I agree with the article above, I pretty much came to a similar conclusion a couple of years ago. For the diehard value investors, this would be just one more sign of investors capitulating to the latest fad.
I would urge you to just consider the possibility that maybe, just maybe, you might be wrong.
Vinod
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Monopoly and Anti-Trust arguments are a complete non-starter. The link below has a summary of the key laws in U.S. related to Anti-Trust.
https://www.justice.gov/atr/file/800691/download
If you can make a case for why Google or Facebook are price gouging consumers, then Anti-Trust laws would apply. If you are looking for weak points in these companies, Anti-Trust would not make it into the top 5 worry list in U.S.
Vinod
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But i disagree that KO, KHC and PG struggled because of them, they just had problems with a strong USD and falling demand for unhealthy products over the last 10 years.
They struggled for a lots of reasons. But I think the street narrative about USD, struggling middle class and unhealthy products, misses more important structural long term factors. Google and Facebook is only scratching the surface. You can look at data not just by these three but many other branded consumer products companies and more importantly by individual markets where currency is not an issue and in emerging markets where the focus is still not yet on healthy stuff. You see they are struggling in many of these markets as well.
Vinod
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Value investing means two different things to two different sets of people
A) Value as defined by Low P/B and/or Low P/E stocks. This is the academic definition that is used.
B) Value investing as defined as paying low price in relation to intrinsic value. This is the Graham/Buffett.
Right now both A & B are under performing market but are due to different reasons.
How did you determine this? I know at least two investors of group A that outperformed the market over the last two years (using low P/NCAV) and i am sure there are more than enough that outperformed over that timeframe with B), too. If tech doesn`t belong into my circle of competence why should i bet there? (My problem there is always to determine the longevity of the cashflows, because of that i also don`t invest in biotech/pharma.)
How did you determine this?
A is pretty simple. Value indexes are underperforming market and growth indexes.
B is a bit more anecdotal. We see how many well known investors are underperforming the benchmarks.
If tech doesn`t belong into my circle of competence why should i bet there?
Fair point. What I am trying to point out is that studying Tech is important because it is impacting so many industries. Unless you study Google and Facebook, you would have no idea why the moats of Coke, Kraft & PG for example are being weakened. That is just scratching the surface. And if you study Tech, maybe it might slowly come into your CoC?
Among value investors there is almost a sort of Techno Racism, for lack of a better word. It is as if investing in Tech threatens their value investing manhood. I used to be one of them. :)
Vinod
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I am guilty of all of the above myself. I changed my mind on these a few years back.
Vinod
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Value investing means two different things to two different sets of people
A) Value as defined by Low P/B and/or Low P/E stocks. This is the academic definition that is used.
B) Value investing as defined as paying low price in relation to intrinsic value. This is the Graham/Buffett.
Right now both A & B are under performing market but are due to different reasons.
As far as (A) is concerned, cycles come and go where growth leads for a while and value takes over for a while. That is likely to continue. The financial crisis impacted a lot of value firms more than growth and this probably contributed to some of the under performance.
As far as (B) is concerned, there are lots of reasons.
Value investing principles always work. Thinking of a stock as a part ownership of a business. Buying with a margin of safety. Mr. Market. None of these change. But how these are applied should keep evolving as markets evolve. The problem is many value investors refuse to evolve. There are many areas where economy has undergone huge changes and the techniques needed to be updated. A few examples:
1) Take Tech. It is almost with as much pride as revealing a Superman cape underneath their shirts, value investors are so damn proud of the fact that they don't invest in Tech. Well Tech now has many companies with as strong moats as any other industry. These investors have chosen to not to even look at it.
2) I think Internet is on the scale of the Industrial revolution. It changed so much of the economic drivers for so many industries. Many of the brands like Coke, PG, Kraft, etc. which dominate some value investors portfolios have seen their competitive advantages deteriorate significantly. Some of these value investors are blind to this which is probably due to the fact they dont even look at Tech to understand what is going on.
3) Low interest rates pushed discount rates to low levels probably for a very long time into the future as well. This resulting increase in asset prices, pushed prices to levels that many value investors feel there is not enough margin of safety when they use much higher discount rates. Some of them believe that 10% stock market returns or 6.5% real returns as a god given divine right of investors.
