vinod1

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

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

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

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

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

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

I am guilty of all of the above myself. I changed my mind on these a few years back. Vinod

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

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

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

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

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

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

“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

“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 think since time immemorial, the previous generation probably always thought the next generation is going to hell in a hand basket. I think the new generation is going to be better than the past. Vinod

If anything, I see a bubble in people calling out "bubbles". Otherwise, it is same old, same old. Nothing much has changed. We first need to have a working definition of a bubble. Rob Arnott's definition would be a good starting point, We define a bubble as a circumstance in which asset prices 1) offer little chance of any positive risk premium relative to bonds or cash, using any reasonable projection of expected cash flows, and 2) are sustained because investors believe they can sell the asset to someone else for a higher price tomorrow, with little regard for the underlying fundamentals. By this definition, I would put only the dot com stocks in the late 1990's and the housing market in 2005 as a bubble. Others cases do not meet the criteria. I do not think we are having more bubbles nowadays than we had in the past. It is just that people scare themselves silly, looking for bubbles everywhere. High prices? Yes. Bubbles? No. Vinod

I think having blanket rules in investing is going to only needlessly hurt one's returns. Things like 1. Dont invest in financials (banks) 2. Dont invest in Tech 3. Dont use leverage, etc. As investors we accept that majority of the time markets are efficient but can occasionally be inefficient for us to make a profitable investment. It is generally true that leverage is risky. But if a rare opportunity comes up, say like the banks (BAC, JPM, etc) over the last few years, I would posit that it is less risky to use leverage (use lots of cash + LEAPS, warrants on deeply undervalued businesses) than most conventional portfolios of value investors. Vinod

Buffett made the following comments in the Annual Meeting last year I think: I don’t think it’s sufficiently appreciated—I believe that, probably, the five largest American companies by market cap—on a given day, they have a market value of over $2.5 trillion. That $2.5 trillion is a big number. That’s probably getting up close to 10% of the whole market cap of the United States. If you take those five companies, essentially, you could run them with no equity capital at all, none. That is a very different world than when Andrew Carnegie was building a steel mill and then using their earnings to build another steel mill and getting very rich in the process, or Rockefeller was building refineries and buying tank cars. Generally speaking, for a very long time in capitalism, growing and earning large amounts of money required considerable reinvestment of capital and large amounts of equity capital, the railroads being a good example. That world has really changed and I don’t think people quite appreciate the difference. Our world was built and when we first looked at it, our US, our capitalist system, basically, was built on tangible assets and reinvestment and all that sort of thing. And a lot of innovation and invention to go with it, but this is so much better if you happen to be good at it. To essentially be able to build hundreds of billions of market value without really needing any capital, that is a different world than what existed in the past, and I think it’s a world that’s likely to continue. I don’t think the trend in that direction is over by a long shot. Besides infatuation with Macro, I think many value investors have paid no attention to the the change that Buffett was talking above. These two along with the growth of Indexing/ETF's, I think are the main sources of underperformance for value investors. Vinod

+1 Very good points. - Investing is a continuously evolving process. The same thing that worked in 40s would not work in 60s and so on. We see that with Net-Nets, high dividend yield, low PE strategies, etc. What was difficult in one era either because of informational advantage or available knowledge, becomes easier to execute in the next era which makes the past strategies lose their effectiveness. - Graham in fact is also evolving he keeps tinkering with his recommendations in each edition of his book. He probably would have been very successful in this era as well. Vinod

Quote from the FPA Funds Report: The macro picture is only an afterthought. The larger environment might help explain why we buy more or less of something but it certainly does not drive the Fund’s overall exposure. Understanding where the world is and the prices markets are offering us for the assets we’d like to own helps to explain the Fund’s positioning. We lack any ability to prognosticate, but here’s what we know… Global stock markets have not been inexpensive enough for a number of years to offer the potential for high single-digit rates of return and are now trading at new highs. We continue to believe there isn’t enough of a margin of safety to warrant a fully-invested portfolio. In one paragraph he says we are not macro investors and in the very next paragraph he makes a macro call on valuations to limit exposure to stocks. This is the issue. Once you begin to develop a view about macro valuations, it is very difficult to avoid taking the next step, which is acting out on them. Even though you know better. The only way out I see is to stop thinking about macro. I know it is difficult. They way I came to handle this is to spend a couple of days of the year, usually in late January to read up everything you want to take a look at from a macro perspective write out a few thoughts (what you think about it and how it might play out) and never look back again until next year. After you have done this for a few years, reading up on what you have written would be a good source material for comedy. And it would also help in not taking macro seriously. Vinod

You are measuring against the wrong benchmarks. A couple of years back I am trying to answer the question of why they are outperforming so much in the bond markets. Equity I can understand and we can see the major investments and how they played out. In bond markets the alpha has to come from (a) security selection or (b) making correct macro calls on interest rates. No doubt there is some of both. But it still does not explain such a large out performance. What I realized is that they are including non-stock investments such as convertibles and possibly warrant deals into the fixed income segment. Nothing wrong in that. But they have a different risk profile and you cannot then measure up against pure bond benchmarks. Vinod

Need to break down the 7% returns. Fairfax has averaged 23% / 50% / 27% for Cash/Bond/Stock Allocation between 1986 to 2014 (when I last calculated them). Assuming a 25% 50% 25% cash bond stock allocation. If you assume 2% returns for the cash portion, 5% returns for bond portion, to get to 7% investment returns on total portfolio, the stock portfolio has to return 16%. Even assuming 6% for bond portfolio would require the stocks to deliver 14% annually. Vinod

Gokou3 - You need to take into account Corporate expenses, runoff, interest expenses and preferred dividends. Vinod

Race - I could not wrap my head around your example. I cannot see any rationale when investing in say the total stock market index or the S&&P 500 index would cause some stocks to get overvalued. Passive investors are buying market weights of the stocks. Stock A might have 10% weight, Stock B might have 5% weight and Stock Z might have 0.1% weight based on their market cap. Every additional dollar value of passive investors is invested in the same exact proportion. So I cannot see any reason for why this would benefit some stocks but not others. One way some stocks could get overvalued is if a sector or a narrow index fund like say Social Media Index Fund (just making it up) attract a large investor base which would increase demand for all the stocks in such indexes to increase which would drive up their prices. Regarding the letter. Blaming indexing and central bankers seem to be the common theme of all the value fund managers who are under-performing the index funds. If you read about either of these in their letter it is pretty good bet they are underperforming the index. Vinod