vinod1
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Posts posted by vinod1
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Taleb seems to me like a man with a hammer syndrome... It has a lot of offer the investor but it is not the basis of an investment strategy.
To me the most important points are (1) Ignore standard risk models - anything that uses std dev, beta, etc. (2) Future is unpredictable and mostly develops in random ways, so be prepared to handle black swan type risks. (3) Be particularly skeptical of causality explanations.
Vinod
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A good article on current market valuations - several methods of valuing the overall market. I pretty must used to do the same calculations, so this guy made my life simple.
http://www.valuewalk.com/stock-market-valuations/stock-market-valuation-february-2nd-2011/
Thanks
Vinod
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shiller's pe10 has officially hit 24 which basically tells us to be extremely cautious as this figure will, sooner or later, revert to it's long term average around 16
it would be interesting to learn from board members if
- they take this indicator serious....
- what their strategy is to minimize the damage when the eventual correction/crash hits.....
is there a cost effective way to replicate Fairfax's equity hedging strategy or is cash the only real hedge for a small investor?
i personally find it harder and harder to hold on to positions like COP & LUK which have increased by 60-80% over the last 12 months....
regards
rijk
S&P mini futures. I have not done it and not sure about the exact mechanics, but that is one way to hedge.
Vinod
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Say you buy a car in 2000 for $20K without ABS. Now, if you can buy the same make, model car with ABS for $20k. Then you would say there was 0% inflation. But in reality, you had deflation, price did fall, if you had considered the quality improvement. This had been the case in many goods and services. Thus BLS uses hedonic adjustments to account for quality improvements when calculating inflation. When we calculate inflation, we need to take the quality improvements into account
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The cost of cars would not be considered in a CPI calculation.. the monthly cost of transportation would however.
A car is part hedonistic depreciating investment as well as a monthly depreciation expense.
Better to use the cost of a monthly bus pass or the combined monthly expenses for a standard 4 year old compact car...gas, depreciation, insurance parking etc... One quickly sees that a person on a fixed income (wages have not risen significantly lately) or no income at all (unemployment and underemployment has risen) is behind the eight ball over the last few years. Pick a number.. BLS or John William's... inflation is rising no matter how you cut it.
You are probably correct, I just picked up a random example.
Vinod
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The car perhaps should have been $17k though including the ABS (due to technology and efficiency improvements) but it is being sold for $20k (due to inflation).
It should be clear that if commodities go up and wages went up (rubber, steel, aluminum, leather) then the price of the car is actually higher than it ought to be. However, it is officially counted as "no inflation" or "deflation" (for the reason you cited).
Technology improvements should make things even cheaper than they've become. But it's not counted as inflation because the absolute price did not go up, and in many cases it fell.
To use an extreme analogy, if a road costs a certain amount to construct via pick and shovel, and then several decades later it costs the same amount to construct using heavy machinery, then something is wrong! It's inflation, but it's not counted that way in the official numbers.
Back to cars though... they once had chrome bumpers. I don't think a hedonic adjustment was made when they stripped out the chrome for cheaper materials. On that note, we could replace diamonds on wedding rings with cubic zirconia -- would that hold the CPI steady?
I think we differ in how inflation should me measured. To me the way BLS measures inflation seems reasonable.
You seem to be saying that productivity improvements should be considered - that is the cost to produce a good, must be incorporated into inflation. I do not think that should be the case.
Cost savings as a result of productivity improvements gets passed to consumers when the business does not have any competitive advantage. In your road construction scenario, those businesses do not have any competitive advantages and the cost savings are realized by consumers as a result. This issue is separate from how inflation should be measured.
Car companies might have a small competitive advantage as result of brand preferences (but not much, although I am not that familiar with these companies), hence they might not have passed on all the cost savings as a result of any productivity improvements they might have made.
Vinod
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Vinod - nice analysis of BRK and WMT in your web page. Do you have updated analysis of BRK?
Also - I heard the inflation rate in India is 10% or higher.
Thanks! Sorry that is the latest that I have. I only update my "inevitables" about once a year when the AR's comes out. Since IV of these companies do not change that much this works out for me.
Vinod
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I wrote a short article on this for those returning back to India at http://vinodp.com/documents/nri/standard_of_living.html.
Imagine that you were living in America in year 1950 and earning as much as the median (50th percentile) American family did in that year. Suppose, in that same year you happen to receive a large inheritance, which your financial advisor then calculates would be enough for you to retire. His calculations shows that you can withdraw the same amount as you are earning now and adjust each year for inflation to maintain your standard of living. You decide to follow his advice and retire.