4) Macro. Some go further and think the 5.7% corporate margins also as some kind of mathematical certainty. The fact is we have less than 150 years of stock and economic data. That is about 5 sets of non-overlapping 30 year periods of stock and economic returns. Not enough to draw any reliable conclusions. Maybe in another 2000 years we would have enough data to draw some conclusions. But to draw strong conclusions from 5 sets?
I think value investing is working just fine. The fact is we as investors need to keep evolving. Buffett did. He did not use the same methods as Graham even though he worked closely with him. So many value investors just copy Buffett. Buffett took advantage of brands when they are just taking off. Media and Consumer staples, for example. You have to ask, what have current set of value investors built on top of Buffett?
Vinod
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I am more worried about tail risks related to Euro currency breakup.
Assets could end up being in one currency and liabilities could end up being in another currency. How would that impact bank capital?
For example, say Italy exits Euro currency. Most of the Italian bank loans are local and they would be marked in Lira. Their funding is more likely going to be remain in Euro.
This mismatch brings a host of risks. European banks look cheap, but every time I try to look at them, this tail risk keeps me from going forward.
Vinod
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Read it eons ego when I was an Efficient Marketeer. It is more for people who index so although interesting for us finance geeks, you might not find it applicable for your own portfolio. There is a critique of the technique by a researcher. You should read that too.
I think reading "The Four Pillars of Investing" which is mostly about Indexing would be a lot more helpful. It should be required reading for value investors. I mention this since you bring up "selfeducational journey into investing".
Many value investors get overdosed on Buffett and Graham. They do not pay enough attention to the other side. This book does as good job as any of explaining from an efficient market perspective.
Vinod
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Eric,
I really sorry you are going though this. I am searching through my notes from the MSN message board days but could not find much from a quick search, but would keep looking over the weekend.
I think Liberty summarized it pretty well and I can vouch for you similarly.
Wish you best of luck and hope things work out well.
Vinod
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Cigarbutt,
If I came across as bullish, I am not. I am more agnostic about market valuations. Do not have very strong views either way.
We have less than 150 years of data for the stock market. If you define a long term hold of 30 years as one representative sample. We have about 5 samples in stock market of long term returns (non-overlapping). Most of us would not put too much faith in a sample size of 5. That is where we are with stock market data.
Imagine 5 coin tosses, results in 3 heads. "Historically" we infer that heads come up 60%, then use that damn thing to make predictions. The stock market equivalent are the historical 6.5% annual real returns and the 6% or so net profit margins.
In another couple of thousand years, we might have a better idea. But until then, it is best not to have strongly held views on macro stock market valuations.
Vinod
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Cigarbutt,
Snce 2009, I changed my mind on two points relevant to S&P 500 valuation:
1. Mean reversion of profit margins. I must have spent several hundreds of hours thinking and researching this issue over the last 17 years. I would not go into detail, but I no longer expect mean reversion of profit margins on a sustained basis to the levels of the period before 1980s. Not saying profit margins dont fluctuate or go down. Just the mean has shifted to a much higher level than the past. It might shift lower again sometime in future but not anytime soon.
2. Expected returns on stock market. I previously expected real returns of 6 to 7% as fair value for the stock market. With inflation of 2-3%, nominal returns of around 9%. In line with what stocks had historically provided. I now think fair value for stock market would be lower returns that this for a several reasons:
a) Even though 9% were the realized returns historically, it is very expensive in the past to get those returns. And few could actually get this return from a diversified portfolio. Think how expensive it would have been in 1900 or 1920 for a person to build a diversified portfolio of stocks to get this return. Think of the difficulty of getting relevant information about companies financials. Think of broker costs, transaction costs, etc. Fraud costs involved with physical shares. Risk of losing those physical shares, etc. A lot of the 9% expected or realized return on stock market would have been consumed by this. So if a person wants to hold 50 stocks, I would think that these costs could easily eat up 2% or more of the return. Now you can get a very diversified portfolio for less than 0.1% cost. So the expected return that the investor could actually realize has gone up by nearly 2% just from these lower costs.
b) Economic risks have gone down as well. Look at the frequency and magnitude of the recessions in the past compared to now (ya even with the 2008 Great Recession). This should naturally reduce the stock risk premium as well.
c) Inflation risk has gone down as well.
