Cigarbutt

LongHaul, I have looked at this (foreign sub advantage) many times. Perhaps you can look at fig. 9 and 10 of the next link (Yardeni work). http://www.yardeni.com/pub/ppphb.pdf I think foreign profits tend to move margins higher but this does not appear to be a major factor especially since the "Great Recession".

I want to move away from these macro questions but the recent letter by Mr. Bill Gross sways me back to this "problem" with "generationally" high margins. https://www.janus.com/insights/bill-gross-investment-outlook/archive-page What is going on here? Concerning the stagnation concept versus more dominant players around notion, I would tend to side with the stagnation mindset as we are going through an amazingly weak recovery despite unprecedented monetary stimulus that just does not seem to get transmitted to the real economy. I prefer to look at companies at the micro level but there may be an interesting parallel to be made here with real implication for the individual value investors. There are typical stages for a firm. When a firm reaches maturity, it will normally "stagnate" in terms of growth but, despite this, will, initially in that phase, maintain its margins. What is expected after is a collapse BEFORE a new phase. At the aggregate level, since the "recovery" after 2008-9, asset utilization has disconnected (down) from profit margins. see end of document, fig.25 p.13:http://www.yardeni.com/pub/ppphb.pdf This disconnect, I think, point to inflated aggregate margins due to unusually low interest rates and a net declining trend for effective tax rates in the US. Some may refer to this state as a zombie economy. Mr Dimon refers to animal spirits being back in the game. I would submit that this awakening is not likely to come durably from promised lower corporate taxation. My take is that our economy may have reached some kind of maturity. Who knows what comes next? Maybe creative destruction will do its magic. Let's not forget though that destruction is sometimes painful. I certainly don't hope for a deep recession but downturns represent opportunities to move with a cleaner slate.

Interesting. Good links too. In the past, J. Grantham, J. Montier and J. Hussmann have also produced interesting work on this issue. At the aggregate level, there are many moving variables and the link of profit margins may be just a correlation through the Dupont ROE decomposition. The chicken or the egg? I still think though that profit margins are cyclical and present levels don't appear to be sustainable long term, but perhaps we should not hold our breath. I agree that unusually low (suppressed?) interest rates play a fundamental role linking much higher debt/leverage and still lower interest payments on that debt. Despite the apparent dynamism of some sectors (FANGs and others), I submit that we need more competition driven creative destruction. Of course, you don't always get what you need. What's the implication for stock picking? From my perspective, I usually use a long term view with normalized earnings that take into account a more normal competitive landscape in the specific industry where the index firm is operating. By doing so right now, a lot of investment candidates simply become too expensive. I then tend to pass. Missed opportunities maybe?

I’m (slowly) working on a few specific investment posts but keep coming across this question when fishing the bottom sea. An argument could be made in favor of a permanently higher plateau for profit margins. Perhaps I need to be educated here cause I think it is mean reverting and, obviously, the implications are very real. Irving Fisher almost last words had to do with « a permanently high plateau ». We know how that ended. Our mentor, Mr. Warren Buffett has made pretty definite comments about this a few years ago (see link below), but I gather that he may have changed his mind on this? http://www.businessinsider.com/warren-buffett-on-profit-margins-1999-2014-3 Recently, respected sources (like the Semper Augustus letter) have tried to define a rational behind this new paradigm. Many pundits support that hypothesis (on premisses of lower interest rates, lower effective taxes, more mature economy, modern Great Moderation macro achievements etc)… When I hear about new areas, I fret. So perhaps, I need to be educated here. Any thoughts?

I also would mostly agree with the provocative post by Jurgis. One of the great things about value investing is that it is OK (even desirable) to be un-conventional. If you have a strong inner score card, independent thinking can be rewarding (fun and $). Having said that, if you want to be happy, probably better to see value investing as an adjunct. If you manage funds for others, it is hard to succeed using a singular approach, in part because unconventional failure (even temporary) may be hard to swallow for the partners. Perhaps this is a topic for another thread (book review), but I have also a copy of the book "Free Capital" that I keep on my desk. Wildly different lifestyles combined with seemingly divergent value investment styles can lead to similar results. Interesting. Interesting links winjitsu. I would only add that investing, in a way, tends to be simple but it's not easy. Outperformance is the goal. To achieve this goal, we have to be different than the average AND we have to be mostly right. And we need to be constantly adapting to new circumstances. And there is a lot of (uneven) competition. Difficult. Worth the try.

