txitxo

In Physics we appreciate mathematical elegance. Economics papers usually look ugly as hell to me. Every time I read one I get the impression that you could have obtained the same results using a much simpler approach. This paper in particular does so many things to the inputs, that at the end, I don't know whether they truly found an effect or they just contorted the poor data into producing one. In any case here is a much simple experiment. The guys at gurufocus have created a portfolio which gathers the most weighted holdings of "gurus", most of which are value investors. These guys obviously haven't made their names by being closet trackers, so in first approximation we can forget about tilts and the like and just look at the straight results: http://www.gurufocus.com/model_portfolio.php?mp=hr_largecap You see many names discussed here in the list. But there is barely any outperformance since 2006. Perhaps if you have several decades of data, track things more often, etc. you will see something. But it does not scream at you.

I think you have your logic backwards here. Seth Klarman, one of this generations best investors, and his team of managers/analysts is able to find 20-30 stocks to invest in . . . I think a retail investor working part time would be nuts to think they could match that. I might know 20 decent companies well enough to own them, but I don't own them because the right price hasn't presented its self. I own 5 stocks in my brokerage account because I can't follow 100 stocks closely and I feel comfortable with the safety and future prospects of each. If I'm wrong my returns will be volatile, but I can accept that. If you buy the stocks in any of Graham screens (net-nets, Enterprising investor, Conservative Investor) you WILL beat the market, guaranteed. The problem is that most of them are companies with <50M capitalization. A retail investor can buy them, but not somebody like Klarman.

Absolutely right.

Scientists have been doing something similar to Kaizen for centuries. Once in a while people come up with a wonderful idea and you get a new theory straight away, but more often great advances are obtained by incremental, continuous improvements during decades, like the last two Nobel Prizes in Cosmology. And talking about Cosmology, most theoretical physicists consider that the most consistent interpretation of quantum mechanics is Everett's Many Worlds theory, where the Universe splits every time entropy increases. So everything is probabilistic by definition. Kaizen, or any other well thought out, systematic process, can help you squeeze the core of the distribution and thin the tails, but never chop them off. You will still have a fire in your factory, a madman who takes a ax to your most expensive robots, an earthquake, a dirty bomb in the port, a war, world economies deleveraging, etc. I don't think Kaizen would have made much of a difference in Fukushima. The same is true about investing. I remember Pabrai talking about the Kelly Criterion, when he had only 10 stocks in its portfolio and was making returns in the high 20's for many years. It sounded very smart, very bold. Then he went down by almost 80% in 2008. Now he talks about diversification, baskets of stocks, etc.

I think that everybody who is concerned about concentration should make this exercise: - Assume that you own N stocks every year - Assume that the returns for any of those stocks can be described by Gaussian distribution with average R and sigma dR - Run 10, 20 and 40 yr simulations varying N and using your estimated values of R and dR. Very few people will wish to systematically own 3 stocks after seeing the results. Now, instead of a Gaussian, use a realistic, fat-tailed distribution which can certainly go to 0. You will see that it is very risky, as in permanent-loss-of-capital, to own only 3 stocks for decades. If it is only a short period of time, because you see an amazing opportunity, well above your average expected returns, then it may be worth the risk, but I would still do the numbers carefully. Seth Klarman has averaged ~20% per year, is managing >23B, and it is still able to find 20-30 stocks to invest in. It should not be that hard for retail investors.

Mechanical value screens: ~+21%, including dividends, similar to an index of European small caps. FFH: Managed to average down quite a bit, but still down by ~ -3%. Bestinver funds: ~+16%

I think they are pretty good. But as I mentioned in a previous thread, I am a bit concerned about the changes they implemented in the last few years, adding more managers and funds.

Well, I was running many backtests, using several mechanical value strategies in different continental European markets, and I noticed that there was a significant correlation between outperformance and size (number of stocks) in the market. The best markets for value investing were France and Germany. Italy's economy is comparable in size with France or the UK, but has many fewer listed stocks with a significant volume. My interpretation is that it is much easier for an Italian fund analyst to know very well all the stocks in their market than for French or UK ones to do the same, so mispricing does not happen so often. Unless you have a big shock like the one we are going through now...

touche! funny! But, really, perhaps it explains why there is limited participation in those stock markets and therefore the markets are not very deep. Which goes to your point about value investing working in counties with deeper markets. Well, we certainly have many problems, insider trading is commonplace and people never get punished for it...but I think that the issue of market depth depends more on how companies finance themselves. For instance in Germany companies get loans from banks instead of issuing shares, so there are fewer companies listed in the stock market compared with typical anglo-saxon economies.

