original mungerville

Dazel, Earlier you mentioned $500 million in gains from bonds. I don't see it - as of yet (but that may change if the US ISM comes in really weak this week). Here is what I see as of today: In terms of long-bond gains, I am staring at page 99 of the annual report. For a 100 basis point parallel move in yield curve, gain of around $850 million. Relative to June 30 (ie final M-to-M date of Q2 for the bonds), yield on the 10-year and 30-year down 30 bps relative to today. So M-to-M gains on bonds this quarter roughly 30/100 multiplied by $850 or $250 million. With only a couple days in the quarter left, I don't see that going past $300 million. Now, are you figuring that they added to their bond position significantly since the end of the year? I can definitely imagine that as they added acquirees along with their asset portfolios so if they just allocated to various securities in line with their current portfolio - all these numbers are likely up somewhat. Don't see how that gets us to $500 million though - unless they added % exposure to long-bonds in recent quarters beyond the level they would have added by the consolidation of new acquirees' asset portfolios. Am I making sense here or do you see that they have added?

Dazel, How large is their short position on individual names (ie not including the Russel or SPY shorts)? I'm staring at p. 59 of the 2014 annual and it looks like its at least $1.7 billion in individual names. Up higher in the paragraph, says they had $6.8 billion notional in equity hedges representing 89% of their equity exposure including equity investments in affiliates. I believe in a recent quarterly, they said they went just above 100%...so 100/89 multiplied by $6.8 billion we are talking about $7.6 billion in hedges now? Is that right? Of which maybe $2 billion might be individual names? Is that what others have?

What if the market hardens when they are sitting on large hedging losses (like right now)? Doesn't that limit their ability to write more business (than otherwise) into the hard market? Yes but the market is much more likely to harden when equity markets sell-off and decrease capital available in the industry relative to a time (ie past 5 years) when any regular insurance company could make money in the stock market. Insurance cycles harden when assets get hit hard and it hits capital available. Some of the biggest hits to capital have been stock market drops over the past 15 years (along with insurance events of course). But people think its just insurance event related, its not as it doesn't matter if the event is from the asset side of the balance sheet or the liability side.

Recent presentation? Also if their gains from shorting resource stocks is small, the total portfolio of shorts on individual names can not be that large (because resources have been massacred here).

Thought about it a little more and 15% is too high because of their cash drag. I think all of their assets might do 15% but if they have 10% in cash then the return is 10%*0% + 90%*15% = 13.5% 12% to 13% is probably a reasonable high point with a low probability they do above this but they would need a healthy amount of financial engineering/leverage to do it either from acquiring with debt or levered PE investments or warrants. Agree on the high point and I generally agree with longinvestor as well - I just can't get to 15% in terms of longer term IV growth of the business (its a relatively minor difference - ie I can see 12-13% whereas longinvestor can see 15%; where we both agree is that earnings/BV growth has the potential to be higher than the last 10 years even though BRK is now bigger and this is the most interesting and counterintuitive point). I would also say the following: 1) My above statement assumes relatively normal inflation - if currencies devalue significantly, the growth in IV on the high end could be higher than 12-13%; 2) Certainly BRK's stock price could rise 15% annually over the next few years in a normal bull or flat market as it reprices higher towards its fair price (this would add to any growth in the business); 3) BRK will beat the S&P 500 in my view over the next 10 years (although I expect the S&P 500 to do badly - at least in real terms); 4) In the shorter term, relative to the S&P 500 which has much greater exposure to foreign markets (where currencies and economies are weakening significantly and will drive earnings down in the next quarter or two) BRK should do well. For what it is worth, I do expect ugly markets for the next little while and so, in the short-term, I feel much more comfortable betting on BRK relative to the S&P 500. I would then take my hedges off if and when the Fed decides to do QE4.

Dazel, How large is their short position on individual names (ie not including the Russel or SPY shorts)?