Fast forward to year 2005. You would be surprised to learn that your standard of living is now only marginally higher than that for a family living in poverty (poverty is around the 12th percentile) in America in 2005. By 1994, you would be having a standard of living around 20th percentile - poorer than 80 percent of the population. Most people would not consider this to be “maintaining” their standard of living!
Vinod
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The way I think inflation is hidden is that some prices have not gone down like they should have (due to lower labor costs in China (vs US), advancements in manufacturing, and shipping for example). I think the term for that is "productivity" gains -- why don't prices fall every year if there are truly productivity gains? So, if a manufactured good doesn't fall in price despite it being produced for less costs, that's a form of inflation (when it is happening all over the place).
Say you buy a car in 2000 for $20K without ABS. Now, if you can buy the same make, model car with ABS for $20k. Then you would say there was 0% inflation. But in reality, you had deflation, price did fall, if you had considered the quality improvement. This had been the case in many goods and services. Thus BLS uses hedonic adjustments to account for quality improvements when calculating inflation. When we calculate inflation, we need to take the quality improvements into account.
We are increasing our standard of living every year. If you accurately calculate the inflation (without quality improvements) and only increase your expenses by that inflation measure, you would find that you would be falling behind the rest of the country in standard of living.
Vinod
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Options are priced with the assumption of something like normal (lognormal) distribution.
Not true at all. Option market makers are quite sophisticated. You can observe "volatility smile" and "volatility skew". Volatility smile means that implied volatility is higher for out of money options than at the money options. And volatility skew means that the implied volatility is higher on one side of the strike price than the other side. This is completely contrary to log normal distribution.
You are correct indeed. However, the point I think Taleb makes is that option pricing models as much as they are tweaked (either via a skew or assumptions of higher volatility), do not really price black swan type events.
Vinod
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They have iShares ETF under their umbrella which has the broad market indices. So they tend to own pretty much every security in the US.
Vinod
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If I remember correctly he buys way out of the money options. Options are priced with the assumption of something like normal (lognormal) distribution. Thus way out of the money options are underpriced if returns do not follow the neat lognormal distribution i.e. black swan type scenarios tend not to be incorporated into the price. So his strategy losses small amounts of money regularly with the occasional home run.
Thanks
Vinod
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Surely he means $1 like 5 years out from now, right? Once Citi starts growing the balance sheet again? That doesn't sound unreasonable.
I think he means $1 in current normalized earning power. See his comments below.
CONSUELO MACK: And so, when you look at, you know, a Citigroup, for instance. Let’s just take them one at a time. I mean, it’s value now. Do you think that there’s still a lot of value left?
BRUCE BERKOWITZ: Yes. Citigroup has the ability to earn a dollar a share, which would put it at $10, let’s just say. And you compare it to where it’s trading today, four. Under four.
Vinod
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You're right, it makes no sense. He is perhaps expecting a lot of loan growth -- that's all one can come up with to defend Bruce.
Another alternative is that there are lots of off-balance sheet assets that are not being reflected on the books. I did try to size the off-balance sheet items but not really able to find anything that would be much higher for Citi than BOA. But then I have never been able to get my head completely around the off-balance sheet stuff of the big four banks.
Vinod
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The thing that bugs me is that most valuation measures implicitly presuppose that the investment is large enough to make the investor a "true owner." This worked for Warren even in his limited partnership days because he would buy an entire company and then make decisions that maximized his partners' return on investment. To take this point of view is just wrong for the small investor (that is, someone with say less than $100 million). The small investor in today's framework has no owner's rights because the small investor has no actual power. A company can be very cheap and the Board can squander the assets (sometimes actually robbing the shareholders). Great managements will eventually be replaced by less capable or scrupulous people; there are just not that many truly great, shareholder-oriented managers out there.
The small investor must make sure that he or she will be paid. In some of his thinking Graham agreed with this. However, rather than looking at earnings yield, the small investor should look at dividends - both payout rate and policy (e.g., propensity toward special dividends, when the company cannot properly allocate all of its capital on hand). I suppose that one could attempt to be paid by capital appreciation. However, as we have seen recently, this can evaporate over night.
So the only defense for the small investor lies in emphasizing dividend yield, dividend policy, and the locking-in of profits when they are realized. Again, Warren can afford to wait for five years between market quotes -- when he owns the entire company! Otherwise, even he should be taking profits when he does not control the company.
Best wishes,
Tex
Here is my notes on Ben Graham's comments on Dividend Policy and how investors should approach dividends.
