vinod1

Like Internet for example. Oh, wait... or Microchip GPS Google Vinod

One more factor to think about when thinking of indexing vs. picking stocks is one's conviction level. For me, I have more conviction (whether in reality that is true or not is an entirely different question) in my ability to assess the earnings of an individual company than in my ability to assess the earnings level of an index. So I find it easier to hold an individual stock in face of severe market losses than an index fund where I have lower confidence. If an index investor does not drink up the kool aid that long term it is going to be ok - I am not talking pejoratively, it is a very effective strategy if you just believe in it - then it does no good to the investor since he is likely to panic and sell at the wrong time. Vinod

Vinod, Tx. I recall reading your notes in conjunction with Security Analysis when I reread it a few years ago. FWIW, Canada's markets are in a bear, with energy, banks, and services all being hit, energy the worst obviously. I have no holdings of US companies right now, and moved all of my margin cash over to Cdn. dollars. I hold SSW but it is not really a US company with its offices in Hong Kong and Vancouver. So, I am still a value investor. I didn't even do this on purpose. The deals in Canada were just better from a Canadian currency perspective. For example the price for RY, and FN present a more compelling value than BAC, and I will get paid to wait. Keeping in mind this is from the perspective of a person operating in Canada. Our dollar will rebound at some point. From a rebounding Cdn dollar perspective a Us stock has an extra 30% hurdle rate. I have definitely shifted to a "being paid to wait approach". With that I am accepting lower likelihood of homeruns, but also lower risk. Al, Makes sense. A 30% currency headwind is too big a hurdle to overcome. I too have taken a lower risk approach by eliminating LEAPS almost entirely and moving up the quality curve in companies, the vast majority of which are happen to be decent dividend payers. Vinod

Vinod, I respect you a lot, but analogy arguments don't necessarily work. We are not in a huge bubble like we were in 2000 although market is a bit overvalued perhaps. My concern is that the argument is "just continue trying for another year and then another year and then another year". Of course, it all depends on a person. If they believe that past 5 (or whatever) years of underperformance was due to market running up from the bottom and it's going to change now, then perhaps they should keep trying. Although, I am afraid that there is a lot of rationalization. In 2013-2014 it was "index is running up too fast, I can't keep up, all stocks are running up without differentiation". In 2015 it was "index did not run up, but was kept up by FANG, value stocks were slaughtered". At which point should investors face the facts and realize that the issue might be them and not what index did? Anyway, I am not saying that people who have underperformed should jump to index right now. I share some concern that this might be wrong time. But like somebody said keeping doing the same thing and expecting different outcome may indicate foolishness. Or it may indicate strong belief in the method that may be rewarded. Or not. ;) Choose your poison wisely. Peace. Jurgis, I do not disagree one bit with what you have written. Current market is no way comparable to that in 1999 either in terms of overvaluation or dispersion in market values. For most of 2014 and 2015, I thought pretty much everything is closer to fully valued, very little opportunities (at least among the companies I follow) and actively dissuaded some friends from picking stocks and put them in index funds. The market action over the last few weeks, opened up a few opportunities and that I think value investors are likely to benefit from. My comments are more directed towards UCCMAL, who I know is a good investor and who I learned a lot from. I am just trying to point out to him that this might be wrong time to give up on value investing. Vinod

UCCMAL, I was investing in index funds from 2001 to 2005. I was a strong proponent of EMH at that time and spent a lot of time studying various finance topics - EMH, factor models, behavioral finance, historical asset class returns, valuation models, etc. As I studied behavioral finance and watched markets and participants, my faith in EMH weakened. At the same time, the expected returns from markets are looking very low. My estimate at that time was if we are lucky we would get 5% to 7% returns and there is a possibility of lower returns. So I started looking at alternatives to indexing and found Buffett and then Graham. As the financial crisis was starting I sold off the last of my index funds and have been investing on my own in stocks. I mention all this to just highlight that I spent 7-8 years in indexing and another 7-8 years investing directly in stocks so I can sympathize with both approaches. I think indexing makes sense for vast majority of the people. But to the inhabitants of Grahamsville, inoculated with teachings of Graham, value investing is a worthwhile and lucrative approach. Expected returns are again in the 5% to 7% range over the long term for the markets. This is a hurdle value investors are likely to overcome. An equal weight of the largest 10 stocks in S&P 500 returned 20% while the remaining 490 stocks returned around -1% in 2015. We have seen this movie before in 1999. The following three years turned out to be among the best ever for value investors (relative to market) as far as I can remember. Given the market level and expected returns, given the opportunity set currently available, I think this is a pretty good time for value investing. Anecdotally also, what can be a better time to be a value investor then many value investors are under performing the market and the market is just coming off a 200% return from bottom? Vinod

