VAL9000

This is what I latched on to. The author ignores the share of profits that Berkshire "owns". i.e. if you only count the dividends then you need to give fair play to retained earnings.

Is it odd to invert the conclusion? I'm exploring the idea that instead of homes being too pricey relative to rents, maybe rents are too cheap relative to homes. My line of thinking was.. A greater portion of renters have been converted to home owners. Vacancy rates have remained steady. So I conclude that rental demand and rental supply are in balance. If the growth in home ownership as a percentage stops and holds at 70%, then relatively more demand will be placed on the rental market, which should push up rents. Yep, and that makes perfect sense to me. Trust me, I am working my ass off trying to refute the theory that homes are overvalued and I'm not really getting anywhere ;) Actually, I think it's time for me to throw in the towel on this side of the debate. I've run out of ideas to justify Canadian home prices at their current levels, and the ones that I've come up with aren't robust enough to flog. The evidence of bad things on the horizon is just too prevalent, and try as I might, I can't imagine a scenario where it ends well with this amount of leverage involved. Thanks for the debate (Liberty especially. I owe him for always being a good sport.) - I think you are right and that I am/was wrong.

Real estate is a producing asset. That's how you know that it's overvalued. I think it has fewer influencing factors than most stocks. I didn't say that real estate wasn't a producing asset, I said it was difficult to value like a non-producing asset. The reason is that so much of real estate isn't about productivity. The productive capacity of a granite counter top is about the same as a laminate one, but the price they command is different. There are 1000's of examples like that, hence why I think it's hard to value. One of the pricing tools for real estate that we've mentioned here is price relative to rents. I came across this document from the CMHC: http://www.cmhc-schl.gc.ca/odpub/esub/64691/64691_2011_A01.pdf?fr=1330958975066 It shows that the cost components of home ownership have all grown faster than rents, which only grew about 11% over 10 years. Meanwhile, the vacancy rate (in Toronto, anyway) hasn't moved around much - between 2 and 3% for that decade. Is there an argument that rents are too cheap? Will they rise rapidly now that we're at a home ownership saturation point (from 62% to 70% - at the level where US real estate started to come down), while overall population is still growing? Just a thought.

This sounds crazy... because it is. My analysis here was flawed. I compared apples (city populations in US) to oranges (metropolitan areas in Canada). Overall urbanization is about the same between Canada and the US.

Not exactly. There are a few markets you can look at to make comparisons. Hong Kong's market is pretty pure in that 100% of the market is urban. Density has come up 50% over 30 years and property prices have come up 10 fold. Japan's density is up about 10% with more recent years seeing negative growth in density. Over there the real estate market has been coming off highs for nearly two decades. In these cases, if you consider Toronto's urban density has grown about 20% over the past 10 years or so, something between negative prices and ten fold growth seems "normal". Another way of thinking about this is by relative property values based on density. Vancouver costs more than Toronto, which costs more than London, On, which costs more than Woodstock, On. Looking at this kind of evidence, it is reasonable to say that more densely populated areas are worth more. A more rigorous approach would be... The amount of land in the Toronto area is fixed, but 20% more people live there. All else equal, the land is at least 20% more productive. Although, due to network effects, my belief is that a 20% increase in density results in a greater than 20% increase in productivity. Urbanization has come up 6% in the past 30 years, overall population density has come up 65%, and Canada's real estate market is mostly made up of 4-5 major urban centers. This gives me some comfort in the idea that real estate in Canada should be rising at a rate greater than inflation, which at least puts a floor under real estate prices.