SharperDingaan, Something relevant to add here vs O+G. Interesting comment about cycles. I have kept a part of my portfolio in expect/hope for a short term return towards IV with potential catalysts in cyclical industries. Exposure has varied vs opportunities. Getting better at it but, overall, prefer long term compounders (more relaxing). Looking forward to discuss future distressed opportunities. Anyways. Came to the CDN oil patch late 2015/early 2016. Many challenged angels. Predators too. Picked one, a fulcrum. Followed, to some extent, your 4 principles. This is almost in the bag now and will be a multi-bagger. Mostly because a confluence of factors (factors that should happen but don’t know exactly when they will occur) manifested themselves at the opportune time. Yes, it is surreal that one can benefit from this. I would tend to drift away from your story however with the exploitation label. During a squeeze, the everyman for himself and the devil take the hindmost philosophy may become the norm for the key players who determine the outcome. Because of human nature this investment could have been a zero. I don't like that. A fair process and constant lookout for the best win win solution should remain essential ingredients even if the starting point is desperate. There may be a lot of dark forces out there. Also, I submit that angels may get recycled from predators but they may not be the same person. Thank you for the insights.

I'm new here but I'll pitch in. giofranchi, before committing myself to this forum, I went back many threads/posts. I appreciated your contribution. Perhaps similar to you, English is not my first language and, during my "productive" life, I invested internally generated funds from my incorporated business. I'm pretty much retired now. For reasons that don't belong to this specific thread, I have essentially no long positions now. But I keep looking. Concerning LKQ, I analyzed this some time ago. I will get my file out, update it and plan to provide constructive comments within 1-3 days.

Valuehalla, This may rapidly turn into a circulation discussion. I respect your position. Amen to your last line. If everybody had invested in BRK in 1965, all would be at least a 100x richer ?! One of Mr. Buffett's messages is that a small difference over time can make a big difference. I like snowballs too. Are you aware of the rice bet and chessboard story? If interested, here is a link: http://www.singularitysymposium.com/exponential-growth.html The recurrent compounding that you refer to (gradually increasing difference between BV and IV) is much less than 100% per year. But small differences do matter. With a 2.8% (20.8-19.0) difference of MKT performance vs BV, over 52 years, BRK achieved a return differential of 1,088,276% (1,972,595-884,319)! So, compounding with no end in sight makes me uncomfortable especially without a defined rational basis. I tend to think that trees don't grow to the sky. I hope I did not insult you with my exaggerated example. We're all going after the truth, aren't we?

SharperDingaan, Your example is interesting. In the end, isn't this about opportunistic number crunching? I agree that buyback decisions need to be flexible and contextual. To keep the link with the topic of the thread, my point is that, in some cases, I felt that these decisions did not make financial sense and, maybe, there was something systemic about all this for a typical CEO: What do I do with all this free money? There is no free lunch, a defunct economist said. Who is going to pay? is my question. With all due respect though, your example might not make it in the open. Your example assumes that BV/E = MKT/E. When higher monetary authorities put the price of money on the floor, market participants tend to reach for "attractive" yields and MKT prices tend to levitate. In our present beloved financial nirvana, isn't this what is happening with the prices in infrastructure, REITs and other levered by nature creatures? I submit that it may be hard to do buyback at sensible market prices. Also, your 100% buyback example results in only a 10% increase in total debt, not exactly an earth-shattering event in the capital structure. In many potential opportunities I looked into lately where buyback seemed to become the main game in town, the increase in leverage became incredibly high and entirely easy money context specific. This thread is about hibernation but I have a feeling that, at some point, this will become a recurring topic when discussing specific securities. I mentioned that buybacks at sensible prices without excessive debt can make a lot of sense. The present easy money era may present a window opportunity with a very short payback for some. When/if the tide recedes, we may find out that some others should have kept their suits on. I may be wrong but I am in a pretty good spot to watch, just in case. By the way SD, I looked back some threads/posts. In my life, despite very real limitations, I have been able to spot brighter and better people. It has made a huge difference for me. I realize that, if there are more face-offs, I'll try to step up my game.

cmlber, I think we may leave it at that for now. Price is what you pay and value is what you get. Price is easy, it appears as a precise number in your liabilities. Value is in the eye of the beholder. Opinions vary here. This is what makes it fun. Isn't it? Maybe, we can reopen the discussion in the future with a specific case. Good luck.