Vinod
• The dividend rate is a simple fact and requires no analysis, but its exact significance is exceedingly difficult to appraise. From one point of view the dividend rate is all important, but from another and equally valid standpoint it must be considered an accidental and minor factor.
• In the years until 1925, the price paid for a common stock would be determined chiefly by the amount of dividend. A common stock investor sought to place himself as nearly as possible in the position of an investor in a bond or a preferred stock. He aimed primarily at a steady income return, which in general would be both somewhat larger and somewhat less certain than that provided by good senior securities. Even if one company had steady earnings and another company had irregular earnings, this had little impact on the price paid which is dominated by the dividend rate.
• Graham questions the established principle of corporate management which subordinates the current dividend to the future welfare of the company and its shareholders. It is considered proper managerial policy to withhold current earnings from stockholders to either strengthen the financial position or to increase productive capacity. The typical shareholder would most certainly prefer to have his dividend today and let tomorrow take care of itself.
• Graham questions the assumptions of the dividend policy
1. It is advantageous to the shareholders to leave a substantial part of annual earnings in the business.
If a business pays out only a small part of the earnings in dividends, the value of the stock should increase over a period of years, but it is by no means certain that this increase will compensate the stockholders for the dividends withheld from them, particularly if interest on these amounts is compounded.
An inductive study would undoubtedly show that the earning power of corporations does not in general expand proportionately with increases in accumulated surplus (retained earnings).
2. It is desirable to maintain steady dividend rate in the face of fluctuations in profits.
Stability is usually accomplished by paying out a small part of the average earnings. The question that arises is if the shareholders might not prefer a much larger aggregate dividend, even with some irregularity.
The main objection to the above is that stockholders receive both currently and ultimately too low a return in relation to the earnings of their property and that the saving up of profits for a rainy day often fails to safeguard even the moderate dividend rate when the rainy day actually arrives.
Gives the example of US Steel that earned a profit of $2.344 billion over the period 1901-1930 and retained $1.25 billon of it. Yet, a small loss over a 1.5 year period in 1931 was sufficient to outweigh the beneficial influence of 30 years of practically continuous reinvestment of profits.
Assuming that the reported earnings were actually available for distribution, then stockholders in general would certainly fare better in dollars and cents if they drew out practically all of these earnings in dividends.
• Graham questions the accepted notion that the determination of dividend polices is entirely a managerial function, in the same way as the general running of the business. This is because the board of directors consists largely of executive officers and their friends. The officers want to retain as much earnings as possible to simplify their financial problems, expand business for personal aggrandizement to secure higher salaries.
• Graham suggests European companies policy of paying out practically all earnings and any capital for expansion purposes be provided by sale of additional stock.
• Experience would confirm the established verdict of the stock market that a dollar of earnings is worth more to the stockholder if paid him in dividends than when carried to surplus (retained earnings).
• Graham suggests that if an investor makes a small concession in dividend yield below the standard, he is entitled to demand a more than corresponding increase in earning power above standard. So if a stock is paying 5% div yield and 7% earnings yield and another company paying 4.4% yield, then the investor should demand an earnings of yield of perhaps 8% to compensate.
• The dividend rate is seen to be important apart from earnings, not only because the investor naturally wants cash income from his capital but also because the earnings that are not paid out in dividends have a tendency to lose part of their effective value for the stockholder.
• The principle for dividends should be for the management to retain or reinvest earnings only with the specific approval of the stockholders. Such “earnings” as must be retained to protect the company’s position are not true earnings at all. They should not be reported as profits but should be deducted in the income statement as necessary reserves, with an adequate explanation thereof. A compulsory surplus is an imaginary surplus.
• Summary
In some cases stockholder derive positive benefits from an ultraconservative dividend policy i.e. through much larger eventual earnings and dividends. In such instances the market’s judgment proves to be wrong in penalizing the shares because of their small dividend.
Far more frequently, however, the stockholders derive much greater benefits from dividend payments than from additions to surplus. This happens because either (a) the reinvested profits fail to add proportionately to the earning power or (b) they are not true profits at all but reserves that had to be retained merely to protect the business. In this majority of the cases the market’s disposition to emphasize the dividend and to ignore the additions to surplus turns out to be sound. A company earning $10 and paying $7 in dividends should increase the value of stock over a period of years. This may be true but at the same time the rate of increase in value may be substantially less than $3 per annum compounded.
The confusion of though arises from the fact that the stockholders votes in accordance with the first premise and invests on the basis of the second.
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1.5% would get you to Bruce's $1 -- Pandit has been saying 1.25% - 1.5% (he said it again today on the conference call).
