Excellent Interview. 5 minute read.

[feynmanresearch]

A case of variant perception would be Cheniere Energy( LNG). Carl Icahn and Seth Clarman both have sizable stakes in it, but for the life of me, I can't figure out what they see in that company

 

OK. Let's take that as an example. How many positions in your portfolio are such that most people will either not understand why you hold the position or will think that you are wrong (crazy, etc.)?

 

I'm not putting you personally on the spot, this is a question to everyone on this thread.

 

Let me make it even easier: what percentage of your portfolio is in positions where you believe to have "variant perception"?

 

For me personally, the number is 0%. Actually, it's probably negative: I have couple positions where I am pretty sure the market is right and I am wrong, so those would count as negative "variant perception". ;)

 

I have 10% of my portfolio in Gilead Sciences( GILD)

[KCLarkin]

 

You are probably saying that most gains are from situations where investors do company valuation and invest in situations where company is cheap and investor's opinion is quite different from majority of investors. (Correct me if I'm wrong).

 

 

Marks has a helpful 2x2 matrix in his Dare to be Great essays.

http://www.oaktreecapital.com/MemoTree/Dare%20to%20Be%20Great%20II.pdf

 

Anyway, not saying this is the only path to success but seems to work for me. Before investing, I try to understand the consensus and the bear case. These are usually easier to determine in mid and large caps.

 

[Ross812]

OK. It's not enough (actually, it is enough if you bought BRK 20 years ago and held, but I won't argue with you). I said so much above. If you are genius and can do "variant perception", great.

 

Edit: reading Munger and Howard Marks in no way guarantees that someone will suddenly be able to do "variant perception" on their investments BTW.

 

Should the rest of us just slit our wrists and buy index funds?

 

Actually I'll add couple more edits:

 

1. Even someone who bought BRK at the top of past peaks, did really well. So not much for pari-mutuel comment from Munger, although he is definitely right short term and for some companies he's right long term.

2. Most people buy stocks all time (DCA) and not at single moment, so they can get great companies at variety of prices, some better some worse.

3. Buying great company at low(ish) price is not "variant perception". It's just valuation.

 

WTH is "variant perception" anyway? I'm gonna partially agree with Hielko that it's mostly meaningless phrase. Can you give examples? Mike Burry and CDSs? (even he was not alone in that perception, so is it really "variant")? Berkowitz and AIG/SHLD/Fannie? Are these really "variant" either? Ackman and HLF? Or Icahn and HLF? ;)

 

If I bought AAPL in 2013, was that "variant perception"? Valuation? Both? Neither?

 

The majority of people, even posters here, would be better off buying index funds. Saying if you bought BRK, AAPL, DHR, etc... 20 years ago is just cherry picking.

 

Buying great companies at fair prices doesn't work all the time. How many of the nifty 50 are still around?

 

You have to evaluate the companies prospects into the future. A lot of companies, IBM was used as an example, are sold off because the market is uncertain of their future. The higher level thinking is evaluating if IBM will be around and can grow passed the fiasco of the day.

 

Buying at an attractive valuation when the market is agonizing about the future of the business is how Buffett has made most of his money. Its not that easy to do, and all that reading is what helps you understand how the business is likely to perform in the future.

[constructive]

I would argue any investment other than buying an index fund is a variant perception. That tells you nothing about whether it varies in the correct direction or the incorrect direction.

[shhughes1116]

All of this talk about "variant perception" makes my head feel like it is going to explode.  "Variant perception" sounds like a term that was coined by someone looking to justify their excessive 2 and 20 compensation. 

 

In investing, every trade you make is ultimately taking a position (buyer) that is different than another market participant's position (seller).  Thus every position you take is a "variant perception" relative to someone else.  Even indexing has an element of "variant perception" since you are making the conscious decision to put money in the market as opposed to selling your position in the market.       

 

Ultimately the concept of "variant perception" is irrelevant, IMHO.  All that matters is whether you got the direction right or wrong at your entry point.  And in that respect, I tend to think it is easier to get the direction right when your view/perception contradicts the prevalent view of the market.   

