ERICOPOLY

Yes, simply because I said the word "leverage". People automatically assume options are used for leverage, but often not. You might simply have a position that's grown too large after a run-up but you don't want to pay taxes the entire gain. So you buy puts on it and write puts on something else. You're both writing and buying puts, but did you increase your risk? You have diversified your downside, but you still have the concentrated upside where perhaps you have more conviction.

From the conference call recently -- it's interesting that share buybacks are part of their "motto". They clearly prefer it over dividends, which is great given where the stock is at right now. And they will surely be heading down that road hand over fist given the fact that they've laid out a 2014 earnings target that requires 12% compounding growth in EPS. Right now they get approximately 14% growth in EPS on every dollar of earnings spent on their own shares (perhaps buybacks are the most explicit example of value being it's own catalyst, the deeper the value the greater the catalyst). The DOW doesn't return 14% long term, so let's see how long this lasts. I don't even think the DOW has returned 10% long term, which would imply a 50% gain from here by next year. Ben Reitzes - Barclays: Leo, you recently laid out $7 earnings figure for 2014. After doing $5 this year, I think it takes 12% EPS growth each year to get there. So, my question is, can you still get there based on what we heard today and how? Then I just was hoping Cathie to clarify the near-term guidance. It seems like the cut for 3Q versus the Street is two-third services, one-third Japan and consumer. I just wanted to clarify that? Leo Apotheker - President and CEO: So, let me answer your question first. We are making tough decisions today to set us up for the future, and in the long term, we have multiple levels to drive our EPS growth, but investments we're making today will help create sustainable growth, including sustainable EPS growth. We are focused on an improved business mix and continued operational excellence including a better mix in each one of our businesses. For example, in services, as demonstrated by today's public decision, our long-term motto is to grow operating profit faster than revenue and EPS faster than operating profit. So, yes, I can confirm that we are maintaining our $7 EPS.

The same argument as goes for puts. Calls just have an embedded put. One can use puts for leveraging a short position, and that's risky, or one can use them for hedging a long position, and that's not risky. Right now the embedded puts in calls are really cheap. I suppose a foreign investor may want to keep their money in the bank earning 6% interest rates, and not take on USD risk. I think if you were Australian and had $20 per share cash in the bank, you could sleep better holding the $20 calls knowing that USD erosion won't erase your returns. Meanwhile your 6+% yield on that cash will be safe and earning back what the embedded put cost you. You miss out on the dividend in the event of the stock going up -- nothing is free but that makes for a fairly cheap hedge against market panic and currency risk. On the other hand, if the stock goes down early in the life of that option the value of that embedded put rises.

The options do have more downside protection (if that matters for anything with the stock at this level).

Some of those houses may have already been underwater (in the mortgage sense) even before the floods hit. Given that hardly anyone carries flood insurance, I figure the banks and other mortgage holders take a big hit here right? I mean, who is going to repay the mortgage at that point if the house is destroyed, whether previously underwater or not. I suppose I'm assuming the house is completely ruined, which may not be the case at all.

They are literally giving away XBox360 consoles now to students (gift with purchase of PC).

I had 7/8 of my paper net worth evaporate (employee options). It was over a half million in losses... I was 28. I thought I had a few bad days. Damn havent been there yet. Did it change the way you look at losses, gains, and investing. Thats nuts, not sure what I would do. I was wondering why you had the Judges name on recall. Sure, I jumped right into real estate like everyone else. That's where I got the bulk of the money for the FFH calls in 2006 (I tapped home equity and used proceeds from selling a rental). This was my line of reasoning: Seattle's high jobless rate after the tech bust kept a lid on real estate despite the low interest rates that were driving prices up all over the country. I speculated that the price increases would spread to Seattle once the job market recovered, and that's what happened. The lenders liked my income -- leverage was cheap and plentiful. Around 2003/2004 I read a little bit about Warren Buffett and he mentioned The Intelligent Investor. So I read that one and soon found Fairfax, I liked how in the early letters Prem described the company investment philosophy as based on Ben Graham, so I bought some shares. Then I went looking for more info and found the MSN Berkshire Board. There I learned much more about Fairfax. Meanwhile I started chatting at work with a guy named Yu, and he soon joined the MSN Board and started discussing the call options. He got me interested in the call options (explained to me how they worked). So soon we were both loaded up to the hilt and we were both able to leave our jobs after that. And of course as soon as I left my job the financial crisis hit with full force. So it's like I can't catch a break from volatility. I have financial PTSD.

