Rabbitisrich

krazeenyc, The article contains a few fundamental errors and inexplicable omissions. Maybe he has thought more deeply about why he focuses on buybacks, but he didn't share those thoughts. petec, Valuation doesn't have anything to do with the difference between buybacks and dividends. Management deserves credit or blame for adjusting the payout ratio. But once they pay out, they paid out. The money is out of their hands. Equity owners are the ones who subsequently adjust their ownership stakes. So why implicate management for shareholder decisions? Implicate management for management decisions, which is most directly represented, in this case, by their payout decisions. Keep in mind that a company is not literally investing in their shares during a buyback. If the valuation shows optimism, management can just issue shares. If shares run low, management can just split shares. A buyback is a release of cash, and not a company's investment in its own shares.

I think they're aligned over the long-run and if you look at the whole (ie. shareholders are part of the economy). I hope that you are right but I have a nagging doubt. To draw an analogy with consumers, if enough people decide to postpone spending on "optional" goods, we risk entering a vicious deflationary spiral. If too many companies decide to deploy their cash on stock buybacks instead of investing in expansion, does that not stifle economic growth? Yes, it does - though there is another way to look at this, which that if there was less debt and more demand in the world companies might *want* to build factories, rather than be in a position where they have more capital than need for capital. But, it all comes back to incentives. I have no problem with buybacks when a) there is no better use for capital and b) the stock is below IV. I just have very serious doubts that that is actually how managements are incentivised. Why build a factory that will generate value over 30 years when you could juice your stock option value with a buyback today? Instead of thinking in terms of buybacks and dividends, think in terms of payout ratios. And then look at differential tax impacts. For example, a stock might be overvalued relative to the market, but the company might have reinvestment opportunities far below the expected market return. In that case, you might want management to increase the payout. The question of how is, for most people, a tax issue. If the stock is overvalued, then the dividend and buyback receivers are deliberately holding overvalued shares. The only difference is that the dividend receiver closes his tax loan for the year, and receives a deferred tax benefit on the lowered basis of his holdings. In other words, he switches from borrowing from the IRS to lending to the IRS. That can be good or bad, but you can see that it isn't obviously connected to the question of stock valuation.

The author might have missed his own argument by focusing too much on the word "buybacks", and not enough on the economic reasoning. Towards the end, he almost pulls it together by implying(?) that favorable tax treatment encourages higher payout ratios than a tax system that somehow treats buybacks and dividends equally. He doesn't explicitly say it, but he must also believe that these excessive payout ratios are not economically punitive, because something prevents reinvestment to fill those areas left undercapitalized by the payouts. If funds are leaving a given legal shell in the cause of shareholder value maximization, then there must be something more interesting outside of those shells. That could mean exciting events outside of public companies, or really uninteresting happenings inside the shells. Instead of tracking the money, and inferring incentives, the author clumsily slaps a bunch of economic concepts together, and assumes that buybacks are the result of self-enrichment, which is apparently a new thing.

I'd argue that the failure is a bit of both material and candidates - more people taking it who are less prepared due to the popularity of the program and having companies pay it for you and because the complexity of material has increased. I know a CFA grader with a PhD in Finance and the CFA designation who has commented that the course work and materially is substantially more difficult then it was when he took it. Harder material + a much larger audience of candidates = increasing failure rate Certainly glad the CFA has improved so much with their materials though. Even the last four years I've seen pretty large improvements. +1 I recently had a look at the 2015 books compared to 2010 and there is a noticeable improvement. Personally I think the CFA material is [mostly] fantastic and very interesting -- the Schweser books skip a lot of interesting stuff. True, but Schweser is very good at teaching you to perform for the test. I had to retake Level 3 because I studied from the source books like I did for 1 and 2. As a result, I answered the writing portions in long essay type narratives, trying to consider possible complications, and framing the answer like CFP talking to a client. Not only did I bomb the writing portion, but I spent so much time that I barely finished the morning section in time. Schweser instructors help you with pacing, and with knowing what the graders want to see. GIPS and Level 3 ethics? No knowledge there, just distractions and satanism! What monster still remembers their GIPS rules?

I like dividends because I don't need to pay a commission to sell any shares. Some of my holdings are very illiquid and a dividend puts real cash in my pocket rather than sitting on the ask for months. Some of my holdings are in IRA's so dividends are tax-free for me in there as well, not that I let the tax-tail wag the dog.. If you are maintaining your ownership %, then dividends and buybacks will be similar even for a taxable account. Most of the benefit of a buyback is in the extended IRS loan, so the advantages of a buyback accrues with more time and higher returns. If you are selling off the extra ownership within that first tax period, then your loan term is the same as a dividend.

The conversation has been difficult to follow, but you previously seemed to argue that you would only value a company based on its current asset values. I and others responded that you can never be neutral with respect to management quality, and that a current market valuation holds under certain management behaviors, while under or overvaluing others. That's why I mentioned liquidation, which is a scenario in which it makes sense to "ignore" management. Except that you aren't ignoring anything; you are just assuming a behavior in which your sum of the parts analysis is valid. The same analysis would be hugely optimistic if the CEO were the dumbest, yet most ambitious, man in the world. But now your argument seems more specific; that you don't think FFH warrants a premium. That's very different from the more extreme claim that you are literally paying for the assets of company despite being an outside passive minority investor.