My point about how quickly the prices rose in the 80's vs. today is that the more people who are "in it" means that the price is more real. i.e. a meteoric rise is more readily followed by a spectacular crash, whereas a more steady rise gives the pricing more credibility. Some of the boomers reached home buying age that early, but the cohort spans 20 years. Many, many more were in a position to buy homes in the late 80's than in the late 70's. The boomers will not cash out at the same time over the next few years. Many started retiring 5-10 years ago, and the latter half of the cohort can expect to prolong their retirement past today's national average of 63 years. Boomers have saved quite a bit. > 70% of them have pension plans, the median of which is about 240k. Something like 55% of assets held are in financial instruments. The home is a big chunk of the asset mix, but this is an historically faithful asset composition. It looks like everything else we're debating is speculation. I think your viewpoint has merit - namely that prices are high based on conventional (and warranted) measures and that boomers will need to liquidate their positions in the next 20 years. This will put downward pressure on the market. My own theory is that prices have been pushed into new territory because urbanization is a new and growing trend, and urban density justifiably moves prices above inflationary growth. I continue to believe that real estate will defy traditional economics (for dozens of reasons), but that anyone buying today (or ever) should err on the side of caution and look for value where possible.

You have to look at the factors that moved real estate prices into negative territory, and what kept them there for thirteen years. Here are three important factors that I looked into: 1) Real estate prices prior to 1989 shot up much more quickly. They more than doubled in a period of 4 years - from ~200k to ~425k (real). Prices came down by 40% over the course of 7 years. The current rise in housing prices has taken much longer to culminate. If we assume that real estate prices are overvalued by 40%, then you're looking at a cohort of about 10-12 years of buyers. A 40% drop over the course of the 90's only captured about 3 years worth of buyers. 2) Interest rates and first-time buyers. Lending rates came down steadily through the 80's. Initially in the 12-19% range in the early 80's, potential home owners saw some relief in the form of 9-11% rates through the mid 80's. The economic events leading to a real estate bubble were three-fold: relatively low interest rates, a period of rapid economic growth from 86-90, and the baby boomer cohort reaching home buying age. The eldest baby boomers were 40 in 1986 and the youngest baby boomers were ~ 25 in 1989. Approximately the entire cohort was in the first time home-buying age at this time. Combine that with good economic prospects and interest rates come down from 19% to 10%, and the result is a crazy buying spree. This buying spree came undone when interest rates shot up in 1989 and 1990 to 13% and 14%. 3) 1990's recession. Even after interest rates started to come down in the 90's, real estate dropped unabated. At this point, the recession and resulting unemployment had taken over as the driving force behind lower home prices. Unemployment jumped from < 8% in 1990 to 12% in 1992. Even as employment figures improved, overall average earnings didn't recover to their 1989 levels until 10 years later, in 1999. So, it definitely took a long time to work back up to those levels, but I don't think we are mimicking the same scenarios today: 1) Price rise is much slower. The bubble mentality / bursting activity requires a faster rise and fewer individuals "caught in the bubble". 2) The boomer cohort is saturated. Current housing prices are not being pushed up by a pent-up glut in housing formation. 3) I can't predict the future, unfortunately. We did just go through a mild recession, but there was little impact on real estate pricing, which I think is strange. The biggest shared risk factor between the 1990's real estate weakness and today is recessionary. We've seen that the debt to income ratio has come up steadily in the past 10 years. This is a combination of low interest rates, as well as a significant increase in home ownership rates - from 62% to about 70% today. A lot of what we're seeing is younger families with bigger mortgages, which is both a good and bad thing. The bad is obvious - interest rate impact on these families is much greater because they have the full mortgage on their books and a long time horizon to pay the mortgage off. The good side is less evident. Younger families have a lot more flexibility to adjust to interest rate increases. For example, a 3% interest rate increase is offset by a 2% per annum rise in earnings, assuming 5 year fixed on a mortgage valued at 5x net income. Younger families can expect greater wage increases as they attain experience and seniority. Older earners tend to plateau earlier, but are less exposed to interest rate shocks. If we enter another recession, then there's a good chance that we'll see some serious price decline. Interest rates are about as low as they can go, so using them to prop up demand is not an option. From what I can tell, there are very few tools that the government has left to maintain or incent economic growth. This is extremely concerning for all markets, including real estate. I guess the question of real estate pricing really centers around interest rates, and I think we're stuck on the low end for quite a while. Canada can't really raise rates, because doing so will push the dollar up, causing further economic pain to our exports. Plus, given all of the debt that people have taken on, doing so would probably cause additional harm in terms of bankrupties, etc. It's politically unsavoury. It could be that the political choice is to just keep rates really low for a long time. The resulting exchange rate impacts and inflation will help Canadian asset prices enter more normal territory. In addition, a few years of high inflation will help push down nominal debt obligations, which would help out. Eventually rates would have to rise, but this would be when the economy is firing on all cylinders. Perhaps in 2-3 years? Does anyone have a macro argument centering around why we would raise our interest rates? Why we would be forced to?