Valuehalla, Fair enough.

cmlber, First of all, if you don't agree with my personal hibernation hypothesis, that's fine. But, I would like to take that discussion further. What works for you may not be what works for me and vice-versa. Let's learn and improve here. My hurdle rate for the last 15 years has been 15%. I have achieved this over time despite keeping almost always (except 2009-2011 when I was about 125% invested long in stocks) a large cash balance. I am trying to figure out, with your help maybe, how I could, over time, reduce cash balance and improve returns without sacrificing margin of safety. Remember, to have results above average, there are two steps: you have to be different from the average AND you have to be right. Also, my universe is relatively small. I just want to broaden my sandbox. Your points are valid. A lot of data point to (at least in N.A.) a dearth of reinvestment opportunities for firms. Companies and management need to adapt to the financial market environment. Especially with the institutional imperative, it must be very hard for entrepreneurial CEOs to let cash accumulate. Also, I agree that, in the end, stock buyback is simply a capital allocation decision. In addition, in the past, I can remember a few occasions where I passed on a rewarding (not for me in these cases) opportunity because of my possible inability to adjust my hurdle rate to the new environment and realizing many years after that the stock return was in fact largely attributable to sound stock buyback by management. Ouch! Having said that, specifically, concerning the "selected few" that I analyzed and in which I was ready to put 20-30% of my portfolio, the problem I had was related to the extent of the debt issued (bringing coverage ratios to off the chart territories) and the price paid (P/IV) for the buyback. We all have to do our homeworks, but in many instances, I find that companies tend to pay a (very) high price. In the cases I digged into, I estimated the P/IV to be a lot more than 2 (often more than 3). This was/is a source of dissonance as, otherwise, management had shown tremendous capital allocation capabilities. In my humble opinion, for many of the buybacks happening now (seems like a mirror image of corporate debt expansion), companies pay too high a price, increase debt ++ in a period of unusually low interest rates and good times and tremendously reduce financial flexibility going forward. That was quite certainly the case in the few cases that I looked into deeply and suggest that there may be something more systemic about this phenomenon. If you identify firms which do the buybacks soundly from the capital allocation point of view, that's fine with me obviously. Maybe, you could share one or some of those examples. In the end, I think that an endpoint for the price paid may be useful. For our friend, Mr. Buffett, his own endpoint is at 1.2 to stated BRK book value (which includes some intangibles). I would tend to use a similar endpoint with adjustments for specific companies. Basically, I submit that a buyback at a ratio of 2 or more of P/IV (not stated book value) is suspect especially if excessive (even the low price kind) debt is used. What do you think?

Yes, Mr. Buffett comes out and he seems to say that stock prices are fairly valued now in large part due to present low interest rates. It is fair to assume here that, for his capital allocation decisions, he uses a satisfactory hurdle rate with a margin of safety. That creates cognitive dissonance for me and I’m struggling with that. Before I change/adapt, I have to understand though. Thanks for the challenge. Again, I don’t intend to drift this thread to the general levels of interest rates vs valuation of markets in general, but I will expand on a specific aspect of this (firm’s cost of capital for debt versus stock buyback decision) with my next post, as an attempt to answer cmlber.

Agree that the potential for IV growth remains favorable and likely. Perhaps an unknown is how Mr. Market may react short term. We know that long term, both will tend to gravitate together, more or less.