I had 7/8 of my paper net worth evaporate (employee options). It was over a half million in losses... I was 28.

I whittled down my initial list of tech large cap to those three, after first getting excited about a much larger bunch of them. I like GOOG and APPLE, but they need to double if not triple earnings just to get to where HPQ is today. I'd rather already be there.

IIRC, the catalyst was actually the outcome of Microsoft's antitrust case. The bubble burst coincided with a federal court decision that MSFT a monopoly. I don't think that piece of trivia is particularly useful in predicting the future, though. Don't they say "value is its own catalyst"? I think the same goes for overvaluation. I remember that day well. The valuations unraveled quickly after Judge Penfield Jackson ruled to break up the company.

GMO made a study recently and concluded that small to mid caps are wildly overvalued. I have in the money puts on IWM. I figure I'll make money both on my large cap positions as well as on that hedge. MSFT, DELL, HPQ -- the P/E are 1/2 of that index.

I have a theory backed by nothing but suspicion: Large cap tech is doing poorly because tech fund managers are chasing the small cap "cloud" stocks. I suppose it's a matter of waiting for them to find those valuations too scary before they come back to large caps. Meanwhile, the large cap stocks are growing EPS at a faster pace due to the share buybacks (this will in turn perhaps be the catalyst to beat EPS targets).

I found a site with some Japan trivia -- however I can't say if their data is accurate. First thing I notice is that their population only gained 4% during the entire 22 years since 1989! Talk about a lack of a tailwind in consumer demand. Does the US have this problem? http://www.tradingeconomics.com/japan/population Their exports have doubled since 1989. http://www.tradingeconomics.com/japan/exports Their unemployment rate since 1989 peaked at 5.5% and has since come down to 4.5%. It's about double today from where it started out at around 2.3%. http://www.tradingeconomics.com/japan/unemployment-rate Why is it that it takes them about 8 years after their crash before their unemployment rate rises even 100 bps? Does it take 3 workers to screw in a lightbulb, and do they never get fired when profitability suffers? Any cultural difference here in the US with regards to cutting staff in the face of slackened demand? GDP per capita has doubled (purchasing power parity): http://www.tradingeconomics.com/japan/gdp-per-capita-ppp GDP growth rate adjusted for inflation: http://www.tradingeconomics.com/japan/gdp-growth GDP per capita constant prices gained roughly 27%: http://www.tradingeconomics.com/japan/gdp-per-capita This data here shows a very small amount of deflation -- prior to 2009 it had always been less than 1% annualized, normally barely above 0%. It leaves me to wonder if their prices would have held up better with US population growth rates -- with an extra 20% more people due to population growth, any impact on consumer prices? Would production have needed to expand more to meet the rising consumer needs? US population has grown about 25% vs Japan's 4%. http://www.rateinflation.com/inflation-rate/japan-historical-inflation-rate.php?form=jpnir I found a US GDP per capita PPP data source, and it looks like from 2000 through 2009 the US and Japan growth rates are the same: http://www.tradingeconomics.com/japan/gdp-per-capita-ppp

The rate of inflation is much lower (all we really care about are real returns). I believe the low P/E in early 1980s was a result of not only high inflation, but the risk-free alternative yield being very, very high made stocks look less attractive until earnings yields went up as P/E compressed. I guess what I'm saying is the comparison is not a good one to today. Except it's a reminder that should we get high inflation and high interest rates, then the market can go down 1/2, even without a hit to profitability. Although, I'm already at 7x P/E in some of my holdings, so a large comfort margin and much cheaper than 1980 in terms of real earnings yield.

I was watching the David Herro interview on Wealthtrack a few minutes ago. He says that before the recent earthquake in Japan, their market was trading below book value and at 8x cash flow. Regarding below normal profit margins: According to what I can find, Japan's market might trade at 1/2 that of the US right now, on a price/sales basis (at least based on their relatively few example provided in this article): http://news.businessweek.com/article.asp?documentKey=1376-LIA1DS1A74E901-4LRJN3S7NRVB4U9LDB6AQ1SBJ5

That what I thought too but why did Fairfax lose money in Australia's flooding?

This strategy makes sense if you are afraid of USD currency exposure as you point out. Otherwise, instead of writing the put it is simpler to just ditch the calls and buy the stock directly. The advantage here is that you won't have to pay tax on the put when it expires (and perhaps you wind up owning the shares longer than initially thought).

