vinod1
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Posts posted by vinod1
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I do not think Governments are going to make up for the reduction in leverage. I see the exact opposite via curbs on various fees and limitations on proprietary trading.
ROE = ROA x Financial Leverage
I think ROA is going to be lower than in the past - not just of the immediate past of 2000-2007 but also of 1990 onwards. This is due to a variety of factors: limitations on fees, limitations on many types of trading activity, elevated loan losses as consumer deleverages, etc.
Financial leverage is going down for sure from something like 15 to a 10. So the net effect should be much lower ROE for banks and I do not see any Govt help on the horizon that mitigates this.
This is coming from a guy who has a portfolio dominated by banks.
The flip side of reduced leverage is that it should result in much lower risk to the banks. This should feed into lower debt costs (which should add a modest amount to earnings) and hold your breath, higher earnings multiple or book value multiple. I do not base my investment case on higher earnings multiple but that is what I would think would happen if banks really end up with the capital ratios that are being talked about with Basel 3 and SIFI buffers.
Vinod
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[amazonsearch]Expected Returns: An Investor's Guide to Harvesting Market Rewards[/amazonsearch]
Has anyone here read this? Please share your thoughts!
Thanks for highlighting this book. I bought the book as soon as I saw your post since this is a topic that has occupied a lot of my time in my previous incarnation as a EMH devotee.
This book goes into a lot of the theory behind returns starting from first principles and is remarkably unbiased between EMH and Behavioral or Ben Graham style arguments. It is basically a text book reflecting the latest finance research findings on all topics related to estimating expected returns and provides both a rational and behavioral (inefficient market) arguments. Overall I really liked the book.
I doubt it would be of interest to most investors here on this board. If you are following Ben Graham it just gives you the underlying finance theory behind investing.
Vinod
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Claphands, you are entirely correct about timing. Part of my procedure is to continuously move the option date out further. Right now I am slowly exiting the jan 2013s and buying the 2014s. If the stock price is stagnant next year but the situation of bac is better then I will roll over to the 2015s. There is a small fee due to time value deterioration but that can be taken as a tax loss. In every year except this one I have had to clear out losing positions to offset gains ahead of tax loss selling season. This year I have already taken most of these losses early. :P
They say that most options expire worthless. My record is closer to 5 % expiring worthless.
I am doing the same with wfc (have warrants as well), a tiny position in jpm, bby. Jury is out on whether I will do the same with ge or rimm. Ge looks to be near fair value right now.
Uccmal,
I have invested in BAC 2013 calls as well and planning to sell these and buy the 2014 options. I am assuming this would trigger the wash sale rule. Is there such a things as "rolling over" into 2014 options or some other way to avoid the wash sale rule in this case?
Thanks
Vinod
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Anyone find it ironic that the European agreement tries to do two things
1. Ensure that a 50% haircut on the Greek bonds is not a "default" and thus render CDS from being paid.
2. Provide an insurance cover on sovereign debt that pays if there is a "default".
I am hoping a Mel Brooks movie comes out on this Euro drama.
Vinod
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1. The only concrete thing that has been achieved is to take a disorderly greek default off the table. That is the good news. Now we have to see which of the European financials are swimming naked i.e. who cannot take a 50% haircut on Greek debt and stay solvent.
2. There is no agreement on how much EFSF would be leveraged. Two general solutions agreed upon are (a) Making available insurance on new sovereign debt. They dont have the capability for complete protection so we have to see what % of the losses would be covered by this and which countries debt would be guarenteed. (b) Vague refrence to private/public paternership. I dont know which private investor would participate in this. Overall I dont see much of substance that has been achieved with respect to how contagion would be contained beyond Greece.
I am unimpressed with the recapitalization plan of their banks ($150 billion) as well. I am surprised that the market reacted so positively to such a small step.
The policy statement is an entertaining read however:
http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/125644.pdf
"All other euro area Member States solemnly reaffirm their inflexible determination to honour
fully their own individual sovereign signature and all their commitments to sustainable fiscal
conditions and structural reforms."
Vinod
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I have a book, brought to my attention some time ago by a friend, that is a bit dated
http://www.amazon.com/Financial-Analysts-Handbook-II-Analysis/dp/087094083X
Thank you! Just ordered this book but seems to have been written in 1975.
