ExpectedValue

Investing is just like writing insurance. When you buy a value stock, you're really just writing an insurance policy against a business from going bust. The market usually overestimates the likelihood of this occurring and has historically paid a pretty good premium to insurers for this. But that's not the only risk in the market you can write insurance against. You could easily write insurance on companies being able to continuously grow their earnings. A lot of guys have tried that and unfortunately, the frequency of catastrophes (growth slowdowns/earnings disappointments) and the premiums available weren't enough to compensate you for that risk. That doesn't have to be true all the time though. There are going to be times when those premiums fluctuate and shift. http://www.highway6.com/grabs/Screen%20Shot%202012-08-02%20at%209.10.40%20PM.png The blue line is Russell 1000 Value (IWD), the red line is Russell 1000 Growth (IWF). Over that period, value has underperformed, especially coming out of the financial crisis. ^ Now this is just for a broad, representation of value based upon quantitative factors. So you might be a good stock picker and do better than that.

Do you have a citation for that? I looked at this back in April and found that only 33% of production was coming from dry gas, with up to 40% coming from wet gas and the remainder from casinghead gas.

The author of that post references the low gas rig counts which is likely a mistake. You have to differentiate between dry gas rigs and then also rigs in liquids rich and oily plays. Liquids rich plays will still produce a ton of gas, oily plays do as well -- and worst of all, the economics of the associated products make it so you can dump the gas at ultra low prices (say $0.50 per mcf in the Permian) and still earn your required rate of return from the well.

That would be covered by your EBITDA/interest expense ratio. And that's the thing, it's entirely wrong to fixate on just one ratio. Instead you should look at a number of different ratios that assess a company's operations, financial structure, and valuation (all over time).

I think it's important to be really really careful about making a distinction here. DCF is not bad, it's a sound way to think about valuing a company. The bad thing is when people relax and massage the inputs that go into the DCF to make excuses for buying inferior or expensive companies. That's where you abuse discounted cash flow analysis. You want to be really conservative and assume a real discount rate and be very conservative about your growth rate to come up with a valuation. And then obtain a margin of safety on top of that.

Sure, I just want to clarify that using the above method is basically the same thing as a DCF though. In the example: He's assuming a normalized earnings figure, 2.50 -- by using a 10x PE multiple he's basically saying he's assuming no/little growth, and a 10ish% discount rate to get the 10x P/E input. Multiples is a shorthand DCF.

I'm pretty sure Buffett does DCFs, maybe not in the way people think. Unless you're buying a company on an assets-basis Ben Graham style... DCF kind of has to play into it. Owning an equity means owning the present value of the future cash flows thrown off by a business. Sell side guys take this type of modeling to an extreme and focus on year by year prediction for magins, growth rates, etc. My guess is Buffett takes a very simple approach where he analyzes a business's competitive position and makes small assumptions on the overall growth rate and attaches a discount rate. You can arrive at something like this by looking at free cash flow multiples. If two businesses have the same amount of FCF, "X" but are worth different multiples, what does that imply? If you were to a 25-period DCF model, you'd see: 10% discount rate, 0% growth rate = 9.1x multiple 10% discount rate, 4% growth rate (about lt avg US growth rate) = 12.6x multiple 10% discount rate, 8% growth rate = 18.4x multiple Using multiples is just a shorthand of doing a really simple DCF. And if you have a good grip on the competitive dynamics of the business and their growth prospects, you can rely on them. It's when things get tricky with distressed businesses where you have to take a more proactive approach I think (or just demand a really really significant discount).

Industry primers are usually pretty good. They introduce you to a sector, outline KPIs, give you context on how to think about businesses within the industry. It's pretty useful when looking at an industry that's just very different than you're used to.

Hilarious. So today he's again the hot hand at the table, and will no doubt take in more money as a result. And he's sharp as a tack, I'm sure. But what's the over/under on the amount of time it takes for him to blow up again? Would you trust him with your money? You know, Boaz Weinstein didnt really blow up. He lost lesss than 2 billion which was only an 18% drawdown in 2008 - that really is not bad.

I think the key with companies like this is to make sure their growth will actually pan out. There are some cases where this can be pretty dangerous, homebuilders are one and I'd argue some of the O&G E&Ps are as well. Basically you can end up where capex and growth is funded at the expense of underlying fundamentals, you can end up buying increasingly expensive assets while taking on debt/diluting shareholders and when a bubble pops you're pretty screwed. Level 3 is another example of this, where lots of capital was spend laying the fiber and only a tiny fraction of it has actually been utilized, supply drastically overshot demand. Looking at companies that have had unusual spikes in capex isn't a bad idea though, for example, a company might have to spend a higher than normal percentage of revenues on capex to get some new factory going in order to satiate demand for whatever they're selling. As long as it isn't at the expense of the pricing of the product they're selling, it should be pretty good. The other way to look at is is in industries where you have a ton of excess capacity relative to demand. You can see this a lot with cyclical companies. Supply overshoots demand, you take a bunch of charges by reducing your capacity (closing factories) which will make your numbers look bad for a few years, eventually the cycle of what you're selling emerges from the trough and you have demand exceeding supply. That's a good time for a company.