The Japanese stock market in 1989, I've read, was at a P/E of 65x, and (I'm guessing) the businesses heavily reliant on sales within Japan have suffered the most. Starting at a high P/E of 65x is hard -- it was going to fall 75% due to mean reversion alone, and that kind of decline brings the market down to a P/E of 16.25x. From there profitability likely fell apart, explaining why it's absorbed 20 years of earnings. Anyhow, to compare Japan to the US market today, we're already at that collapsed level of P/E in the teens -- the risks now would be the collapse in earnings and, can you avoid it by sticking to the multinationals? Even if the Japanese market had started at 16x PE in 1989 (i.e at 10,000 instead of 40,000), the market today would still be only about the same level as it was >20 years ago. I agree. I pointed out that the market (adjusted for valuation premium) being flat for 20 years in Japan must have been due to collapse in earnings. Unless the Nikkei market index doesn't include paid dividends, but I'm assuming it does include them. I'm not ruling it out either, but I wonder if our market with over 40% of it's revenues in international markets is as vulnerable as Japan's. Is our index better diversified by geography? I have no idea -- for some reason the guru's don't care enough to find out either (I've never heard them mention it). I've spent a lot of time on Google/Bing trying to find any mention of it, hopefully somebody else can do better. Right, you are being more fair by picking a better entry valuation (however still historically quite high), but you've cherry picked a terminal point with a historically low terminal valuation. And in the 1965 the market P/E was about 23. So between 1965 and 1980, the market premium on earnings declined by nearly 2/3 -- not quite as big as the Nikkei valuation adjustment, but impressive nonetheless. I think if you had picked 1966 and 1982 as the terminal points you might see a Nikkei sized premium adjustment.

I want to hear what actually happened to Japanese earnings during this period, vs what the stock market did. How did a focus on Japanese listed stocks perform where no more than 25% of sales were on the Japanese mainland -- would that have done far better than a focus on stocks where 100% of sales were on the mainland? Did one suffer 75% losses over the past 20 years if one had bought multinationals with P/E of 7-12 and only 25% of sales in Japan? That was rhetorical, we know the answer to that one. The Japanese stock market in 1989, I've read, was at a P/E of 65x, and (I'm guessing) the businesses heavily reliant on sales within Japan have suffered the most. Starting at a high P/E of 65x is hard -- it was going to fall 75% due to mean reversion alone, and that kind of decline brings the market down to a P/E of 16.25x. From there profitability likely fell apart, explaining why it's absorbed 20 years of earnings. Anyhow, to compare Japan to the US market today, we're already at that collapsed level of P/E in the teens -- the risks now would be the collapse in earnings and, can you avoid it by sticking to the multinationals?

Quoting from the 2010 annual letter: In 2011, we will set a new record for capital spending – $8 billion – and spend all of the $2 billion increase in the United States. A housing recovery will probably begin within a year or so. Watsa also thinks his stocks like JNJ, WFC will increase significantly in value over the coming years (it says so right there in the annual reports). He is just pessimistic about the market as a whole.

I'm saying that if you get cap rates of 10% today, then it's a good investment. This is way above the long term mean, so it's a value investment. Doesn't matter to me whether you live in it yourself or rent it out.

That's not very instructive to use bubble prices for examples. Every asset has been through a bubble -- all of them. How about buying FFH at it's valuation peak in the late 1990s? Does that lead to any meaningful conclusion as to it's merits as an investment today? It traded on April 14, 1998 -- for $600 CDN. Today, 13 years later, you're still left wondering how much longer you need to hold it just to get back to break even. Had somebody bought at 10% cap rate at the top of the real estate market in 2006 they would have largely already recovered any lost "wealth" through cash flow. The trouble of course is that real estate deals with 10% cap rates were not available in 2006.

I am facing exhaustion. Last 10 years have been something else -- 50% drop in .com collapse, 50% drop in credit crisis. Will the markets really go down 50% for the third time in 15 years? Aside from including the Depression, there has been no other period like it in the past 100. It's like people are always talking about the next collapse around the corner, and then there is one! Why does this have to keep happening to us? At this pace there just may be 20 yr olds in the coming years ahead who will be able to say the market was higher back when they were born.

I think it was like 0.65x book value though. That kind of deal is a no-brainer -- roughly a 54% tax-free return.

Take a look at the market P/E in the early 1980s.