Vinod
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Security Analysis and Business Valuation on WallStreet - Hooke. This is a pretty good book that lays out the valuation for stocks in general and then specifically covers a few industries that differ from the general technique like banks, P&C, Oil and Gas. I bought the 1st edition but recently a second edition has been released. This book can be considered as the next level after Pat Dorsey's book.
Vinod
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In any case, you are totally missing my point: My point is that your strategy is optimal for say 85 years out of 100, but you are not realizing that when you get 15 years where things are so out of wack your strategy of no hedges is suboptimal. Like I said, after 2015, I'll be investing like you - when it will be optimal again. That's the point. So yes, you are right, but only in the very long-term - ie 10 years plus.
Mungerville,
I am following you comments with much interest as it seems to be somewhat in line with my own thinking. If I may restate or summarize you point as below, would you agree?
Most of the time it makes sense to ignore the macro because it is really difficult for one person to be able to assess with any degree of confidence how the economy and stock markets would fare. However, there are few occasions, very few and far between maybe once or twice in an investor's lifetime where it does make sense to pay attention to macro. These could be for example, extremes of valuation (say using Shiller's PE) or some other form of excess (say very high leverage among companies, consumers, governments). In these few cases it would make sense to take this into account and position once's portfolio appropriately - higher levels of cash, active hedges, etc. We take these precautions not because we predict or know something is going to happen, but because we learned from history that such occassions have led to severe losses. We fully understand that such precaution would necessarily penalize returns if such a risk does not actually materalize.
Vinod
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I asked Prem about Japan's cultural tendency to not fire the personnel when business turns down. He agreed that it was one of the differences between US and Japan. So while yes they have low interest rates, they also don't throw the worker under the bus to save margins.
Their unemployment peaked at 5.5%.
There are quite a bit of differences with Japan so I agree with you point. This leads to one more way for margins to come down. Employment compensation to go up even in a weak economic environment. Outsourcing has enabled companies to cut down on compensation via moving some of the work offshore to lower labor cost locations. As wages increase in those lower cost locations (directly impacting margins) or backlash aganst oursourcing limits or even reverses the outsourcing trend it could cut down on the profit margins.
Vinod
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Vinod, it doesn't seem to work through the Google Finance website, but if you're using the =GoogleFinance() function in Google Spreadsheet, it works fine.
Thanks peter_burke_ceo -- the =GoogleFinance() function is so much faster and more reliable than =importData() using Yahoo Finance.
Thank you!
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I'm not saying there is no way you are right.
I just think its going to play out differently -- we're in a period of high unemployment currently that will abate in the years ahead. This will raise animal spirits.
I liked Parsad's explanation -- higher interest rates will change the margins. However an exception would be a company that doesn't lever through borrowed money. And if the margins are high during this crappy economy I wouldn't think a return to normal will hurt the margins. There is either a moat everywhere that's been protecting these margins for years, or it's some easy explanation such as interest rates that's floating the market's profit margin boat.
I have doubts about Parsad's point about higher interest rates changing margins. Look at Japan, even with super low interest rates their margins are at very low levels. Higher interest rates would allow many companies to earn higher margins via greater returns on their cash and investments. Although companies on a net basis have debt so overall costs should increase with higher rates, but not sure if that is really the critical element supporting margins.
Vinod
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We're not in boom times right now. What's going to force the switch to generics? You say "if consumers are feeling poor". Well, aren't they? Are they delevering because they feel rich or something?
You are right they should be feeling poor right now, but many homeowners still have expectations (or hope) that their home values would recover. It might take a few more years of low prices along with sustained high unemployment to change behavior.
Vinod
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Portfolio is set up using Google Spreadsheets importing Yahoo Finance quotes. (only because I have no idea how to get warrant quotes on Google Finance.)
Watchlist is set up using Google Finance.
I jump between Google and Yahoo to check out stocks.
they use the + sign. for example. aig is aig+. wfc is wfc+. bofa has two. bac+a bac+b. Hope you get the idea.
If I put in aig+ Google finance is not able to recognize the symbol. Am I doing something wrong?
Thanks
Vinod
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Those of you who are worried about the profit margins collapsing. Your reasoning is something along the lines where capitalism will fail in theory if these margins hold up -- thus competition will move in for sure.
Well, lets say a company makes a widget where he's got these huge margins. And given that the entire market taken as a whole trades at these fat margins, you are worried about competition springing up anywhere and everywhere, essentially.