When you take all these factors (a, b & c) into account and consider that cash/bond returns are also going to be low (low real rate + low inflation + low inflation risk premium), then a higher multiple can be justified for S&P 500.
So not only are normalized earnings much higher in 2017 than I expected in 2009 (due to point #1) but the multiple that can be justified is also much higher than I expected in 2009 (due to point #2).
So I was actually wrong in my assessment of S&P 500 value in 2009. I made the mistake of reducing my allocation due to this a couple of years later. But was saved from this mistake due to opportunity in financials in 2011/12 period.
I actually reduced allocation in 2006/7/8 due to worries about profit margins and mean reversion. When markets fell in 2008/9 I felt vindicated. I was wrong of course. But got bailed out by the financial crisis in 2008/9. The reason I changed my mind about profit margins/mean reversion is that when reducing allocation in 2006/7/8, I made a note to myself that if profit margins again go up in 5 years, then I should take a hard look at this issue again.
Vinod
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I may need to duck and cover after posting this, but I bought some Biglari Holdings today.
I know, Sardar is the worst partner money can buy, but this is just a short-term trade on the assumption that the 20%+ drop in the price of BH is due mostly to the company getting dumped from the Smallcap 600 index. Reading reports of the annual meeting that was held last week, it doesn't look like Sardar dropped any unexpected bombs that would explain the cratering stock price (the dual class stock structure was a foregone conclusion). Volume in the stock today was about 30 times normal volume, which is probably due to index funds selling.
In any case, the next couple of weeks will either make me some money or teach me an expensive lesson.
“If you don't feel comfortable owning something for 10 years, then don't own it for 10 minutes.”
“Charlie and I look for companies that have a) a business we understand; b) favorable long-term economics; c) able and trustworthy management, and d) a sensible price tag.”
Both Buffett quotes.
I don’t think Biglari is an investment you should feel comfortable owning long-term, nor Sardar a trustworthy partner!
I think people are interpreting Buffett way too literally. His Korean stock purchases clearly do not meet the criteria above as well. But Buffett still did that trade and made it a point to highlight that.
treasurehunt has a rationale for why the business could be mispriced due to structural factors, understands management factor and seems to think there is enough margin of safety to make a profitable trade. That to me is the essence of value investing. Whether it works or not is a separate issue.
Vinod
I quoted Buffett because I agree with the quote, completely! If you put your money in the hands of somebody that’s not trustworthy you’re on a ride you shouldn’t be. That to me is the essence of a bad investment, whether it works or not.
All I am saying is, by being less dogmatic and our returns would be much better.
If you draw a line in the sand and say if there is a question of management integrity, you would not invest. I can understand that. We all have to draw the line somewhere.
When Buffett invested in Korean stocks, he had no idea about the management. The margin of safety is so high, he can ignore it and still expect good results.
There are many approaches that work in investing. No need for a value investing Jihad on the one right approach.
It is not like what Buffett says is the scripture. There is always more nuance.
What you quote makes perfect sense. I agree too. But you also need to understand the context and where it is applicable.
Here a person is not investing in a business with the intent to hold long term. Walter Schloss did alright with a different approach.
I would buy BH too if the discount to IV is large enough. It is not there for me.
Vinod
Uber filing for IPO
in General Discussion
Posted
I spent more than $15,000 annually in each of the last 3 years on Uber. It is about 35% to 40% cheaper than taking a taxi. So what would cost $100 is costing me $60-$65.
Given all the conveniences it offers over taxi, a 15% to 20% discount would make Uber/Lyft a no brainer. So I think they can increase prices by about 30% - 35% and still offer a compelling value proposition.
I have not looked at the S-1 yet, but if the business can make money once prices are increased by 30-35% and it reaches scale, I think it is a viable business model.
Right now market share is extremely important and it is local market share that is important. So I can understand why each company would be hell bent on increasing the market penetration as much as possible.
At the local level one of the companies is going to become dominant and in aggregate one dominates 60% of the local market and other dominates the other 40%, they can exist in a fashion similar to Visa and MasterCard.
Vinod