 

 

 

 

[rb]

All of this talk about "variant perception" makes my head feel like it is going to explode.  "Variant perception" sounds like a term that was coined by someone looking to justify their excessive 2 and 20 compensation. 

 

In investing, every trade you make is ultimately taking a position (buyer) that is different than another market participant's position (seller).  Thus every position you take is a "variant perception" relative to someone else.  Even indexing has an element of "variant perception" since you are making the conscious decision to put money in the market as opposed to selling your position in the market.       

 

Ultimately the concept of "variant perception" is irrelevant, IMHO.  All that matters is whether you got the direction right or wrong at your entry point.  And in that respect, I tend to think it is easier to get the direction right when your view/perception contradicts the prevalent view of the market. 

I completely agree, the whole concept is meaningless. As an investor you analyze the company and come up with an estimate. At the end of the day why should one care if the market disagrees with him.

 

Also if one is good at what he does it's better if the market disagrees with him often. That means opportunities.

[Rainforesthiker]

All of this talk about "variant perception" makes my head feel like it is going to explode.  "Variant perception" sounds like a term that was coined by someone looking to justify their excessive 2 and 20 compensation. 

 

In investing, every trade you make is ultimately taking a position (buyer) that is different than another market participant's position (seller).  Thus every position you take is a "variant perception" relative to someone else.  Even indexing has an element of "variant perception" since you are making the conscious decision to put money in the market as opposed to selling your position in the market.       

 

Ultimately the concept of "variant perception" is irrelevant, IMHO.  All that matters is whether you got the direction right or wrong at your entry point.  And in that respect, I tend to think it is easier to get the direction right when your view/perception contradicts the prevalent view of the market. 

I completely agree, the whole concept is meaningless. As an investor you analyze the company and come up with an estimate. At the end of the day why should one care if the market disagrees with him.

 

Also if one is good at what he does it's better if the market disagrees with him often. That means opportunities.

 

IMO you should care about exactly WHY the market is disagreeing with you.  When you make a stock purchase (which probably should be done only a few times a year) you should have an understanding as to why you think the market is getting the price wrong.  Is it simply because your valuation is different than the market's valuation?  In this case, the investor should tread carefully and reconsider - it is difficult to successfully go against the wisdom of the crowd on a regular basis.  But if you think the market is getting the price wrong due to some clear irrationality (biases, problems with uncertainty, etc.), you can be more comfortable making your investment, knowing that you are not going against the wisdom of the crowd, but rather against some identifiable foolishness of the crowd.

 

Note I make a distinction between:

variant perception:  your appraisal of the company is different than the market's; perhaps you think a company's future growth is greater than what the                  market thinks it will be

inefficient rationale:  WHY is the market getting it wrong; what irrationality, systemic constraint, short-term thinking, etc. lies behind the market placing an incorrect price on this stock. 

 

[rb]

IMO you should care about exactly WHY the market is disagreeing with you.  When you make a stock purchase (which probably should be done only a few times a year) you should have an understanding as to why you think the market is getting the price wrong.  Is it simply because your valuation is different than the market's valuation?  In this case, the investor should tread carefully and reconsider - it is difficult to successfully go against the wisdom of the crowd on a regular basis.  But if you think the market is getting the price wrong due to some clear irrationality (biases, problems with uncertainty, etc.), you can be more comfortable making your investment, knowing that you are not going against the wisdom of the crowd, but rather against some identifiable foolishness of the crowd.

 

Note I make a distinction between:

variant perception:  your appraisal of the company is different than the market's; perhaps you think a company's future growth is greater than what the                  market thinks it will be

inefficient rationale:  WHY is the market getting it wrong; what irrationality, systemic constraint, short-term thinking, etc. lies behind the market placing an incorrect price on this stock.

I respectfully disagree. First of all, about the only thing that you disagree with the market is about the valuation. You think it's worth X, it thinks it's worth Y.