I don't think a simplistic approach like P/E is really good enough to determine whether or not Posco is cheap. Steel is a cyclical industry, looking at trailing earnings can be pretty dangerous because earnings might be ready to fall off of a cliff. A good example of this was with the US homebuilders which looked cheap on a valuations basis in 2005/2006 but were actually monstrously overvalued. I think the right way to look at it would be first, to see what a contraction of Chinese steel imports would do to Posco's volumes. In some years 30% of their exports have gone to China, so you've got to watch out for that, plus you've got to see if steel is being shipped to another country where it eventually ends up in China (as part of a supply chain/intermediate production). At that point you can stress test volumes for what happens if/when China steel consumption really contracts.

Are you sure it's because of North Korea? You have to be sensitive to the fact that China's currently on a building spree/bubble, so a lot Korean industrials (Posco) are having inflated sales as a result. Any pull back in their valuations will need to be analyzed from that context.

I don't know how accurate that is. If that were the case you'd have a ton of hedge funds flooding into the space to trade the 'arb'. I've looked at a few gas E&Ps recently and you're seeing the futures curve + their hedges being used to come up with price assumptions that are used to model the cash flows.

While I disagree with some of Gundlach's opinions on the US being a tragedy waiting to happen, I believe he has the correct view on nat gas. Who cares what nat gas prices go to at this point? Nat gas is likely trading at well below the marginal cost of production. You want to be in a position to snap up nat gas assets from distressed companies. Partner with the best to do that, I say. I think you have to differentiate between spot nat gas and longer dated nat gas, looking at the futures curve, you do see it upward sloping especially when you go longer out. At that point I don't see prices getting too below marginal cost

I disagree with Sharper's argument against working for banks. Look, if you want to end up at a buy side fund, the most straightforward route is to go the investment banking route. Look at almost any value fund that employs handfuls of analysts, they all tend to have a couple years of i-banking experience. That's not to say its an absolute requirement, it isn't, but you'll just end up having a harder time breaking in.

In theory, you could buy a gas E&P that has no shale assets, just on shore or offshore gas wells that are not economic at current gas prices.

I believe you are thinking of Kyle Bass

They actually aren't, maybe of the more well known guys, but there are a number of value funds / event driven value funds that watch the biotech space. Third Point has an analyst who solely looks for biotech plays, Icahn is sometimes active in it too. If you look at 13Ds there's a Biotech Deep Value fund that sometimes posts.

Do you think the ability to market time something like commodities is really a sustainable advantage? Some people have great instincts on macro opportunities (Soros) but it seems like you end up playing a dangerous game by investing in them because you're hoping they'll continue to be able to do something that's just really really hard. I'd rather look at value managers who have an understandable process in place with a great long-term track record.

I subscribe to the WSJ and actually like it (with a few caveats). I think the WSJ and FT try to accomplish different goals. I like to follow a lot of event driven investments and find the WSJ is great for covering these kids of things / has articles which give color on what's likely to be a future event driven scenario. Pretty much the only section I read in the WSJ is the business section. I don't read the Op-Ed, World News, or anything else. I find the FT to be better at giving a daily global perspective on what's going on with economics. It's good and high quality reporting, but I don't bother reading or subscribing to it because I don't view it as adding enough incrementally to my investing. I'd rather subscribe to the WSJ and then use the Economist and other random sources to get that global macro perspective.

direct link to presentation pdf: http://www.visualwebcaster.com/Pershing/84724/files/The%20Nominees%20for%20Management%20Change.pdf

I don't know Al, when you back out cash from Apple isn't trading at the multiple of a growth stock. You talk a lot about growth, but you don't really seem to mention the company's price relative to earnings.

From the conference call: Tim: I wouldn't classify it like Mac and Windows at all. The Mac has outgrown the market for over 20 quarters in a row, but still has a single-digit percentage of the worldwide market whereas iOS, if you look at phones and tablets and iPod touch, we've sold over 315 million iOS devices If you look at the NPD data, it shows in the US, and this is just looking at October & November, so part of our launch in October and all of it in November, it shows iPhone at 43% and Android at 47% the Nielsen data from a few days ago shows iPhone at 45% versus Android at 47% Comscore data that came out on October/November shows iPhone at 42% and Android at 41% it seems that all of the data from the US would seem it's a very close race for iPhone, and I think on the iPad side, I think all of us inherently believe the iPad is way ahead there's really no comparable product to the iPod touch out there I wouldn't say it's a two-horse race. There's a horse in Redmond that always suits up and always runs and will keep running So what we focus on is innovating and making the world's best products. We'll just keep doing that and somewhat ignore how many horses there are.

Well, they can at least be thankful that Android has bigger market share. I find it's much more useful to compare companies and their market shares on the basis of the difference in market share rather than who's absolute first, second, etc. In this case, Apple according to the latest Nielsen report has 45% share and Android has 47% share.