I am not into reading tea leaves. Please don’t extrapolate too much my post. My post has to do with a context and certain comments. CONTEXT (my take, for what it’s worth) -WB’s messages are often cryptic and subject to interpretation. -He is not known to telegraph his moves if that may cause competition. -However, he has historically talked about the possibility of share buybacks. -He has always shown ability to adapt. -He has commented, in the past, very positively on Teledyne’s (Henry Singleton as CEO) abilty to radically change strategy on capital allocation (use of stock as currency versus massive share buybacks). -BRK has grown massive. In some ways, it has become mature. Looking at the numbers for a relatively long time, it has not done better that the general market levels. -However, in the future, it may continue to produce « decent » results, and, in a more difficult environment, it may make sense to buy back++. Shooting for the elephant may then mean to significantly shrink the equity base. COMMENTS -For the first time so clearly said, WB mentions that his own huge portfolio of securities is potentially for sale. Where would he deploy all this cash? -This year, he discusses the topic of buyback again and mentions that he does not agree that it is un-American. -Specifically, he says : « Still, market circumstances could create a situation in which repurchases would benefit both continuing and exiting shareholders. If so, we will be ready to act. »

scorpioncapital, Thank you for your thoughtful post and link. I don't want to spend to much time on the general level of interest rates and this may be an idea for another thread for those interested, but here are a few potentially relevant comments. Mr. Buffett in the 1970's elegantly showed that, despite the high interest rates prevailing then and despite the institutional inclination to hold bonds, the best long term bet was on stocks. I think that, looking at his long term track record since then, most would agree that he had a point. However many have showed with math and graphs that, with a starting point around 1980 to now (ie starting point with very high interest rates), investors in long term government bonds did better than stock indexers. !? Like many investment macro topics, there are many many variables to consider. The direction or trend of interest rates is perhaps more important than the level itself. Also, right now, one may say that interest rates are suppressed (some say manipulated). How will this play out? I simply don't know. But I don't like it. For instance, not unlike thefatbabboon, in the last few years, I have uncovered only a few interesting ideas (even less relatively speaking). Illustrating how low interest rates entered into my decision process, many of the opportunities I spotted were owner-operator led type of growing businesses with enduring moat. Progressing through the 10-Ks and as IV value was crystallizing, ending up with the last couple of years, many of those selected few started to incur very significant debt (at extra low rates for now) in order to essentially buyback their own shares (at an already massive premium to book value) in order "to return funds to shareholders". Because of low interest rates, I felt that the companies literally destroyed value that had taken years to build. Only this is not visible yet. So, interest rates don't matter to me that much in terms of the overall landscape. It disturbs me though when it annihilates capital allocation rationality.

Jurgis, I am reviewing your post. I can't find ARMHY. Another symbol? Thanks

Studying mistakes is hard, painful but essential. I have made a lot of errors of omission (sucking my thumb). Perhaps too selective. I have bought stocks which I thought had value in a declining markets ie became value traps. The most painful one was the purchase (very early on, it is when perhaps it is the most important to remember rule # 1) of a relatively small furniture manufacturer (Amisco). When I studied the industry dynamics, failed to see the lasting competitive advantage of Chines manufacturers. Was slow to react. What is even more irritating is that I fell into a similar trap with Supremex after, a leading CDN envelope manufacturer. Underestimated the declining trends and did not get the timing right. Ended up with dividend gains pretty much cancelling a capital loss. But the opportunity cost was real. As far as your specific pick, I can be of no help. I have absolutely no valuable insight for FB. Good luck.