Just remember. In order for a competitor to spring up, then people need to be hired to create this duplicate competing product, and factories need to be built. Offices need to be occupied. But you are worried about the margin for the entire market coming down, so this is going to be the mother of all economic expansions.
I do not think that is the only way for margins to collapse. I can think of two examples
1. Take PG. Many of its brand products sell at a premium price to more generic ones. If consumers are feeling poor, they can switch to non premium brands and margins would collapse at PG. This can occur at any company - actually more likely at other companies that do not have moats like PG.
2. Take Apple. Profit margins of iPhone, iPad etc are going to come down as rivals just catch up just enough in quality to erode margins. At some point say iPhone 12, the androids and windows phones of the world are going to be pretty close to iPhone to reduce the premium Apple was able to charge.
No huge spending boom needed for either case.
Vinod
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Vinod - other than holding fins, I don't know if you could have worded what I am thinking any better. Im even around 80pc long right now!
I'm surprised you are comfortable holding BAC (guess it depends on position sizing too, since a big position to me is 10pc) given ur view on where the economy could ultimately end up. IMO, if even half of the Great Depression scenario plays out, banks will get crushed.
The way I see it we either
1. See a pretty severe economic crisis - which I think would crush all the stocks, but banks would suffer really severely. In which case I would deploy some of my cash which should produce satisfactory returns.
2. Escape without a severe economic crisis but muddle through - in which case financials would likely provide satisfactory returns.
Either scenario would leave me satisfied. Not a very scientific way to invest but it minimizes regret and allows me to sleep well.
If we really see something like the Great Depression, we are going to be counting if the losses are 90% or 95%. To me they both feel the same even though you end up with twice the money in one case. Hence my barbell strategy.
Vinod
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I get your point about value investing and not worrying about macro. I would caution on a few things
1. S&P 500 profit margins are historically at their highest levels ever. So it would be imprudent to assume that such margins are sustainable or base your earnings for S&P 500 at that levels into the future. You are essentially betting that "This time it is different". To use analyst expectations for next year earnings is not a good idea. They are very consistently too high. Lots of studies if you want to look it up.
2. Given the high debt levels of both consumers and government (and the current political background) and zero rates by fed, we ran out of both fiscal and monetary bullets. Europe is in a pretty dire situation, comparable to years preceeding the Great Depression. Not that it is likely, but it is certainly a possibility. If such a scenario should happen, it would have a significant impact on US at a time when we ran out of fiscal and monetary ammunition. Not that I would avoid investing in stocks due to this but I want to position my portfolio to be able to survive should this scenario play out. Assuming that great depression would not happen again does not seem to be a good risk control. Whether this might mean 10% cash or 50% cash depends on you.
3. A careful reading of Great Depression and humility to accept that something like that or even worse could happen again is a must for any investor. This is what I took when Buffett said about what he is looking for in an investment manager "genetically programmed to recognize and avoid risk, including those never before encountered". I came from a very poor family, and I do not every want to be that poor again. I read a great deal about the Great Depression and protecting myself from such an event has been high on my list of priorities since I got interested in Investing several years back. If you look at what happened during Great Depressions stocks first fell 50%, investors jumped in and it went up 60%, then it crashed 85%. Unless one is holding some cash or holding a significant portion of portfolio in wide moat exceptionally strong companies, it would not be possible to recover from such a shock.
That said I am about 80% long nominally (about 70% cash). BAC is my top holding. My thinking was either BAC and other financials do well and I make a pretty good return or they go bankrupt or get diluted to such an extent that it is essentially permanent loss of capital. In such a scenario, I think it is likely that some pretty good bargains would be available to deploy cash at very attractive returns.
Vinod
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2. The ability to print money must count for something. Since some amount of inflation (1-2%) is widely accepted to be necessary, this at a minimum provides one source of funding that is not accounted for. If Govt were to auction of the ability to print money, what would be its value? Bidding starts at $10 Trillion. :)
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I'm curious, who are some of the current 'gurus' that have used leverage when they were younger?
For the record: I'm genuinely asking because I don't know, and because I think looking at how very smart people who've proven they can do it decided to manage their money can tell us something about this. This isn't a hidden message (I know some people love to never actually say what they mean, but I always strive for clarity).
I do not know of any of the Super Investors of (G&D ville) who used leverage other than via float. It could be because non-callable leverage like LEAPS are a relatively recent phenomenon. I think the key is non-callable.
Vinod
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Thanks for posting. This is fantastic.