**MANDATORY CREDIT: BLOOMBERG TELEVISION** Video for viewing and embedding here: http://www.bloomberg.com/video/84733876/ Buffett on whether he would donate 15% of his income to the government: "If you can get a significant percentage of Congress to do that, I would do it. If out of 435 in the House, the additional in the Senate, if 50 of them would do it, I would. 10% of Congress, sure." Buffett on Mitt Romney's 15% tax rate: "Exactly what I expected. He makes money the way I do. He makes money by moving around big bucks, not by straining his back and going to work, cleaning the toilets or whatever it may be. He makes it shoving around money. I make it shoving around money. If you look at the 400 highest incomes in the United States, the average is $220 million. Something like 90 of them are effectively unemployed. They have no earned income, and that number has gone up over the years. That will not solve the budget deficit, what I'm talking about. The truth is, I am paying a tax rate less than when I was making $15,000 a year." Buffett on whether it's wrong of Romney to pay 15%: "It is the wrong policy. Nothing wrong about him doing that. He will not pay more than the law requires. I do not fault him for that in the least, but i do fault the law that allows him and me, earning enormous sums to pay over all federal taxes at a rate that is about half what the average person in my office pays." Buffett on the Republican presidential candidates and their tax plans: "I think Republicans, like Democrats, have trouble breaking ranks, particularly when they're running for election. I do not know what they would do if they got in any way. There is history that shows campaign promises to not end up being law…somebody has to come forth. One way or another, we have to get this down to a place where the average deficit does not run 2% of GDP. That probably involves numbers around 19%, 20% on revenues. Almost everyone agrees on that, they just do not want to be the ones to step forward. I will cheer for the Republican or Independent or Democrat who comes up with a plan like that. You can argue about things around the edges, but then you have something that is workable. What we have now is not workable." Buffett on whether Romney has better experience than Obama to run the country: "If you look at the leaders of the past, Roosevelt, Lincoln, the great leaders -- they come from all different backgrounds. What is required is a real belief in what this country can do, and it can do it, and then the ability to garner support which will take support from both sides of the aisle. That will happen. I am optimistic about that happening, but I just hope it would happen quicker than it is happening." Buffett on whether he sees any validity in Newt Gingrich's recent attacks on Romney: "Romney did a lot of things in the private sector that are perfectly legitimate. I do not like buying businesses with lots of debt, but there is nothing immoral about it. In some businesses, they hired more people, in others they let people go… I see nothing specific about him. I think his tax rate is too low, but that is the fault of Congress, not his fault." Buffett on supporting President Obama's millionaires tax: My general theory is you should have a tax system where those making millions and millions of dollars, who are paying a much lower rate for one reason or another, get moved up to the rate that people think they are paying, in the mid 30's. There are about 80,000 taxpayers within that group paying that lower percentage of taxes. I would move those people up -- one of whom is me and another is Governor Romney. Move them up to the mid 30's where most of the people are. Rigell on who he endorses: "I have not…It is helpful to have more business people in Washington. My own preference is to have someone who has had business experience in the White House." Buffett on Gingrich's recent surge: "I think Romney hurt himself…losing ground in the past 10 days than Newt gaining. I have watched all the debates, self flagellation here. On both Monday and Thursday, Romney hurt himself. He did not have a good answer on taxes, but it will not be the determining factor on who will be president." Buffett on whether he wishes that more Congressman would stand up to his challenge: "Absolutely. Yes, but it's more than that. What I really admire about Scott, he is dedicated to getting a sensible relationship between revenue and expenses in this country. It is a tough issue to face. He and I in the first five minutes found we were within fractions of a point, virtually. We both feel we could tolerate a small gap between the two, but we know we need more revenues and we have to bring down expenses, and we know it has to be believable. And it has to be attacked right now." Buffett on why it's so difficult to find common ground in Washington: "Neither side wants to move first. The Democrats do not want to talk about talk about expenditures and the Republicans do not want to talk about revenues. They have their own constituencies, they do not want to break ranks with their own comrades. It is human dynamics, but it has to be done. Scott wants to do it, and he wants to do it now. I join him with that." Buffett on whether he's trying to bring common ground to Washington with his challenge: "That was more symbolic. We have a $1.20 trillion deficit. Contributions are not going to make a big difference. I think the American public wants to see a sign of any kind that the members of Congress take this as seriously as they should. It is it is symbolic and it says, we are going to get to work on this. It is not that contributions will amount to anything significant -- but it draws attention to it. The American people want to believe in Congress, but they do not believe in Congress. They see this important issue getting pushed off, each side blaming each other. I do not want to look back at all, I just want to look forward." Rigell on whether he's disappointed that more members of Congress haven't stepped up to Buffett's challenge: "We are headed in the right direction, certainly in the Republican conference, and I hope across both sides of the aisle in recognizing that leaders must step up and we must lead by example." Buffett on expanding his challenge to Wall Street and corporate America: "I would rather just have a policy change. If I have $1.20 trillion to work on -- it would be nice to do it that way, but how many would do it? The press would focus on who did not do it. I do not see that as a way to get to where we need to be. You would see far more that would not do it than would unfortunately…it is more about getting organized. We need to change the law." Rigell on whether he would agree to tax the wealthy more in order to generate more needed revenue for the government: "If there were a comprehensive effort that included expenses going down, reduced to the 19%, 20% for me, I think we would have to look at that."