Oh, that explains why all the big frauds happen with Italian or Spanish companies: Enrone, Mundocom, Los Hermanos Lehman, MFI Globale, etc. :) More seriously, when you look at how simple value investing methods work in different EU countries, you see that they tend to do better in deeper markets, those with more listed companies, like France, Germany and of course the UK. They do mediocrely in smaller countries, like Holland or Spain, probably because there is more scrutiny of each company by local funds, which forces markets to be more efficient. But corporate governance may certainly be a factor too, I remember Jim Grant complaining that net-nets do not work in Japan because of that.

Well, you have García-Paramés, but he is from Galicia, the Spanish Celtic fringe (where people are famously tightfisted). In general, Mediterranean societies put an enormous value on conformity. If you go against the majority, it is often considered morally wrong, even if you happen to be intellectually right. Take Keynes "it is better for the reputation to fail conventionally than to succeed unconventionally" and multiply it by 10.

Is your probabilistic prediction entirely based on your observtion that there is an overabundance of expensive junk in the market now, or other factors too? What factor(s) influence the timing? Thank you for your interesting comments. Yes, the fraction of expensive junk in the US market is about the same level it was at the end of 2007. Since 1990 this indicator has only been triggered three times: 2000, 2007 and now. In the EU it is below its long term average, which usually means good returns during the next year for a value strategy (the correlation between this signal and the overall market is slightly weaker).

OK, you had me worried with the Yale Plan :) But remember Warren Buffett: "If I was running $1 million today, or $10 million for that matter, I'd be fully invested. Anyone who says that size does not hurt investment performance is selling. The highest rates of return I've ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It's a huge structural advantage not to have a lot of money." Seth Klarman is running >23B. Anyway, let's retake this discussion a year from now, by then we will know whether the US market has crashed, Europe has imploded and/or Japan has gone the way of Zimbabwe... Cheers and happy new year! Txitxo

Gio, I think it is wise to hold cash right now, specially if your investing universe is mainly the US, but I would backtest the Yale Plan or at least have a quick look at a Shiller P/E plot to see where your entry and exit points would have been if you had followed it during the last decades. For instance the Shiller P/E ratio got into its higher 20% quintile in 1996 and only left it in 2009...would you have been comfortable being <30% invested in the market during all those years? BRK-A went up by 800% during that time and you would have captured only a small fraction of that return. For a timing system to work properly, it has to produce very few signals. The Shiller P/E is useful because it tells you in which phase of the bull or bear market you are and whether you are at risk of a a major crash and therefore warns you to pay attention to timing indicators. Even following a dumb 200 day SMA starting on 1996 would have saved lots of money to most investors, whereas it mostly produced useless signals between 1982 and 1996. Intuitively, I think it would be much more robust to use something like the Yale system individually. That is, split your portfolio into 10 "golden" companies and assign money to each stock using the historical valuation (P/B or Shiller P/E, or 10yr FCF, etc.) of each company.

I know. My intuition tells me that Europe looks awful, that none of the important problems have been solved, that we are bound to have another crisis next year, whereas the US, with all the QE and the housing market rebound should be much better; it certainly looks as if Tepper is right. But the numbers tell a very different story...so keep up those protections... And remember that what moves prices is the difference between current perception and future reality. The US will probably grow more than Europe in the next year. But if the market is too optimistic about the US and too pessimistic about the EU, EU stocks will go up and US stocks will go down.

Actually the number of deep value stocks (e.g. any of the Graham screens) is a mildly successful timing indicator.

Gio, nice to see you quoting Capablanca. He was truly an artist. I fully agree with Howard Marks, and he was vindicated by 2008-2009. But I am very reluctant to hold large amounts of cash. I've looked a lot into timing systems, and I think I've found a very good one but I am still skeptical about it because there has only been a couple of bear markets to test it. And I've done many backtests which prove that unless you time exceedingly well your entry and exit points, your performance will be inferior with respect to buy and hold. So putting together macro and micro, the optimum strategy should be to buy cheap stocks in cheap markets. You do your favorite variant of value investing, either mechanical investing as I like, owner-managers which is your specialty, Grahamesque cigar-butts, or Buffett-like palaces with moats. But you buy those stocks in markets which are statistically cheap according to all the possible indicators you can muster. You only go to cash if all the markets in the world become expensive at the same time. Right now my model indicates that sometime before the end of next quarter, US, Canadian and Australian stocks are about to start a big decline. The UK market is pretty rich too. This is a statistical prediction, and I have no idea what will be the actual detonator of the decline. But if that does not happen, this time will be truly different. On the other hand, Euro-zone markets are very cheap and buying value stocks there should work very well in 2013. It is a pity that there are no real equivalents of LUK, BRK, MKL, FFH, etc. in the Eurozone. That would simplify the life of the part-time investor significantly...