Thanks Liberty and Kiltacular. I was misinformed regarding the non-recourse nature of loans in the US. I had read that it was the default for all mortgages, but I've since gotten a nice little education on the law of the land ;)

As I said, people are unwilling to sell at a loss, generally speaking. The situation you're suggesting requires some kind of forced sale. The vast, vast majority of people who have mortgages in Canada today are able to make payments with their current income streams. The forced selling scenario is one of unemployment. Which means we're not forecasting an independent real estate bust, we're forecasting a sustained rise in unemployment. Which we just went through. House prices weakened for a year and then shot back up again. Granted, it was a pretty mild spike - from 6% to 8.5%. The unemployment spikes from the 80's and 90's were much more severe and resulted in much more drastic drops in real estate prices. I think these are two major contributors to that conundrum: - CAD/USD exchange - typically the Canadian dollar trades at a > 20% discount to the US dollar, but more recently the Canadian dollar has been trading at par. If the dollar corrects itself (i.e. a US recovery is in full swing), then the price gap between Canadian and US real estate will narrow. If it doesn't then maybe real estate values will do the correcting. - Urbanization - US and Canada have similar urbanization rates, but Canada's is much more concentrated at the high end. About 7.5% of the US population lives in cities with a population > 1mm. In Canada, this number is 50%. That's crazy. As a comparison, for cities of populations > 100,000, you're looking at only 28% of the 300mm people that live in the US. That means that 75% of Americans live in cities smaller than Waterloo. So that's another major contributing factor for why real estate prices are so comparatively high. I am somewhat regretting wading into this discussion about house pricing because it's kind of pointless. It's like trying to forecast the price of gold or any other non-producing asset. The price of real estate depends too much on other factors - it can't be forecasted independently. It is fun to get a better understanding of the real estate picture, though. My fundamental belief is that homes are not normal assets. They are romantic, reusable, and they have significant utility for the buyer. I would never view a home as anything other than an expense and I encourage everyone I know to consider homes this way.

No, I'm serious. I think that real estate prices correct downwards more slowly because of the bankruptcy requirement and an unwillingness to sell at a loss. If the economics of their situation dictate a change in lifestyle, you will see the impact in credit card debt, auto loans, rv loans, lines of credit, etc. well before you see the impact in housing. It's like Maslow's hierarchy of needs for debtors :P

This is probably just seasonal weakness. Look at the chart - those markets demonstrate weakness from November through about March every year. This is exactly right. Mortgages are non-recourse in the US, which is why "it's different" in Canada. You have to declare personal bankruptcy to get out of your poorly devised home ownership plan. The result is that downward price trends are throttled because home owners can't just walk away like they did in the US. I think RE prices will be forever buoyed by two things that people are loathe to do: one declaring bankruptcy and two selling at a loss.

Yes I actually do believe he is such a high profile human being that he has a security detail that restricts him from flying on a commercial airliner. You bring up an interesting example with senators and congressman, considering that one got shot in the head last year. Do you think that Zuckerberg, whose wealth, age, cultural background, unprecedented influence, and ability to impact the social lives of 850 million people (internationally) is more or less of a candidate for a security event than Gabby Giffords? I guess your alternate theory is that a multi-billionaire is bilking his shareholders out of $700k to fly Mom and Dad to Asia, and then opted to tell shareholders about it in an S-1 by listing it as additional compensation, before he even accepted their money. There are plenty of things in the S-1 that require scrutiny, like whether or not Sheryl Sandberg is worth $30mm a year, but I don't think that this is one of them. If anything, I think FB is being extremely cautious and forthright with everything related to Zuckerberg because it's critical that he keeps his image squeaky clean. In a typical CEO scenario I am certain that they wouldn't even bother reporting that a few friends and family hitched a ride on the company jet.