I actually partially agree with longinvestor. I think intrinsic value has a shot (not a certainty) at growing faster than the 10% of the past 15 years. Like maybe 12% - possibly for the same reasons as longinvestor, but I can't see 15% over an extended period (ie say 2015 - 2025)

Why are you looking back to 2010? (A low point? - helps your case?) Book value per share has grown by around 10% for the 15 years from 2000 to 2014. (Probably peak to peak in the stock market and probably similar highs for the business cycle - not that the Fed lets us have any of those anymore but that's a different issue). So now you expect that to increase by 50% to 15% compounded over say the next 10 years? On what basis?

I agree that intrinsic value growth (approximated by book value growth over time) can be measureed as the combination of the growth of investments per share and earnings per share. As such, it would be helpful for you to stare at not only the numbers above re earnings growth but also investments per share growth and book value growth. This would help our conversation and make clear to you that BRK will not grow intrinsic business value at 15% compounded going forward. Buffett said "focus" on earnings per share growth, not "only look at that" and ignore the other parts of the business which drive intrinsic business value - this is where you are erring. Let's not get hung up on 15% though. If you are saying the next 10-15 years may look better than the last 10-15 years for BRK (especially relative to the S&P) as the driver of intrinsic value is shifting more and more from growth in investments per share to pre-tax earnings growth - and not everyone has figured that out yet - then I completely agree with you. And this is counter-intuitive to a degree because you would not expect this result after the business has become larger. 12% on the high end may be doable because of this point I think you are making. Just forget about 15%.

Right. I said they will not get 15% growth in the business going forward for any extended period of time. You come back with this matrix on the stock price. Even in this matrix of stock price, I see very little evidence of sustainable 15% growth in the stock price over the past 5, 10 or 15 years. So I can't see the point you are trying to make. Are you agreeing with me? Or are you suggesting we should look at the last 20-30-40 years in order to forecast the next 10 years? (This seems to be what you are saying, hopefully not because that makes ZERO sense.) Or is there something more subtle you are getting at?

That'll do! Especially since "going forward" is in all likelihood 20+ years. " That'd be "quite satisfactory" in Ben Graham's terms. I do think BRK can grow much more than most think on the high end, but 15% will not happen. When is the last time BRK grew by 15% over an extended period (ie not the stock but the business)??

Ericopoly does 20% before getting out of bed in the morning. He eats LEAPS for breakfast and shits big returns by mid-morning. All this before lunch. He probably won't be in touch with you though because he's already quite rich!! There are a few people on this board with healthy metabolisms.

That's pretty impressive. Do the past 5 years look pretty similar (since you've been hedged - for a while I'm assuming)? Thanks ... but no, its not impressive because a return for 8 months is not indicative of much. This just seems to be the way it goes for me. I underperform in big up years and significantly outperform in down years. This year I have been outperforming in a flat year because I felt there was enough evidence to bet on macro events and was fortunate with the timing (but this could just be pure luck as I am no macro expert) while my long-term value picks outperformed. 5 years? No, no... 5 years is for the weak, I've been partially hedged for half of the last 15 years (adding precious metals no less since the crisis)!!!! Highly costly - probably not the best idea, I do not recommend it but that's the way I roll. I did not catch the downdrafts in 2000-2002 or in 2008/09 as I moved to more than fully hedged in in both situations which helped tremendously (eg, up 80% during the last crisis as I went significantly short in summer 2007 - this when markets were down 50%). We need to see where this big Fed experiment ends up, the next year or two or three should be telling. I don't necessarily expect the markets to drop here. Stocks are real assets and so if they print enough money, they could continue to go up significantly. I do think there is a limit to the value of stocks in real terms though, but this game has gone on for much longer than I ever expected and may continue to do so. Bottom line is that the game, whenever it ends, will not end well. I have learnt a ton: buy value with a large margin of safety and concentrate (this is where most or all of my returns have come from), find cheap asymmetric hedges when possible, and don't hedge any more than 50% of notional. My hedges now include precious metals because I think that a "neutral" position now (ie a 100% cash position) is actually 85% cash and 15% precious metals. You just can't keep printing forever and have things work out well. We each have to find our own way - this seems to be mine.