That's exactly right. Double counting. Understood. FWIW, I'd pay a significant premium to TBV for the assets PW has assembled. I don't really follow this argument, and it seems like you [Petec] aren't committed to it either in that last comment. Why is it a matter of direct interest what is the liquidation value, or the snapshot value of assets, unless you are planning to immediately liquidate or sell the company? If the business is a going concern, then the snapshot value is the material for managerial discretion. I might decide to pay no more than book value, but that is due to my expectations about the use of assets. There is no room for a passive regard of management.

But a P/DCF is simultaneously a P/BV. You just divide DCF/BV.

What if, instead of FFH, you were talking about the Medallion Fund? Would you refuse to pay more than the SOTP snapshot from a given day? It's likely that you would pay up until you felt you were getting your risk adjusted expected return, even if that meant paying for a premium over the day's portfolio value. In that case, management is not easily replaceable, and the strategies are not easily duplicable. Management quality has a value, and the accounting treatment looks like you apply it to the NAV, even though you are economically valuing future behavior. That said, the above logic is totally consistent with refusing to pay a premium for FFH. It's just that rather than insisting that management behavior is always a neutral value, you value it at zero. Maybe you feel that Hamblin-Watsa is "replaceable", in the sense that you can replicate them in your own portfolio, as a free-rider or through alternative investments. But why would you assume that all potential management candidates are equivalent and neutral with respect to the potential pathways of NAV?

Moody's releases older versions of their Corporate Default and Recovery Rates 1920-2010. The up to date version is available for purchase, but you can download the older copies from their website.

Valuing a company according to the market value of its assets is an implicit modelling of management decision making. You are modelling that they will have the same impact as if you simply owned the stocks directly and went passive. Think about a holding company consisting of only SPY shares. Now imagine that the newly hired CEO is: A. The Dumbest person you know B. The Smartest person you know C. A young orangutan If your valuation of the company is the same across all options, then you are implicitly modelling different relationships between assets and CEO decisions. The balance sheet is just a snapshot. Furthermore, how is modeling spelled?

But it does happen thought fees, lockups, collateral calls, and any other conditions that transfer value from investors to management. It is difficult to match variable fees like performance charges to a flat upfront fee, but that is a modeling challenge rather than a theoretical issue, I think.

The business and the management aren't so clearly separable. After all, management can divert money from one business line into another. Payouts are another option. In that sense, there isn't really an operation that you can distinguish from management decisions, without assuming a baseline management plugin. If it's trivially easy to replace a management team, then you just have to determine whether your team is superior to available alternatives. So in the case of a low turnover, secondary market investor, like Bruce Berkowitz, degree of portfolio replicability approaches that condition of being trivially easy to "replace" management. In which case, management becomes more valuable when outperformance can only be achieved through less available instruments and methods.

For developed nations with large gross trade volumes, and international scale industries, the gains and losses of currency depreciation are muted: http://libertystreeteconomics.newyorkfed.org/2014/07/why-hasnt-the-yen-depreciation-spurred-japanese-exports.html "The new finding in our study is that the incomplete pass-through is the most pronounced for exporters with large import shares—each additional 10 percentage points of imports in total variable costs reduces exchange rate pass-through by over 6 percentage points. We also show that large exporters are import-intensive, have high foreign market shares, set high markups, and actively move them in response to changes in their marginal costs. Thus, the prices of the largest firms, which account for a disproportionate share of trade, are insulated from exchange rate movements both through the hedging effect of imported inputs and through active offsetting markup adjustment in response to cost shocks." You might also enjoy this David Glasner post: http://uneasymoney.com/2014/08/11/misunderstanding-totally-competitive-currency-devaluations/ 'The benefit that a country derives from the depreciation of its currency is in the rise of its price level relative to its wage level, and does not depend on its competitive advantage. [There is a slight ambiguity here, because Hawtrey admitted above that there is a demand shift. But there is also an increase in demand, and it is the increase in demand, associated with a rise of its price level relative to its wage level, which does not depend on a competitive advantage associated with a demand shift. -- DG] If other countries depreciate their currencies, its competitive advantage is destroyed, but the advantage of the price level remains both to it and to them. They in turn may carry the depreciation further, and gain a competitive advantage. But this race in depreciation reaches a natural limit when the fall in wages and in the prices of manufactured goods in terms of gold has gone so far in all the countries concerned as to regain the normal relation with the prices of primary products.'

I disagree about the point at which dividends are more valuable than buybacks. The apples to apples comparison would be to fix your desired % ownership and arrive at the same cash balance via dividends or selling the excess % ownership (in the case of buybacks). Aside from technical issues, the first-order difference is in the tax treatment. In order for dividends to beat buybacks in an apples to apples comparison, dividends would have to show a persistently higher valuation for the company.