I'll take this one. The reason is due to Zuckerberg's "comprehensive security program." The reason why you're even able to comment on it is because elsewhere in the S-1, FB has outlined the terms of its private aircraft use. They state explicitly that the CEO and COO are allowed to use the private aircraft for business purposes. Zuckerberg is allowed to use the private aircraft for any purpose because his security program requires that he doesn't fly commercial. If Zuckerberg travels with family and friends, the flight cost attributed to them is added to Zuckerberg's compensation so that everyone can see. So, not really bone chilling and it seems like an honest inclusion to me. From the S-1:

If only RIM understood this, too. A significant chunk of their marketing and product development is targeted squarely at the consumer (think Playbook gaming, BBM billboard ads). If RIM started to act in a manner consistent with the "business first" thesis, I would consider acquiring shares at this level. I'm with SharperDingaan for now - sitting this out, but keeping an eye on either a change in position or another move down in price. For what it's worth, being saturated at a customer site doesn't qualify as a moat with mobile devices. This isn't Windows, where all of your software runs on a single platform. The vast majority of businesses supply their people with smart-phones solely for voice and email capabilities. Those two applications are nearly frictionless in terms of switching. This will change if businesses begin using mobile hardware as a platform, but today it's just not relevant. It may never be the case if the cloud application model becomes the default standard. The comparison to Dell isn't a fair one, either. In this context, Dell is a low cost producer of computer hardware. RIM is not. Smart phones haven't yet become a commodity business, so price isn't the key decision factor for most buyers. Hence why we rarely see Android in the corporate world, despite their lower pricing. I am going to offer that we're well on the way to a commoditized smart phone market. As has been mentioned elsewhere, the innovation gap that Apple originally opened has largely been closed by competitors. Assuming there are no game-changing innovations in the next few years (think touch-interface circa 2007), the race in the future will be won by software marketshare first and phone hardware pricing second. The problem for RIM is that they are a hardware maker (terrible margins) supplying exclusively to a third- or fourth-place software platform (terrible scale). So when commoditization kicks in, they are going to be squeezed from both sides, and that's not a good place to be. I still think that the best way forward for RIM is that they should either become a hardware company, a software company, or split themselves in two. I would also support a niche business model where they service only the business world, with product development geared towards security, reliability, device fleet management, and other business-oriented concerns. Right now, they appear to be fighting too many battles on too many fronts, and I think it's pretty clear that they are losing most of them.

I don't think that it's notable unless we can get some concrete numbers on how prevalent this typo phenomenon is. Based on what I see with respect to the data, it's an insignificant factor. You're saying that the impact should be more visible with Bing, but as I showed with the graphs, it's not visible at all. IE's browser share was huge and is getting smaller. You should expect a decrease in search share in line with that if default search (and default search typo correction) were a significant factor. Bayesian amplification should make the effect of dropping default search share more pronounced, not less so. Also, Google's default search share isn't relatively small. It's relatively big. They own default search for Chrome, Firefox, Safari, and mobile, which collectively make up about 55% of the browser market, which is greater than IE's 40%.

Not this theory again... ;) It doesn't make sense. Look at the browser share of IE: http://upload.wikimedia.org/wikipedia/commons/8/86/Usage_share_of_web_browsers_%28Source_StatCounter%29.svg Now look at the search share of Bing: http://static8.businessinsider.com/image/4f0e050e69bedd0b1900000f/chart-of-the-day-sai-share-of-core-searches-us-jan-11-2012.jpg If a meaningful chunk of the Bing search share were due to typos captured and processed by the default search engine, how come the search share doesn't drop in line with IE's market share? But this argument does bring up a vexing question.. Can anyone explain why Bing and Yahoo's search share is roughly stable in aggregate while the share of default-to-Bing browsers has been dropping like a rock?