I’m new here and already ready to duel! Sorry longinvestor and Valuehalla, I disagree here. In a way, this is a relatively minor point because, as value investors, we have to come up with a range of intrinsic values for an investment but a P/B ratio is useful and the way to come to « adjusted » ratios is important. Let’s dissect this. You seem to imply that, using BRK as a reference, P/B will significantly rise over time. Mr. Buffett’s comments seem to imply this also. He explains the disconnect between devaluations which need to be recognized and revaluations which are not, at the controlled subsidiary level. True but, with all due respect, I think that this « disconnect » or « overage » is much much smaller than is implied here. Here’s my take. Apologies, I cannot be clear and concise like Munger_Disciple but I hope to improve. For the « first half », it is said that book value approximated the value of marketable securities which were marked to market. Isn’t it common acceptance that Mr. Buffets holdings then were under-valued or at least fairly valued by the markets? My understanding is that Mr. Buffett’s record did not happen because of his tendency to buy and hold over-valued securities. Implying then that the capacity to build a portfolio of undervalued securities warrants perhaps some kind of premium to BV. That notion points in the opposite direction of a « disconnect » for the « first half ». More importantly though, the notion of goodwill (recognized or not) means that the earning power is superior to stated tangible book value. For the superior subsidiary itself, overtime, the gap between its book value and reported earnings clearly get « disconnected » and gets wider with time. See’s was a spectacular example of that. However, this unrecognized earning power, over time, will get recognized by the entity controlling the subsidiary, ie BRK. The extra cash is sent to the head office. Remember BRK’s equity is largely retained earnings. They have not distributed dividends. They have never bought back stock at a high premium and when they issued stock, WB and CM always underlined that they aimed to issue at around fair value. Of course, if you use this extra cash to buy other assets that are undervalued, there will be a tendency (especially if you pay less than IV) for the gap to grow, to some and limited extent, but, like a growing deferred depreciation liability, it will have an underlying tendency to reverse. I would submit also that, over time and perhaps especially for the more recent period, BRK purchased acquisitions by paying at least a moderate amount of goodwill/intangibles (think PCC, Duracell and others). What are the numbers saying? Let’s compare the CAGR (geometric) of BV vs IV for two periods : The non « disconnect » period from 1965 to 1990 BV 23.1% MV 28.7% The « disconnect » period from 1991 to 2016 BV 15.3% MV 13.7% The numbers suggest actually the opposite ie the disconnect, as recognized by the market for BRK shares, was more important when BRK was putting more emphasis on securities versus outright purchases. (!) My take is that over time growth in BV for BRK should approximate closely growth in IV (as measured by the market or by more objective measures of IV over long periods of time). What Mr. Buffett describes is a very interesting concept and, at the margin, may create an unrecognized premium but, as the above reasoning and calculations above show, I submit that this effect is small and not significant for instance in relation to Mr. Market’s expectations. In my humble opinion, the first 26 years were characterized by the Mr. Market’s recognition of the potential for BRK to continue to compound at a high rate, whereas, the last 26 years (especially since 2000) were characterized by lower expectations because, among others, of the sheer size that BRK reached. With all due respect, I submit that, for BRK, it may not be reasonable to expect a widening gap between book value and price on a ratio basis. It is interesting to note that, if this notion of a widening gap would apply, BRK’s policy of stock buyback at progressively higher P/B ratios has never been documented or discussed.

scorpion capital, Thank you for the insight. I wonder if there is such a strong link between general valuation levels and so called risk-free interest rates. To tie in with a concept shared by SharperDingaan, some solid investments were sold in the recovery after the GR in order to get rid of investment leverage which I don't use generally and which I don't plan to use anymore. The key for me is not really the general valuation levels but the fact that, in my own limited universe, I just don't see compelling opportunities. Hopefully, in this forum, I can help uncover some and be assisted by others on this forum in doing so.

The message of being ready, just in case, has been a recurrent one. Even after all this time and with the investment landscape constantly changing, I really admire how Mr. Buffett kept key concepts intact while, at the same time, adapting to the environment. He still does that even as he is probably getting ready to pass the baton. For instance, some comments in the letter opens the possibility, I think, of large scale stock buybacks over time. Things change after all and BRK has become a mature kind of blue chip in some ways. Perhaps, one of the possibilities going forward to increase the IV per share may be to shrink significantly the equity base.

Yes, that's the right link. Indeed, one has to go further than the headlines. As the article mentions and similar to what Gregmal alludes to above: "you never know what will happen next". There are two sides to a coin.

