twacowfca

Shiller's latest calculation of the S&P500's PE10 after the recent unpleasantness in the market is 19.39. :)

Or is it? Take a closer look at the Shiller graph. It's based on a PE10, not a current, forward PE. The last time I checked the PE10 was about 23. With the recent decline, it should be between 19 and 20. The graph shows the midpoint of future gains over the next twenty years to be about 2% to 3% per annum when the PE10 is at that level.

There have been eight steep declines in the US stock market of sixteen percent or more in a short period of time since 1928 like the current pullback, according to Bespoke Investment Group. All of these have been followed by additional declines, averaging seventeen percent deeper losses. :o

Blessings!

Thank you for posting. Good article.

Hester you're kidding right? Maybe he has long term plans and will wait for the dinosaur bones to turn into fossil fuel. Coprolites anyone?

Thanks, Fan. As it happened, in the 1980's we were looking for a software product to sell using our A+ direct marketing skills at the same time Cook was trying to see how he could sell his accounting software through direct marketing. We never connected. At that time our company was about ten times the size of Intuit. Today, intuit is about fifty times as big as our core business minus the investing is. Guess he didn't need us as much as we needed him. ::)

Fairfax is the only thing we've bought recently with the exception of our arbitrage in TRH. :)

Touche! Studies have shown that the US economy has done best when Congress was stalemated with control divided between the two parties. :o

That's amazing! Thanks, Sanjeev.

There are other great owner operated companies, of course, but it's rare that we can buy them at a great price compared to IV. Owner operated companies generally outperform the market by a very large amount. On average about 80 of the S&P500 firms are owner operated. These account for about half the real returns of that index over a long period of time. When one can find a great one at a good price, the outperformance is awesome! :)

Very thoughtful questions. I don't think our strategy is particularly courageous, but risk averse. We had a lot of cash before the recent sell off by design as the psychological inflection point of the end of QE2 approached. The TRH trade presented as the market was about to bounce. The trade appeared to have a better risk/reward than playing the bounce. If the trade goes against us, we probably won't be much worse off than if we had been fully invested going into summer. If the trade works out well, we have a pegged price with protection against another step down in the market, and we could exit the trade with little or no transaction haircut before the terminal date and use funds to pick up any compelling bargains that may present. My take on risk is very different than the conventional view. At one time or another, we've had more than 40% of assets in FFH, BRK and LRE. These are all run by ethical men who are about the best of class in what they do with very long term records to prove it. They have most of their wealth tied up in the companies they run. Two of these companies are acyclical or contracyclical and actually saw their market price go up during the 08 to 09 market meltdown. This was a better outcome than most diversified portfolios experienced. With most of our assets invested in these owner operated companies, and the occasional special situation like TRH, we have done remarkably well in the value of all accounts from the market peak in 07. Friends and family accounts are the most difficult, but there is much goodwill there after the excellent returns over the years. My sister, especially doesn't like hairy situations, but doesn't mind having almost all her funds in LRE, FFH or BRK. :)

Excellent points. I remember listening to Sellers tell about how he was using Kelly to have these huge allocations to Contango, and I remember thinking how blind he is to risk as his main allocation was to a cyclical stock at the peak of the market. But the truth is that we all have our blind spots. That's why it's good to see if others can poke holes in our enthusiasms. I shared your view about DIMEQ's probability of working out favorably until I asked our securities lawyer to take a look at it. He told me that it was a crap shoot because the Judge didn't understand the arguments. He said that an appeals court probably would understand the merits of the LTW holders' argument, but they would probably uphold the Bankruptcy judge's decision. Since then, he thinks the judge is starting to understand the argument better, but he still realizes that there are so many variables that it's hard to make a prediction. As a result of his feedback, we cut our probability estimate down from .80 to .60. Since then, our estimate has been creeping back up because it is becoming more and more apparent to the WAMU BOD that they have major liability for shafting the LTW holders. This is how we use Kelly. We continually recalculate the probabilities as new information surfaces. Our allocation to TRH is almost all of our cash, but only about 40% of our total portfolio value. As such, it's about a half Kelly as calculated with estimated probabilities and odds. This would be way too high if I were running a fund because investors could get spooked and redeem their funds. One reason I'm OK with this amount is that the downside volatility seems to have a practical limit of about 20% to 30%. This would be only a 12% drawdown in total capital. That's less than half what we're up this year to date. I'm OK with this risk, and friends and family are too as we've had highly positive absolute returns over several years.