This post is a story about how I developed an investment thesis, committed to it, came across new information, and abandoned it over the course of nine months. At the start of the year I had a lot of free time. I decided that it would be good for me to use this time to come up with my own investment idea. Normally I find ideas from other people's initial analysis and promotion, but I wanted to "Be Like Buffett" and come up with my own. I pulled a lot of data, looked at a lot of small caps, and eventually learned about FreightCar America (NASDAQ:RAIL). I was attracted to RAIL initially because it seemed like it was being overlooked in terms of long-term earnings potential. They had been making losses for a while and US manufacturing was heavily out of favour at the time. Overall their metrics were good, with a low average P/E (over 6-7 years) in the high singles depending on how you counted, a reasonable price/book of <2.0, and no debt. I computed the numbers backwards and forwards and thought that they'd see about $60-$70 in share price over the next three years as rail car demand increased. The company had been struggling under a CEO whose main focus was internal change, including cost reduction and management strategies. What RAIL was clearly missing was sales. Orders were down to their lowest levels in reported history. Much of this was due to the broader market, but I thought that the replacement CEO was also indicative. The former head of sales, Ed Whalen, was brought out of retirement to run the company. I took this as a good sign. RAIL had consolidated its manufacturing operations and reduced its SG&A during the downturn. In terms of industry structure, rail car manufacturing is compelling. There are five competitors in NA, and it's expensive to ship these overseas because they can't be containerized. RAIL is narrowly focused on coal car manufacturing, and captures about 80-90% of the market in any given year. At the time, coal was also very interesting to me. I had researched a number of coal companies as well, which I missed the boat on. I thought that RAIL was overlooked as an obvious beneficiary of rising coal demand. I also came across some really positive market data that was further reinforcing the idea that RAIL would be a cash cow over the next 3-5 years: - Rail car orders over the past 5 years were at all time lows, while rail loadings were up - Coal demand was again rising as coal burning power plant inventories began to come down - Steel price was up, which would increase scrapping of old steel coal cars (modern cars are made of aluminum) - Unused rail car inventory was steadily dropping I invested at $28.89 in February. Not a huge investment, but enough for me to pay attention to. Over the coming six months, my thesis began to play out. Orders increased, car loadings were up, and train speeds were starting to come down. An interesting fact that I learned during my study is that rail car demand accelerates as the rail network becomes busy both because of natural demand and because a busier system is a slower system. A slower system requires more product in transit to meet the natural demand. Neat huh? In the face of all this good news, RAIL dropped in August with the broad market. I roughly tripled my position at $16.34. I ended up selling in mid-November at $24.01 for a gain of 22.13%. I think I got lucky, and here's why: Around this time I began to learn more about the future of coal. Currently, coal is used to meet almost half of the US's electricity needs. The underlying demand theory I was working with was that coal would continue to play an important role in the future of energy for the next 30+ years. I don't think this is true any longer. There are two major alternatives to coal: natural gas and solar power. Natural gas price has dropped considerably, and many modern power plants are equipped to burn both coal and nat gas. Based on the shale discoveries and environmental concerns, I see increased preference to burning natural gas in place of coal at many of these plants. The other competitor, solar power, was illustrated to me in this article: http://www.bloomberg.com/news/2011-11-08/solar-shakeout-could-soon-reach-china.html Note the timing of my exit vs. the timing of this article. The logic that caused me to abandon my investment was that between solar power and natural gas, coal demand will begin to drop in the US for the foreseeable future. Coal cars last about 30 years. I can't see how anybody would be willing to invest heavily new coal cars over the next five years when the thirty year lifespan of those cars will probably not be required. RAIL's business is 80-90% based on demand for coal cars. This just isn't a good place to be invested given the chain of demand. And so, I got out. I loved this process and I can't complain about the result. The best outcomes were: - I learned that I could take the plunge on my own idea, which adds to my confidence in investing and gives me more freedom in choosing investments in the future. - I learned a ton about the rail business, the coal business, and some about the energy business. - It was a successful endeavour. I consider this bit pure luck because the information around solar power and natural gas was readily available back in February. - I abandoned an investment that I had an emotional tie to (my first baby, if you will), which is a good sign for maintaining objectivity. The thing I regret the most is that I didn't post this idea to the board when I was researching it. I was new to the board, I didn't think I could handle the criticism, and since this was my first foray into deep analysis I didn't want to be driven off track by external opinions. Stupid move, though. For future research projects I will be presenting before or shortly-after investing. - VAL