Just to clarify here - BYD is 15B HKD not USD. That takes a 600B USD market cap down to 77.5B USD at a 40x based on 793.1Million shares O/S. However there are 2.35 Billion shares o/s which would put the 40X number at 232.5B USD. Not so crazy. Also, they are really a battery company, not a car company. Every time I do more research on them they are selling batteries of ever increasing sizes for all sorts of applications from cell phones to shipping container sized 500kwh sized monsters yet the media keeps calling them an electric car company. It's hard to get good info on BYD . . . hence misunderstood. That's right, thanks.

It is easier to imagine a technology company achieving these kinds of returns than an auto company, in any case. The interesting thing is that Fiat actually works as a play on higher future energy prices, too, given their predilection towards smaller cars. But I can't get to 40x return on Fiat without assuming they just miraculously achieve amazing margins, or miraculously achieve enormous market share (helped by shift to smaller cars??). The point is that BYD is an auto company and a technology company. All big car companies will do well when internal engine cars are substituted by the new electric cars, but, as you say, how is Fiat going to grow a factor or even 10? The same applies to the auto division of BYD, despite being in a much better position because of the expected growth of the chinese market. So the key are the batteries.

I would also go with BYD because of the long term energy situation. The first tailwind is the physical certainty of cheap peak oil. Oil prices can fluctuate but eventually they will go to 200$, 300$ and we will stop burning gas for transportation and move to all-electric cars. The second tailwind is that a such a shift is a good, popular excuse for governments to spend lots of money in Keynesian stimulus programs. Good for the left (clean energy) and good for the right (cash to big companies) This will produce a huge demand for batteries, not only for cars, but also for alternative energy sources. The number of produced cars will also increase (people will have to get rid of their old cars faster). If you assume that the car production will double with respect to the current levels and that each battery pack in a new car costs ~10000$, this will be a market of 120Mx10k= 1.2T $. From what I've read, BYD seems like one of the best positioned companies in the world to capture a large fraction of that windfall, plus whichever share it gets of the growth in the world and China car markets. A factor 10 increase in market cap would put it at ~150B$, a factor 40 at ~600B$, >3 times larger than the current size of GE, which may be too much. But >20% returns 10 years from now do not seem outlandish. Another nice statistical tailwind is that the Chinese stock markets are very cheap now. I am certainly going to have a deeper look at BYD. It would be good to see the more knowledgeable people in this forum do their best to kill this company.

Bestinver has a long term track record which is almost unmatched in Europe, they are classical, hard-core value investors, but I would certainly not invest in their hedge fund. They have a perverse incentive structure, they get paid 50% of their overperformance over Bestinfond (which is their flagship fund). That means that since BHF has much fewer positions than Bestinfond they can make money purely out of the higher volatility or by making Bestinfond underperform. The hedge fund has a high-water mark, but only for 3 years. There is not reason whatsoever to assume that these guys will not do their best to perform as well as possible with both funds, but following Charlie Munger, I never bet against the power of incentives. In fact I am pulling my money out of Bestinfond and putting it into Bestinver International (which is only a palliative because both funds have a significant overlap). I am keeping a eye on them and I may pull out my money in the future if I see anything I don't like. García Paramés, who is the manager responsible for the overperformance of the first 15 years, had an near-death experience in 2006, barely surviving a plane crash, and right afterwards he instituted the new system, with two additional managers and a hedge fund. He may have decided it was time to smell the roses and it is still not clear whether the new, expanded team can match the historical results. Regarding the thread theme, my recommendations would be: - FFH (as a safe store of value in NA) - Any good value fund or basket of cheap stocks concentrated on the Eurozone. Run like hell from Australia and Canada (the expensive crap indicator goes crazy for them), keep out of the US and UK (same danger levels as in 2000 and 2007). The Eurozone is safe, and the best world market should be Japan, but when stocks go up there the yen will sink (or viceversa) so tread with care. If I am right in my "predictions", there will be a big crash in the NA stock market in the next 1-2 years, perhaps getting us close to the secular lows that we haven't seen yet. If I am wrong, and the sky doesn't fall after all, FFH bought at close to BV is a very nice long term investment, same as Eurozone stocks at the current levels.