Aside from impact on global warming and renewable energy, I cannot think of a single negative to low oil prices. I have no idea about #5, but I do not think #1 to #4 are correct. As to why low oil prices are good, this has been addressed 170 years ago in this letter. http://bastiat.org/en/petition.html Vinod

If you want to understand some of the behavior read "Pedigree: How Elite Students Get Elite Jobs". The book itself is very good and would be useful if you have kids. http://www.amazon.com/Pedigree-How-Elite-Students-Jobs/dp/0691155623 Vinod

Great opportunities might come even if a general market crash doesn’t happen. Think about the recent rout in the pharma and biotech industry. If you hold a company that is very diversified and very well hedged against the gyrations of the stock market, you can sell it when some great opportunities present themselves. I agree with Eric that in a general market crash FFH might not prove to be a good cash equivalent, but in almost any other circumstance I think it could serve that purpose quite satisfactorily. In fact I would say FFH will be a better substitute for cash, if no general market crash comes our way. If, instead, we will continue to witness crashes circumscribed to specific sectors (energy, biotech, whichever will be next), I guess FFH will be a fantastic substitute for cash: because, as Eric has pointed out, the effect of a slow compounding machine will be added to the great optionality cash offers. Cheers, Gio I am a lot more paranoid than you about the risks to FFH (inflation, catastrophic losses, etc) to consider it as a cash equivalent. Vinod

My point is, if you see FFH as a portfolio diversifier, I can understand but as a cash substitute I am not so sure. Vinod

The assumption that FFH would do spectacularly well in crash might not hold. Prem Watsa has a view of how the crash might happen (heavily influenced by the the great depression and the Japanese crash) and optimized FFH for that particular view of the world. If crash happens say due to inflationary reasons - FFH would likely suffer just as much as others. Of course, it seems like nearly everyone seems to discount inflationary risks. Or do 100 year storms come only from what everyone worries about? Vinod

Per efficient market theory the reason for Third Avenue funds under-performing the benchmark beyond the expense ratio must be because they are taking lower risk than the markets :) :) The only other reason that efficient marketeers could point to - idiosyncratic risk - I would think should tend to be close to being eliminated over the very long term. Larry Swedroe (the author) had the most influence of me before I found Graham and Buffett and I am pretty familiar with his writings. I participated in many online discussions with him and he was very generous with his time. My comments above are partly tongue in cheek and I think he has made many excellent points. But he also goes a bit extreme - suggesting that Buffett has no outperformance once we adjust for a new factor (quality). Vinod

If you had to chose between the McKinsey book and Damodaran's book, which would you chose? Did not see this until now. I would pick Damodaran's book. To me the terminology is a bit more intuitive. But you cannot go wrong with either one. Vinod

A thriller very much in the tradition of "Barbarians at the Gate". It is about insider trading at the hedge fund of Raj Rajaratnam. It provides background info on what goes on behind the scenes at hedge funds and board room maneuvering. Also adds a bit more color on Buffett's investment in Goldman Sachs. Vinod

Premium or discount is related to the value add that is generated at the conglomerate level. How many conglomerates suck out all the cash flow from the subs and allocate them to the highest risk adjusted returns? Berkshire additionally gets low cost leverage from float - a value add due to its structure. Compare it to other conglomerates. It is not great salesmanship or popularity that gets Berkshire its premium to book value. Vinod

To me long term the more likely risk is management succession at subs. All these companies that have sold themselves to Berkshire, have owners who have personal loyalty to Buffett. They are willing to work for probably lower salaries than they could get outside just because they love doing what they are doing and basking in Buffett's praises. As these owners die off or retire, the next generation might have less personal attachment to Buffett's successor. That is when problems could start coming up with "Management bordering on negligence". Vinod