 

But I know what you mean. So let me give you an example about pure valuation. Back in 2012 BRK was trading at around 1.15 P/B. I thought the value was about 50% above that. This is a big company not some obscure venture. There was no market chatter about it. No worries that the insurance companies cocked up, really no opinions on anything and everything was running smoothly. So that was purely a difference of opinion about valuation between me and the market. I bought a ton of BRK and made about 100% return on in. According to you since there were no other points of contention I should have just said that the market is probably right and I'm probably wrong and move along. If I did that I'd have less money today.

 

Also how do you even know what the market's opinion is? The market is the collective presence of all participants and as another poster said we don't have the ability to read minds. So how do you find out what the market thinks? From the newspapers? Talking heads on CNBC? Analysts? In reality when you hear anything about what the market thinks, it's not the market that thinks it, but some rather small (compared to the whole) but really loud participants in the market.

 

Let me use another example. The short attack on Fairfax. In the middle of that storm what you would deduce is that the market thinks that Fairfax is a fraud. But Kynikos, SAC, et all were only a small part of the market for Fairfax, the much larger part of the market was Watsa family, Southeastern, Cundill, and a lot of ppl on this board. So really the market believed that FFH was a nicely run and undervalued company, but you sure didn't hear any of that about FFH back then.

 

So yea, I think it's best for one to just do their own homework, come up with a valuation, act on that, and not worry too much about the market.

 

Personally, I prefer the situations when the only point of contention between me and the market is just the valuation and no other pending items. Sometimes stuff is just on sale. But life is messy and I don't think that I (or for that matter most people) have a very good ability to handicap the outcome of major events. It's much easier to just wait for the sale and buy squared away companies.

 

[Mephistopheles]

Knowing the variant perception is helpful but has its limitations. I like to read bear cases simply to be challenged i.e. to try and kill the idea. Sometimes though, as abovementioned, there is no concrete variant perception, or there are tons of variant perceptions. Ultimately what matters is if you think the cash excreted is greater than what you're putting up - if I can know why others think I'm wrong, that's great, I happily read their thesis. If I can't find out a reason why they think I'm wrong, or if it's something silly like the economy, China, or Greece; also great - I buy anyway.

 

People have stupid rationale for buying and selling (including professionals). So no need to worry so much about what they're thinking, because often times, they're not.

[Rainforesthiker]

IMO you should care about exactly WHY the market is disagreeing with you.  When you make a stock purchase (which probably should be done only a few times a year) you should have an understanding as to why you think the market is getting the price wrong.  Is it simply because your valuation is different than the market's valuation?  In this case, the investor should tread carefully and reconsider - it is difficult to successfully go against the wisdom of the crowd on a regular basis.  But if you think the market is getting the price wrong due to some clear irrationality (biases, problems with uncertainty, etc.), you can be more comfortable making your investment, knowing that you are not going against the wisdom of the crowd, but rather against some identifiable foolishness of the crowd.

 

Note I make a distinction between:

variant perception:  your appraisal of the company is different than the market's; perhaps you think a company's future growth is greater than what the                  market thinks it will be

inefficient rationale:  WHY is the market getting it wrong; what irrationality, systemic constraint, short-term thinking, etc. lies behind the market placing an incorrect price on this stock.

I respectfully disagree. First of all, about the only thing that you disagree with the market is about the valuation. You think it's worth X, it thinks it's worth Y.

 

Right there we obviously disagree.  If you think everybody in the market makes decisions solely based on valuation then I think you really don't understand human behavior.  People are not the rational actors you are taught in business school.  Many times the crowd will sell because there is a large amount of uncertainty or pessimism (think GM recalls, 2011 Greece issues with American banks, EZPW accounting issues, etc.).  People are emotional creatures, and very often they will sell without regard to valuation, and likewise very often, due to the human desire to get rich quick, they will buy things that are wildly overpriced (e.g., tech bubble). 

 

But I know what you mean. So let me give you an example about pure valuation. Back in 2012 BRK was trading at around 1.15 P/B. I thought the value was about 50% above that. This is a big company not some obscure venture. There was no market chatter about it. No worries that the insurance companies cocked up, really no opinions on anything and everything was running smoothly. So that was purely a difference of opinion about valuation between me and the market. I bought a ton of BRK and made about 100% return on in. According to you since there were no other points of contention I should have just said that the market is probably right and I'm probably wrong and move along. If I did that I'd have less money today.