IRR of 37.07% and an underlying gain of 14.24%. IRR is heavily skewed due to large portfolio influxes mid-year, which turned out to be good timing for such events. Smartest moves: - Took a large position in USG at $7.99 in August. - Took a medium position in PBN at $10.63 in late August. Dumbest moves: - Bought a very small speculative position in TSE:PLS, which is down 78%. - Added lots of SSW at $17.58 after it moved down from $20 in May. Luckiest events: - SSW announced a tender offer for shares that brought my largest holding up by 30% in the last month of the year. - I ended up investing in RAIL, watching it drop, investing more, watching it rise, and trading out at 20% over 9 months. The way this whole thing developed is interesting and I will post on it in detail shortly. Best lesson: PLS is the obvious flub. I look at the end of year performance and focus mostly on what the heck I was thinking with that play. What I came up with is: - I was greedy because I saw a company that used to be worth a lot and was now worth very little. - I thought they could outrun their financial problems with an asset sale (that never materialized). - I did very little analysis. The business model seemed good (I still believe this), but I completely ignored the financial state of the company. - My big bet was on the housing recovery, which would trickle down to PLS being a profitable business again. I made the same bet with USG. The difference is that I used much more rigour with USG, ensuring they would have years to ride out a housing recovery, whereas PLS's time horizon is really only 6-9 months (which is coming to an end). - I justified my speculation with "it's not a lot of money" which is a ridiculous and stupid way to rationalize an investment. I was looking for an easy win and I was punished accordingly. Good lesson and I hope never to repeat this mistake.

Wait, did you just tell us that your wife is choking your chicken? In front of the KIDS?! ;)

Liberty, good videos. Definitely an interesting guy with vision. We'll see how it plays out, but I think he's on the right track with his ventures. Menlo, I'm not sure that a government loan vs. other sources of investment are a significant qualifier for what makes a great tech visionary or entrepreneur... Musk also reminds me a bit of Howard Hughes in that he seems to dive headlong into a bunch of unrelated businesses and projects. Richard Branson is also like this.

As you no doubt have seen, Steve is being memorialized all over the internet right now. It's great to be able to find so much content on a single person in such a short time. I've watched a number of videos and read articles about Steve and his legend over the past 24 hours and it's really quite inspiring. This got me thinking about the huge gap that he has left in the world, and who might possibly fill that gap one day. So far I've landed on Elon Musk, former founder of PayPal and current CEO of SpaceX and Tesla Motors. There are a few striking similarities between Steve and Elon: - Entrepreneurial history with a strong technical background. - Focus on disrupting industries with new thinking (p2p payment, rockets, automobiles vs. cell phones, entertainment, computing) - A flair for the dramatic and controversial - Most importantly: focus on product. Have you seen the photos of the Tesla Model S? It is gorgeous: http://www.teslamotors.com/models/gallery I think what Tesla is doing is very interesting. It reminds me of Apple circa 2003. Though this isn't a value investing topic, I'm interested in everyone's thoughts on this. Also, anyone care to nominate others who are or could be future titans of innovation?

I knew next-to-nothing about baseball and thoroughly enjoyed it. Michael Lewis is the kind of author that can take a subject that you have no knowledge of and make you feel smart about it while he teaches you. You won't feel like you know nothing about baseball after reading it. And yeah, it's all about value.

Kuhndan, What's your favourite cuisine? If there's one thing you can get in Toronto, it's really good food from any cultural background. I'm representing Etobicoke!

Ugh, now I have to change my alias.

Hey Ericopoly, I saw this article on multigenerational homes and thought you might be interested. I agree with your overall thesis that 30-year-olds don't want to live in their parents' basements forever, but this article brings up an interesting cultural preference with respect to Asian and Latin families. Grandparents living with their children is reasonably common here in Toronto. However, my observation has been that you're more likely to live with your grandparents if your parents are first generation immigrants. Race was less of a factor. http://www.bloomberg.com/news/2011-08-30/grandma-bunks-with-jobless-kids-as-multigenerational-homes-surge.html