Simple answer is the people investing in Berkshire. Shareholders of Berkshire are people who believe in Warren Buffett and value investing and so they want to invest at a discount. They also want to buy Berkshire at a discount. Would any of you pay full Intrinsic Value for Berkshire? I know I wouldn't. I bought Berkshire when I thought it was at a large discount. As long as the investors it attracts are Buffett style value investors Berkshire Hathaway will almost always trade at a discount to intrinsic value. I am not so sure about that. As recently as 2007, BRK is traded at nearly 2x BV. With S&P 500 then at 1500, it was a tough call for someone choosing between Index and BRK. Now with S&P around 2000, BRK at 1.3x BV was very attractive compared to S&P 500. It is at least to me seems to be an easy call. For close friends for whom I help out with their portfolios, I have had them realllocate 10 to 15% of portfolios from market index to BRK. I was agonizing over that decision in 2007. Presumably there are just as many investors interested in BRK now as in 2007. Hence, my skepticism about your explanation. Vinod

I agree. Where we differ is in magnitude. I think the growth in IV/BV is somewhat slightly less than 1% per year while you think it is much higher than that. Vinod shalab, Thanks for the kind words. You seem to have studied this quite in depth as well. I might be giving a false impression about the precision of my estimates. I did two snapshot valuations one for year end 2009 and one for year end 2014, trying to keep everything the same (which is difficult in the best of circumstances). My central estimate of IV came out to be 1.55 BV in 2009 and 1.6 BV in 2014. So the IV growth seems to be outpacing BV growth by about 0.6% annually. I do not put too much faith in this number myself, but is done more to get a very rough idea of the rate of the increase. I would not be too surprised if this growth is say 1% but much more than that seems unlikely. I agree Berkshire is very attractive at the current price. I keep wondering why it is not above $150 already. Vinod

longinvestor, As I mentioned above to shalab I do think IV/BV multiple is increasing each year. Buffett is pretty much also confirming that. So I think the buybacks would also be done at higher levels in future. But at the current time, he also outlined very clearly what he thinks are reasonable prices and what are on expensive side. Vinod

I agree. Where we differ is in magnitude. I think the growth in IV/BV is somewhat slightly less than 1% per year while you think it is much higher than that. Vinod

After 22 pages of discussing the fact that BV is / has become a poor proxy of BRK's IV, why would I do that? Because of the nature of BRK today...they keep adding value to the coffers regularly which in turn contributes to earnings which is increasingly retained and adds to IV but BV never gets revised upwards. The whole reason why BRK is misunderstood today. Why WEB has started measuring stock price in the table for the very first time. It is clearly explained on the very first page of the Annual report. My bet is self-explanatory. It is based on stock price which over time converges with IV. I want to go back to the year 2010 for a very specific reason. There is a whole new BRK developing since then, the world is late to catch on. "Berkshire has not gotten that worse". That is my bet, and it is in stock price growth. I disagree with your interpretation of Buffett's comments in the annual report. The context for that discussion is Berkshire's failure to meet his 5 year test. That Berkshire as measured by book value would beat S&P 500 total return over a 5 year period as defense for retaining all the earnings. He was saying book value as in "IV being roughly equal to book value" was a good measure early on but that now IV is much higher than book value. He never said that IV is unrelated to book value. In fact, he lays out when he thinks Berkshire is attractive and when it is overvalued entirely as a multiple of book value later on in the annual report. So all he is saying is we need to use a multiple of book value now and not just 1x book value. I do not disagree that IV and MV would converge over the long term. But Berkshire is undervalued now and over 5 or 10 year period changes in valuation would add or detract to returns just due to end points. Growth in IV I believe would be much closer to growth in IV. I do believe that IV is growing at a slightly faster rate than BV but that difference is less than 1% annually. So book value growth remains a convienent and reasonable method to estimate growth in IV. As I said before, I root for you to be right for my portfolio sake. Vinod BNSF was of the best investments that Buffett made in recent years and it was an opportunity that came about from the 2008 bear market. I do not think you can extrapolate such results onto all other investments. Energy is a good example. Vinod