Media headlines from the last few days: “The longest winning streak in decades is annihilating bears”, “America: confident and consuming”, “9 reasons the stock market is optimistic about 2017”, “Animal spirits are back”, and “Around the world, confidence is on the rise”, “Euphoria returns to markets” and “The case for Dow 30,000 in Trump's first term”. These days, overall, the story line seems to be so good…Can it get any better? Even significant net losses on investments can arise “as a result of fundamental changes in the U.S. in the fourth quarter that may bolster economic growth and business development in the future”…In his last letter, Mr. Buffett supplies us with his usual long term justified common sense optimism. Despite all that, it’s time to go back to my lair. This is my first post. It will run longer because of that and will serve as an introduction. I still prefer to read (and write on) printed financial reports and involvement in investment blogs is very recent. A few weeks ago, I started posting on the Stockhouse board…Interesting but, apart from intermittent nuggets, it was mostly useful to assess the playing field. Choose your opponents, some say. By chance, I came across this site. Over time, I have become a regular visitor and now feel I can prospectively contribute punctually. I have looked back many threads. My postings will probably mirror my investing style with periods of intense activity and focus interspersed by very long periods of apparent sleep. Like most, I really respect Mr. Buffett as an investor. My investment decisions though are more Graham-like in good times and more Fisher-like in tough times. Unconventional and contrarian I am and that suits me fine. Investing occupies a part of my free time which has grown at a comfortable rate in the last 15 to 20 years. Like many on this board, I really like the idea of compounding over long periods. Lumpy returns are OK. My strengths are overshadowed by weaknesses and biases but, I keep learning and, over the years, I have been able to opportunistically apply unrecognized simplicities of effective action. Investment results have allowed me to pretty much retire in my early 40’s. I tend to choose very selectively. I dig bottom-up but try to appreciate the context. I happened to be on the right side of the trades before and after the 2008-2009 episode. Perhaps, that nourished an overconfidence bias. Have been mostly selling since then (way too early, it seems, in certain cases). These days, I feel pretty much like during the months following my sale of Nortel in 1999 at around 36$ on the way up ie I felt like I was missing all the fun. Investment is truly fascinating. I find that many investing ideas on this forum are outside my circle of competence which remains patchy. Also, right now, I really don’t see value in the stocks that I follow and elsewhere, apart from the occasional cigar-butt. The stocks that I follow (the potential long term compounder type) would need to go down by at least 50% before I would start to get excited… Maybe, I just need to retire? Recently, I even sold my core positions. My only “long” position now is a debenture in liquidation that is about to enter the last stretch (claims process). Last year, I sold all my holdings in Fairfax... This was pretty much a permanent holding and yes, I am turning my back against one of my mentors. Ouch! This is a Corner of Berkshire and Fairfax Board after all and, reluctantly, for the first time in 20 years, I will read the annual report from the other side of the fence. Interesting time, isn’t it? This presidential volte-face is and will remain a nagging and perplexing head-scratcher… It would then seem to be an inopportune time to get involved in an investment forum, especially this one. I accept that others do well even if I don’t. From my perspective however, I doubt that this time is different and suspect/hope that I’ll eventually spread my wings again as the pendulum swings. Sometimes the wildness lies in wait. I may be just out of step and inappropriate anti-conformism may prevent me from embracing the present market environment but, for now, I feel comfortable waiving potential future returns. Unless convinced otherwise, I will watch from the sidelines, play defense and carry on my unspectacular preparation. Oh well, some of you may see Cassandra here. But, reflecting on this Greek mythology tragedy, I submit that, in the end, the tragedy is that Cassandra was right. In no way, do I know the future. It’s just that now does not feel right. The primary driver here is the absence of options in my opportunity set. I understand and concur with Mr. Buffett’s optimism but, now, I’m also kind of worried about the “short interruptions” that can happen from “time to time”. This site appears to overall provide a constructive forum that allows respectful collisions of ideas. We’ll see. By the way, looking back at various threads, I was impressed for instance by the thread on Canadian preferred shares especially concerning the Aimia preferreds. This was especially frustrating since I had extensively analyzed the company on my own concurrently and decided to pass, not noticing and taking into account the significant value proposition that Mr. Market specifically offered for the preferreds. Very rarely, investing is simple AND easy. This was a big miss as this was going right up my alley and I had significant dry powder to use. Error of omission. I have been impressed by many other posters as well. Long term, I am looking forward to participate in investment ideas/themes posts. GLTA.