40% year-to-date: 1) highly concentrated value picks, 2) partially to more than fully hedged portfolio, 3) made gains on call options on $US rise early in the year, 4) gains from increasing portfolio hedge to 100%+ in early August. Despite this, did not make too many trades, kept it simple.

Yes, I think he will get 10% (or damn close) otherwise he'll start paying a dividend or do buy-backs. In the recent past, every time he makes a big deal Burlington, Heinz, the latest one - everyone thinks he overpaid at first blush and then a few year later, it look like a steal. That pattern is repeating itself with the latest one.

Don't kick yourself too hard, because you will get more than 5-7% return even if the multiple holds - so good to try and factor in the following: - BRK is providing no dividend right now, but it is safe to say the Buffett's minimal return on capital deployed is probably 10%. - This means all retained earnings will eventually get deployed at 10% return minimum. - You have retained earnings growing 5 -7 % which means that that amount that will be deployed at 10% is also growing. The key with valuing BRK correctly, is to factor in that 10% return on new capital employed into your valuation. The earnings yield is 7% right now - so you that is your base yield at these prices. To that you add new capital invested at 10%. So that means your answer has to be between 7-10% return. Now, having said that, if BRK also grows float, by say 2% a year and insurance is half the business, you might get an extra 1% with that. So we might say new capital may actually be invested at 11% - ie 10% + 1% from insurance float. Basically if all new earnings were immediately invested in 10+1% opportunities, and the current multiple held, your return would be 11%. If none of those future earnings get invested ever, and because cash earns 0%, your return would be your 7% (or inverse of the p/e). So your return is probably closer to 11% if you think Buffett will be able to continually deploy capital and 7% if he just sits on cash and doesn't ever pay a dividend. Anyway, factoring the above in to your analysis will improve it.

Shane, this all sounds reasonable - what I would have expected at this price for BRK (ie 13-14x p/e, 7% yield) however, why are you adding your 5-7% growth to your 7% earnings yield to get to 12-14% total return. There is something very wrong with this. If the 13-14x multiple holds going forward, then you get that 5-7% growth and that is all. How to you figure you can get 12-14% return unless you assume multiple expansion?

So you are 100% sure of the base case and every gold miner on the globe will be poorly managed going forward. Alright, I'm going to bed.

Ya OK, you are 100% sure of that? I am not 100% but your case is my base case. I am advocating that people take a small percentage of their portfolio and search for cheap asymmetric deflationary (eg, FFH provides a free call option on deflation while providing some business growth in the base case scenario) and inflationary (precious metals / miners) insurance - say 10% and 10%. Then go value invest with the other 80%, and personally I would hedge about 33% to 50% of that amount depending on how bullish or bearish you are at any point in time. In this manner, you won't get killed if the base case doesn't hold while your hedging costs are limited (FFH gives you business growth which could offset in losses in your precious metals over time in the base case scenario so we might call that a wash). If you only hedge 33% of the rest, that is not that costly and the opportunity cost of the 20% in FFH and precious metals is not great because the cost of borrowing that 20% is so low in the base case.

The gold miners are in the shitter relative to Gold, they make the oil producers look like they are in a bull market relative to Oil. The gold miners have indeed pissed away capital over the past 15 years and have been horrible investments, but over the past 3-4 years investors started getting pissed and management started to adjust. So they aren't pissing away as much as they used to and they are cheap relative to the gold price and oil (one of their most important input costs).

Possibly, yes that may be the case, or my theory may be correct. Obviously Gold is very hard to value - other than when the price is well below production costs. I just think its value is the inverse of the value of currency and the inverse of the confidence in central banks and I can't value those things. Or I could be totally totally wrong and there are other forces at play which I do not understand. But there are multiple experts, hedge fund managers, etc, who have bet on Gold over the past several years and have been wrong thus far - at least in $US terms...In several other currencies I think Gold has only had one or two down years in the last 13 or so. Gold is up this year relative to several currencies, just not relative to the $US. Same for last year.