I think the optimism around higher than historical ROA is based on a return to a lower cost funding strategy (leaning more on deposits). They effectively (pre crisis) used high cost debt to buy high yield assets. The Citi Holdings split moves them away from that (liquidating non-core assets for reducing debt as it matures). In doing so the risk of the blowup that you speak of every 10 years is also reduced. Most of their pain came from that risky strategy. And they had concentrated US consumer exposure, which they will no longer have -- geographic diversification ought to help. Anyhow I got into the stock at $3.30 12 months ago, and it's not the same value proposition any longer (that's not all bad news for me though).
Interestingly (I only recently realized this), if you had bought the stock at book value 10 years ago (which you couldn't have) you would have actually made a little bit of money even if you are still holding it (counting dividends). Of course, it was trading at 2x book in 2000 -- but today it isn't. I'm just saying that even if the next 10 years look just like the last 10, you won't lose any of your capital (but not making much money is quite painful isn't it?).
Good job on Citi!
Yes, you do get $1 if you assume a 1.5% ROA on the $1850 billion in current asset base. But, Citi excluding Citi Holdings has only about $1300 billion in assets. The $500 billion odd in assets in Citi holdings I assume are going to be in runoff. So would require more than 2% ROA to generate $1 EPS. To put this in perspective, it require earnings of more than $30 billion a year or 50% more than either WFC or BOA.
Also the Book Value has held up because they were able to raise $90 billion in equity sales mostly at greater than book value so BV per share has been helped by this. Also the $300 billion in bad debt that it was able to hand off to Govt has also helped in this regard.
Vinod
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As much as I try to come up with a "normalized earnings" for citi, I am never able to get much above $0.8 EPS which is based on a very simplistic 1.2% ROA which I think is about average for Citi even after excluding the 2008-2010 period. Given that Citi is shrinking its BS I cannot see how Citi can earn $1 with nearly 30 billion in shares outstanding. Given that it is a near certanity that it would go through a near death experience once again over the next 10 years (having gone through this about once a decade for the last 4 decades and having participated in every significant scandal involving the financial industry of the last 20 years), I am just not able to see the value here.
Obviously Bruce is on to something but along with AIG, I have not been able to understand the value he sees in Citi.
Vinod
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You got great feedback from others. My 2 cents
1. I strongly recommend reading Security Analysis. You would find it astonishingly relevant to the current environment. However, it is not a book that teaches you how to value stocks. The most surprising thing I found after a very detailed study of Security Analysis is that Graham does not think it is necessary to actually value a business. "Instead Graham focused on how to ensure that what you are buying is very cheap, which means you don't know the value is, but you do know that the value is much higher than the price that you are paying. And then you diversify. So, when you follow that approach, for example, you don't have to do management interviews, you don't have to really worry about the industry prospects. Graham said that you don't need to value the business. It's too hard to value a business. Anyway, it is not the job of an investor to value a business, that's the job of a business valuer which is very different from the job of an investor. The job of an investor, he felt, was to make sure that there is a big margin between the value that you are receiving and the price that you are paying." (Quoted from Sanjay Bakshi). If you read this book go with one of the first four editions, the other editions had much less Graham.
My notes to the book are at http://vinodp.com/documents/investing/security_analysis_index.html
2. The best practical book on valuation I found is "Value Investing" by Greenwald. This is a definite must read for developing the right method of thinking about valuation.
Vinod
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Came across a good site for Oil and Gas stocks and thought it might be of interest to those who are following this industry.
http://www.mcdep.com/index.htm
Think it could be of some use as a screening tool for further analysis of each company.
Vinod
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I just completed a look at investment rerturns on funds over the past 10 to 15 years for myself and my Dad. The top funds are Fairholme, Yacktman and Chou. The one disadvantage of Fairholme is size ($17 billion). Some other value funds have really been hurt when they became large (Dodge & Cox is an example). Yacktman had a bad stretch of relative performance in the late 90s that dragged performance down to other value funds such as Third Ave and Mutual Series. Does anyone know the story behind this underperformance?
Another alternative to funds are investment holding companies that hold securities or whole business. Some of these have outperformed all the funds and include Fairfax, WR Berkley, HCC, Loews and Leucadia. All of these are trading at either below or slightly above book value (HCC and Leucadia). Leucadia sounds like they are cranking up Berkcadia so its value may appreciate nicely.