Vinod
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Do you need to know anything about baseball to make sense of this book? I wanted to read this book for a long time but I have next to no knowledge of baseball.
Thanks
Vinod
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What would the PE10 look like if you ignore the 2009 earnings?
Tossing out true outliers is something completely reasonable.
How much of an outlier was it? Well, it was consistent with the lowest reported earnings of the 1940s (inflation adjusted).
http://www.multpl.com/s-p-500-earnings/
+1, and I do not think people realize how the composition of the S&P 500 has evolved since the 70s (oil crisis) to business with better margins, ROI, and global growth prospects.
Invest bottom up, lots of opportunities in this market.
Good point. There had been two changes
(1) Change in composition of S&P 500. Earlier it was dominated by low margin businesses (Top 10 in 1960 were ATT, GM, Du Pont, Standard Oil, Union Carbine, Sears, Kodak, IBM, GE and Texas Company) but in the most recent years it was dominated by much higher margin business (Microsoft, PG, JNJ, Coke, etc).
(2) Change in profit margins of many of the competitively advantaged companies within S&P 500. For example, profit margins of PG, JNJ, Coke have significantly improved from what used to be the case in the 1960s and 1970s. PG used to have profit margins of about 6.3% between 1951-1970 but recently has about 13%. Even if 13% margins are not sustainable I would think something like 10% is more likely than the 6% of earlier years. This is representative of other competitively advantaged business in S&P 500.
The above two have to be balanced with the fact that overall profit margins are mean reverting. GMO and Hussman wrote about this extensively.
If we completely ignore profit margins we would be looking at $90+ normalized earnings for S&P 500 and if ignore the changes in composition of S&P 500 and treat increases within the constituent companies as temporary we are looking at slightly below $60 normalized earnings for S&P 500.
To me ignoring either does not make sense and think normalized earnings are more around $70 - $75 for S&P 500.
Vinod
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1. Slightly overvalued as it currently stands. I think euro is being held up by Chinese for a variety of reasons and it would be much weaker otherwise. Otherwise I do not understand its current strength.
2. Undervalued if any of the weak countries (PIIGS) exit. Euro would soar once the weak links are out. Theory being a chain is as strong as its weakest link and when the weak links are taken out it leaves a much stronger chain.
Vinod, how exactly can you evaluate if a currency is overvalued or not?
BeerBaron
My response is partly tongue in cheek. I do not have a strong opinion as I do not think it would be possible to really say if a currency if overvalued or undervalued.
I do not really care all that much about exchange rates, important as they might be. Any view I have is mostly based on
1. Eyeballing say trade weighted exchange rates might give us some rough idea if a particular currency is overvalued or undervalued and could be of some use at extremes.
2. Inflation rate differentials, Bond Yield differentials, Expected economic growth rate differentials and Expected capital flows would give a rough idea of changes in exchange rates. This again is most useful during extremes i.e. when either all these are pointing to moving exchange rate in the same direction or the magnitude of the differentials is very large.
Vinod
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What do you guys think of the value of the Euro in the near future (1 year or so) vs other currencies?
1. Slightly overvalued as it currently stands. I think euro is being held up by Chinese for a variety of reasons and it would be much weaker otherwise. Otherwise I do not understand its current strength.
2. Undervalued if any of the weak countries (PIIGS) exit. Euro would soar once the weak links are out. Theory being a chain is as strong as its weakest link and when the weak links are taken out it leaves a much stronger chain.
Vinod
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Anybody ever found WEB's reaction to this investment a bit "peculiar"
I've listened to him answer questions about BYD for a few years now under different contexts from the General Meeting in Omaha to CNBC and everything in between, and every single time we get a version of the same answer (I think):
"You really have to ask my partner Charlie as he is much smarter than I am in these things"
My personal translation: I have nothing to do with this thing, Charlie is the one who decided to swing and I went along and I've been trying to distance myself for a few years now.
That is exactly the impression I get. I wondered about it whenever I hear his comments on BYD. He clearly seems to distance himself and associate BYD to Charlie.
Vinod
Well That Takes Care Of One Of The PIGS!
in General Discussion
Posted
In mid 2007 we had this as well, TED was elevated, CDS were going up but equity market ignored all this and kept going up. This might be rear view mirror thinking but I cannot help thinking how close the parallel is between the two. Hopefully, we have an equally wonderful volatility this time.
Vinod