Well, I have a theory that the developed world central banks have been selling gold to the bullion banks who have been selling paper gold into the market as QE1,2,and 3 were implemented. But I think that that game ends at some point because there will be a failure to deliver physical Gold on the Comex at some point which will send the price upwards quite fast. Its not unlike the situation in Fairfax shares where the bad guys were naked short-selling into the US market effectively producing unlimited amounts of Fairfax shares at will at key points to take down the price. I saw the action then in Fairfax shares, and I see it now in Gold. Same for the action in Overstock shares around the same period. This stuff can persist until the physical takes over. Like when did Fairfax start paying a dividend? Remember, it seemed odd given their capital position at the time...but when you pay a dividend, if the market maker specialist / broker on the NYSE has permitted naked short selling on behalf of his clients, that broker has to pay dividends on every paper share it created. So if 100% of shares were sold short (and not covered - ie naked shorted) by a broker, that broker effectively owed clients double the dividend amount in aggregate. At some point the physical takes over, and I think the same will happen in Gold. I should also say that with enough QE and ever-increasing amounts of money printing, one would think confidence in paper currency would decrease exponentially at some point. This just seems logical and the value of Gold is one divided by the value of paper currency.

Well if the US did something like that maybe the S&P would be worth 1000. But I don't really see your point? Why would the US want to suddenly go to a surplus to pay down some debt? That would be horrible economic policy even as you put it. So in order to pay down a bit of debt, the US should cause horrible human suffering through unemployment, etc. Probably go into deflation, destroy the profitability of its companies and a lot of value... for what? to feel good that they paid down some debt? We could go around like this forever. If my grandma had wheels then she'd have been a bicycle but she didn't she had legs, and the S&P is not worth 1000. Right, I didn't say it was worth less than a 1000, I said it was worth somewhere between that and a trillion. The center can hold for as long as there is confidence in currencies and the debt does not implode the economy. But to have Dalio start talking about QE again might make people wonder just how many QEs are there going to be and when does this end, does it ever end? Let's just leave the valuation of the S&P to the side. At this point it's like saying it's between zero and infinity. Now Dalio may be a smart guy but he's no oracle either. We may have another QE at some time, but so what? The CNBC crowd thinks that the FED is more concerned about the stock markets than the real economy. I hold the opposite view. The thing is that at this point I don't see why the fed should tighten - inflation is very tame. I also don't really see why the should loosen much - job growth is going at a decent pace, though there is a long way to go. If the current problems in other parts of the world spill into the US then they will probably loosen (so QE4) and that will be the right thing to do. Agree, it will be the right thing to do to hold the center - so this correction should be limited to 10 to 25%. But of course the risk is, that at some point, maybe soon, may in a few years, maybe in 5 years or even 10. At some point, ever increasing amount of debt and QE have to lead to disaster. Would you not agree?

This is where I agree with you fully. The CNBC crowd is all about the FED. I think the community here can make nice returns without worrying much about all of that. Well, just to be clear, I am not saying to disregard this stuff. I am saying try to establish cheap long-term asymmetric hedges against this stuff with a small portion of your portfolio so that you don't have to worry about this stuff with the rest of your portfolio and you can go along in your merry way value investing like we all just want to do!!

Well if the US did something like that maybe the S&P would be worth 1000. But I don't really see your point? Why would the US want to suddenly go to a surplus to pay down some debt? That would be horrible economic policy even as you put it. So in order to pay down a bit of debt, the US should cause horrible human suffering through unemployment, etc. Probably go into deflation, destroy the profitability of its companies and a lot of value... for what? to feel good that they paid down some debt? We could go around like this forever. If my grandma had wheels then she'd have been a bicycle but she didn't she had legs, and the S&P is not worth 1000. Right, I didn't say it was worth less than a 1000, I said it was worth somewhere between that and a trillion. The center can hold for as long as there is confidence in currencies and the debt does not implode the economy. But to have Dalio start talking about QE again might make people wonder just how many QEs are there going to be and when does this end, does it ever end?