Packer
A little info you may or may not find useful:
I think it might have to do with fund withdrawals for Yacktman. Assets dropped from $1.1 billion to $0.3 billion during 1998-99 period. The withdrawals might be because he loaded up on deep value stocks like Philip Mliorris and also started under performing for whatever reason early in the bubble period than the other value investors. The under performance is concentrated tightly in the three year period between 1997-1999 - a badge of honor.
I was told in an online message board discussion from a person who I respect enormously but do not have data that Fairholme has underperformed in its managed accounts in the mid 1990's. Since the fund did not start in this period we do not have public record.
Vinod
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Good catch.
I looked at S&P 500 and Small Cap indices and they are up roughly 29% and 42% over this period. So the 7 year forecast change for these two tally out quite well over this period with the market moves. Quality on the other hand seems to have moved from a 6.1% annual premium over S&P 500 to a 3.5% premium while providing nearly identical returns over this period. Very strange.
Vinod
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Does anyone here invest in Bruce Fund, BRUFX? I have been following it for a little while, and its performance is great when looking at 15 year to now. However, some articles I have read on it mention that it trailed very badly in the 90's with only 5% average gain. I can't decide if I find this attractive or not, this was the time when tech stocks were booming and it may mean that he will not fall into stocks he cant understand and therefore missed the boat and avoided a bubble.
It is difficult for me to find information on his performance since inception, I'd like to know this his excellent performance in the past was not because of a few good years that sent the fund booming.
Taking a very quick look it underperformed from its inception till late 1999. Most of the out performance came from 2002-2007 period. Maybe the manager improved his skill. To really assess his performance, reading up his letters to see how he thinks might give you a better indication of his performance. You might find more feedback on the Morningstar board about this fund.
Vinod
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Although the voices in my head always try to convince me otherwise, I think it makes sense to focus on good/great businesses. There are enough to go around, and many at good prices.
This is a value investing board - but there are different ways to look at this.
I would rather buy the dollar bill at 80 cents (50 is better) than buy a piece of sh-- that I might be able to sell as fertilizer.
I don't view most of the pharmas as good businesses. They will get squeezed - generics are the future. The U.S. subsidizes the rest of the world - this is well known. How long can that continue? I have been in the business on the finance side and while margins are MONSTEROUS, R&D costs are killer and lawsuits a pain. Competition is tough. Pfizer for example can only grow through monster acquisitions.
Something like BAC is intriguing to me, just very complicated. Blackrock, MER - some real assets tucked in there.
I am "Inevitables" at 80 cents kind of guy. Vast majority of my portfolio - heck pretty much all - is invested in such businesses. However, I made a first foray into BAC this week. I am afraid that a great calamity is about to fall on US Banking system given my investment :)
Vinod
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The main difference is valuation. JNJ, PFE, MRK, etc are all being valued at PE ratios in the mid 30's.
Vinod
Vinod - do you mean "were being valued"? As far as I can tell, the three companies you mentioned all have low-mid teens PEs.
Unless I'm missing something...
-M
I was not clear. I took the orginal poster to mean, "why are banks currently an investment candidate if healthcare was deadmoney the last 8 years. Can banks suffer something similar?"
I am referring to valuations about 8 years back in healthcare. They are priced to perfection at that time so it is not surprising that they did not provide good returns. Right now the valuations of Banks is vastly different compared to the situation with healthcare in 2002.
Banks have their share of risks, but valuations are such that, on a risk adjusted basis (fully incorporating say a complete wipeout probability of say 10%), they are starting to look attractive.
Vinod
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The main difference is valuation. JNJ, PFE, MRK, etc are all being valued at PE ratios in the mid 30's. At an earnings yield of less than 3%, poor returns are baked in at those prices. Even using conservative normalized earnings, some of the bank stocks are at PE of about 6. At an earnings yield of greater than 15%, unless you run into some really severe economic/company specific issues you should have a satisfactory return.
Vinod
Not really.
JNJ forward earnings yield = 7.7%
PFE = 13%
MRK = 10%
You cannot just break down a case for investing in a bank because of its P/E ratio, it's far too simplistic. That's the kind of mentality that got people killed when they were investing in seemingly cheap banks on backwards looking metrics during the financial crisis.
I am talking about valuations of healthcare back in early 2000-2002 time frame (8 years back).
I do not disagree with you, just pointing out that while 8 years is a long time period, for healthcare stocks the past 8 year period started with very high valuations as opposed to Banks at the current time.
Vinod
Real inflation at 10%
in General Discussion
Posted
Perhaps bad terminology on my part. I do not think I disagree with you. In my own calculations I always factor inflation + increase in living standards (a close proxy to productivity increases) as the minimum growth needed to protect the purchasing power of my assets.
Vinod