txitxo, you always bring the scientist’s and the statistician’s point of view into the discussion, and for this I thank you, because every time it is very interesting! ;) You said the absolute minimum is at least 4 companies, and I am curious: take, for instance, twacowfca’s portfolio of BRK, LRE, and FFH. Though presently not that much concentrated, I am sure I would sleep very soundly at night with such a portfolio! 3 stocks, not 4… How do you look at such a portfolio? Of course, my point of view is that BRK is a collection of 70 plus businesses, with a very large and diversified portfolio of stocks; the same is true for FFH, which is a collection of many insurance companies and possesses a diversified, very well protected, portfolio of stocks. So, intuitively I judge twacowfca’s portfolio to be much more diversified than it appears to be at first glance. Now, to my question: do you think that my intuitive judgement has statistical relevance, or that it is statistically flawed? twacowfca, I know from your posts that you are much versed in statistics, what’s your thought on the subject? Thank you, giofranchi Giofranchi, it is really difficult, if not impossible, to calculate probabilities of such extreme events (that's one of the main points of the Black Swan book). I am not talking about regular diversification, to reduce the volatility of your results. BRK and FFH are wonderful companies in that respect, very solid (a significant chunk of my portfolio is in FFH). I am talking about "Black Swans", things which would seriously affect the whole company. BRK is so big that it is difficult to think of something which would kill it and not kill most of the stock market simultaneously, but imagine a succession of unprecedented, freak weather events which bankrupt all the insurance companies in the world, or a problem with some of the subsidiaries which involves terrible lawsuits, or WB going nuts, etc. In the case of FFH there was a Black Swan several years ago, with the concerted attack of the hedgies. Yes, there are institutions which are TBTF, but that doesn't mean their shareholders won't lose their shirts. 3 or 4 companies? If the probability of failure per year is some small epsilon, let's say a few hundredths, and you invest during ~50 years, being invested in 3 companies makes the probability of all of them failing at some point close to 1%. Having 4 or better, 5, starts to make that probability negligibly small. Of course assuming that their failure rate is not correlated. BRK, FFH and LRE are correlated. Don't get me wrong, the most likely outcome is that you own those three companies, nothing happens during decades and you grow rich, because you understand them well, don't get scared during crashes, and keep adding to them, etc. But there is a tail risk lurking there which is not so difficult to eliminate or at least to reduce enormously. You could add some of LUK, L, SHLD, BAM, Jardine Matheson, Pargesa, Bestinver, Fairholme or other good NA funds (Chou, etc.) to the mix, buying whenever you think it is a good entry point and you would probably have a very similar rate of return long term, and reduce the risk of a total blow up to almost zero (of course we could always get an asteroid hitting the Earth, a zombie epidemics, half of La Palma falling into the sea etc.).

Investing is a probabilistic game. You can use whatever underlying parameter you want, e.g. Estimate of Intrinsic Value/ Price, FCF/price, or more sophisticated multiparameter approaches, but in the end, you are making a bet: if I buy stocks with a certain value of that parameter, I have an expectation of X% return with Y years. If markets were efficient, X% would always be the same as the market average. But they are not, so if you choose well the corners of the parameter space you invest in, you will beat the market. Graham, who was an accomplished writer, invented the Mr. Market and the margin and safety metaphors to dress mathematics in a more palatable form and provide psychological support when things get hard. But all of value investing reduces to placing bets with the odds slightly in your favor. That's why nobody has invented a 100% safe procedure to avoid value traps, or why not all the stocks in the portfolio of the best investors beat the market. Things always work statistically, on average. Now, it is obvious that the most extreme the "statistical mispricing" of a stock, the larger your average returns. For instance if you buy the top 3 stocks with better intrinsic value/price ratio, the expected return will be 30%, the top 5, 25%, the best 25, only 15%, etc. If you include too many stocks, your returns will start to resemble those of the market. But remember that those returns are realized on average. The scatter in the performance of individual stocks are huge. So if you are really good choosing stocks, like Eric seems to be, you will certainly have better returns if you concentrate everything on your best idea. But one day you may wake up broke because your company was killed by a Black Swan which was not foreseen by even such a smart board as this. That's why I guess that the absolute minimum is at least 4 companies which have an extremely low risk of going belly up. Imagine that the risk for each of them is 1e-2, then the probability of all of them failing simultaneously (assuming there is no correlation, a big if) is 1e-8, almost negligible. Your average returns will be slightly lower, but the volatility will go down and you will know that it is almost impossible for you to lose all your investments. Having all your money in a single stock is like mooning the goddess Fate. It may work wonderfully for years, until it doesn't. Read Nassim Taleb's books. Not everybody likes his writing style, but he does know his math.

Congratulations. I looked up the lowest P/E during the last 5 years in Reuters, which quotes 14.82, I haven't been tracking this stock.

Yeah, I'd like to really see how they valued this, and then compare it on an apple-to-apple comparison in terms of Inditex's normalized P/E, cash flows, etc relative to Berkshire's. Cheers! Sure, Inditex has always been expensive (the lowest P/E in the last 5 years was ~15) and right now I'd much rather own BRK. But it is an impressive achievement nonetheless for the son of a railway worker born just before the Spanish Civil War and who had to leave school when he was 14. You'll agree that being the son of a US Congressman and attending Ben Graham's classes at Columbia is a much better starting position.