"The moment Sancho talks him into believing that the uncouth peasant girl is Dulcinea under a spell, he loses his freedom to depict her in his imagination as he pleases." _ Harold Bloom

Imagine you live in a city that has a notorious red light district with 200 "ladies of the evening". Thirty of these have been convicted of robbing their clients. A friend takes up with one of these fine ladies and declares that his true love is nothing of the sort and entrusts large sums of money to his Dulcinea. Would you remain silent about your friend's blindness?

Nope, I never go short except rarely on an arbitrage. It's disgusting to see something that has fraud written all over it being touted over and over again on our board after good advice that the thread should be dropped.

How do you explain the satellite photos taken at the expense of one of our board members showing the phony Potempkin Village of what was supposed to be their main operations?

If a tree falls in a forest and there is no one there to hear it, does it count?

I am not recommending buying this stock, so I do not really care if the growth will continue. My point is that this is a very typical case where a 10-bagger was born in a lousy industry. This company succeeded by inventing a whole different set of products catering to SMEs. The result is astounding. I have heard hundreds of time management talking about differentiation. But it is to hard to believe them, just like M2. How could anybody reselling telecommunications service differentiates itself? M2 did it. You may argue other larger competitors can copy its products and crash it. But M2 has done this successfully over the last 10 years. I believe reading into history is the best way to learn about the future. M2 offers a great case study(and free!) to give you insights about how a small company in a commodity business can succeed. At least for me, this lesson is priceless! How did they do it? Thanks for sharing!

Leverage multiplies risk. Not a good thing for lowering risk, unless it means replacing owned shares with leaps and putting the cash difference into something secure. :) Owning leaps on a great company is far less risky than the situation where the leverage is internal, within the company That situation is analogous to owning stocks in an account that is heavily margined. Lots of things can go wrong. Quantifying probabilities is imperfect, but necessary. The key determinant is the upside/downside probability. Look at all factors that might bear on that estimation. For example, after considering all known key factors, I estimate conservatively .90 probability that the Transatlantic Holdings risk arbitrage described on another thread will work out favorably. Next, I estimate the payout odds as 1:1, meaning that a favorable outcome would have about the same gain as would be the loss for an unfavorable outcome. This estimation is also conservative because there are three bidders for TRH, and this means that there are multiple layers of downside protection. The low P/B of the target and the fact that it is a good business that holds liquid assets and isn't highly leveraged offers additional downside protection. Finally, I go to albionresearch.com and use their Kelly calculator and discover that 80% of my capital is the optimal full Kelly bet. Of course, I'm not going to use a full Kelly, but I'm comfortable using a one fourth to a one half Kelly because I think my estimates are conservative, and I think my realistic downside volatility limit is about 20% to 30% of the funds I put at risk because IPC never sold off that much despite the market turmoil when they were a target a few years ago. :)

The probability of a highly leveraged company working out well is far less than with a company with little or no leverage for many reasons. The main reason is that hitting a speed bump can be fatal to a highly leveraged company. Experiencing any difficulty can cause the screws to be tightened, sending the leveraged company into survival mode. The only time having lots of leverage might make sense is when a business has a great moat or is firing on all cylinders with the wind beneath their wings. Otherwise, lots of leverage merely multiplies the problems.

Leverage multiplies risk. Not a good thing for lowering risk, unless it means replacing owned shares with leaps and putting the cash difference into something secure. :) Owning leaps on a great company is far less risky than the situation where the leverage is internal, within the company That situation is analogous to owning stocks in an account that is heavily margined. Lots of things can go wrong.

The most important idea is to size the positions in your portfolio by risk/reward rather than by arbitrary proportions or other means. It's important to realize that you can lose a lot of money by using a full Kelly. With a full Kelly you have a 50% chance of a 50% drawdown below the initial value, but only a 25% chance of a 50% drawdown using half Kelly position sizing. Interestingly, with a full Kelly, you have a 1% probability of a 99% drawdown. Even half Kelly sizing is too volatile for most risk adverse people, especially in view of the fact that low risk/high reward situations are rare, and it's not likely to be able to keep rolling the dice until your number comes up. The most important aspect of risk/reward when using The Kelly Criterion is the risk part. In other words, when sizing positions, the probability of a successful outcome should be the main focus, not the expected value of the peceived percentage gain on what you have at risk. :)

It's a great book. As mentioned on another thread, don't let the math scare you. Go to Thorp's essays and read around any of the proofs you don't understand. Thorp's comments are written in plain language and are well worth the price of the book. :)

Alpha has been a statistics term before it became a financial buzzword. It is a zero sum game in the statistical sense.