After 22 pages of discussing the fact that BV is / has become a poor proxy of BRK's IV, why would I do that? Because of the nature of BRK today...they keep adding value to the coffers regularly which in turn contributes to earnings which is increasingly retained and adds to IV but BV never gets revised upwards. The whole reason why BRK is misunderstood today. Why WEB has started measuring stock price in the table for the very first time. It is clearly explained on the very first page of the Annual report. My bet is self-explanatory. It is based on stock price which over time converges with IV. I want to go back to the year 2010 for a very specific reason. There is a whole new BRK developing since then, the world is late to catch on. "Berkshire has not gotten that worse". That is my bet, and it is in stock price growth. I disagree with your interpretation of Buffett's comments in the annual report. The context for that discussion is Berkshire's failure to meet his 5 year test. That Berkshire as measured by book value would beat S&P 500 total return over a 5 year period as defense for retaining all the earnings. He was saying book value as in "IV being roughly equal to book value" was a good measure early on but that now IV is much higher than book value. He never said that IV is unrelated to book value. In fact, he lays out when he thinks Berkshire is attractive and when it is overvalued entirely as a multiple of book value later on in the annual report. So all he is saying is we need to use a multiple of book value now and not just 1x book value. I do not disagree that IV and MV would converge over the long term. But Berkshire is undervalued now and over 5 or 10 year period changes in valuation would add or detract to returns just due to end points. Growth in IV I believe would be much closer to growth in IV. I do believe that IV is growing at a slightly faster rate than BV but that difference is less than 1% annually. So book value growth remains a convienent and reasonable method to estimate growth in IV. As I said before, I root for you to be right for my portfolio sake. Vinod

longinvestor, If you start with year end 2014 and use book value for measuring performance to say either year end 2019 or 2024, I am on. Vinod

A few thoughts 1. As long as the businesses with "temporary problems" have a strong moat and I have conviction in the moat, I find it easy to hold and even add on to the business as price drops. The key really is that moat is real. IMO there are only about a couple of dozen businesses with moats - all others are more riding industry tailwinds or operationally outstanding (which is not a moat). If you have several dozens of businesses then probably your definition of moat might not be stringent enough to give confidence. So I would really be hoping the prices for these businesses to be going down more and more. I would give in general any business 3 years for the "temporary problem" to be fixed. If problem continues it is likely that its moat is impaired in some way. 2. As far a limiting problem businesses to a certain % of portfolio, I think it is better to avoid setting such guidelines top down. I used to do that but it never really worked in practice as I always violated the guidelines since opportunities in the market do not fit nicely with our top down preferences. Some times there is an abundance of cheap high quality businesses, sometimes there is an abundance of 'temporary problem" businesses within your circle of competence. So it makes sense to go where opportunities are. Three years ago I was entirely (2x or more notional portfolio exposure) to problem businesses (financials) because they are dead cheap. Now I have moved in a major way to high quality companies. So instead of a "problem business" at 0.6x IV, I would rather own 0.8x IV high quality business. But when I own mostly problem companies, I would have a higher percentage of cash to balance tail risks and/or have some hedges in place. Vinod

I agree that intrinsic value growth (approximated by book value growth over time) can be measureed as the combination of the growth of investments per share and earnings per share. As such, it would be helpful for you to stare at not only the numbers above re earnings growth but also investments per share growth and book value growth. This would help our conversation and make clear to you that BRK will not grow intrinsic business value at 15% compounded going forward. Buffett said "focus" on earnings per share growth, not "only look at that" and ignore the other parts of the business which drive intrinsic business value - this is where you are erring. Let's not get hung up on 15% though. If you are saying the next 10-15 years may look better than the last 10-15 years for BRK (especially relative to the S&P) as the driver of intrinsic value is shifting more and more from growth in investments per share to pre-tax earnings growth - and not everyone has figured that out yet - then I completely agree with you. And this is counter-intuitive to a degree because you would not expect this result after the business has become larger. 12% on the high end may be doable because of this point I think you are making. Just forget about 15%. +1

Vinod, I think you hit the nail squarely on the head. Their explanation fit very nicely with my estimate of Berkshires IV. But this was the most clear estimate of Berkshire's IV yet from Buffett and Munger. I was shocked to see it spelled out so clearly when they've been playing can and mouse games for years regarding the IV. Just to share another insight. It was an off the cuff response from Buffett at an annual meeting a few years ago. There were questions about the value of the smaller BRK subs. Buffett came out and said that they're worth about 14x pre-tax earnings. I was shocked to hear such a direct answer about their value - it was late in the meeting so maybe he was tires. Then I went home and dove deep and found that it's true. I think these days maybe they're trying to obfuscate the valuation of the smaller subs by combining them with insurance. rb, Can you share any insight into what subs Buffett is talking about? This is the first time I am hearing about this, so any additional info you can share around this would be great. Vinod Vinod, Sorry to get back to you so many pages later in this post but real life intervened. I went back to my notes and that comment was at the 2012 meeting and he was referring to the small subs so ex BNS, BHE, Finance, Insurance, Lubrizol, etc. Basically he was saying the "Other" divisions were worth 14x pre tax. rb, Thanks for the info. Vinod