 

Berrkshire circa 2012 is an excellent example for my style of investing.  Do you know WHY BRK was (at least in part) trading so low in 2012?  A large part of the reason was that BRK was the largest component of a very prominent financial index that was being heavily shorted at the time.  The reason people were shorting this index was because the index also contained the American banks they really wanted to short, such as JPM, BofA, Citi, WFM, etc.  BRK was really nothing like these banks, but BRK was lumped in the index with them, and was its largest member.  This was plainly irrational.  I call this a "systemic constraint", much like where large mutual funds are constrained to purchase only certain large cap stocks.  People at the time also mistakenly lumped Berkshire in with other financial institutions.  If you recall there was an extreme amount of uncertainty at the time over ANY company that could be characterized as "financial", coupled with mass over-selling.  So you see, if you dig a little deeper you can identify market irrationalities (in this case systemic constraints coupled with uncertainty and fear of anything financial) that explain the mispricing.  This most certainly WAS NOT merely "a difference of opinion about valuation between me and the market".  I observed this in 2011 and 2012 and heavily invested in Berkshire stock as well, going on margin to do so.  I too bought a lot of it, a good bit with margin, and am up about 106% on it right now.  My "inefficient rationale" served me well exactly in the situation that you mistakenly thought it did not apply.  I would never have gone on margin had I not known exactly WHY the market was mispricing Berkshire.

 

Also how do you even know what the market's opinion is? The market is the collective presence of all participants and as another poster said we don't have the ability to read minds. So how do you find out what the market thinks? From the newspapers? Talking heads on CNBC? Analysts? In reality when you hear anything about what the market thinks, it's not the market that thinks it, but some rather small (compared to the whole) but really loud participants in the market.

 

IMO it is fairly easy to observe large scale irrationality going on, such as problems with uncertainty, fear, pessimism, get rich quick syndrome, etc.  These things affect human behaviour, and affect the prices set by the market.

 

Let me use another example. The short attack on Fairfax. In the middle of that storm what you would deduce is that the market thinks that Fairfax is a fraud. But Kynikos, SAC, et all were only a small part of the market for Fairfax, the much larger part of the market was Watsa family, Southeastern, Cundill, and a lot of ppl on this board. So really the market believed that FFH was a nicely run and undervalued company, but you sure didn't hear any of that about FFH back then.

 

I am not that familiar with the Fairfax short attack, but I can presume this caused a large amount of uncertainty and fear, driving the price down.  Had I been aware of the situation, and if I could have convinced myself that FFH was going to survive, I would have loaded up.  The fear and uncertainty would have virtually guaranteed a mispricing - as I presume it actually did.

 

So yea, I think it's best for one to just do their own homework, come up with a valuation, act on that, and not worry too much about the market.

 

Personally, I prefer the situations when the only point of contention between me and the market is just the valuation and no other pending items. Sometimes stuff is just on sale. But life is messy and I don't think that I (or for that matter most people) have a very good ability to handicap the outcome of major events. It's much easier to just wait for the sale and buy squared away companies.

[KCLarkin]

Back in 2012 BRK was trading at around 1.15 P/B. I thought the value was about 50% above that. This is a big company not some obscure venture. There was no market chatter about it. No worries that the insurance companies cocked up, really no opinions on anything and everything was running smoothly. So that was purely a difference of opinion about valuation between me and the market. I bought a ton of BRK and made about 100% return on in. According to you since there were no other points of contention I should have just said that the market is probably right and I'm probably wrong and move along. If I did that I'd have less money today.

 

This sounds like a case study for Fooled by Randomness. If you look at the returns from a selection of other big cap names from that period, you will find that a return of 100% is unexceptional. Compare with UNP, WFC, BAC, AAPL, GOOG, AMZN...

 

The real insight in this case was that the risk/reward was dramatically skewed, relative to the market. Allan Mecham had this insight. He borrowed on margin and made BRK 60% of his portfolio. Rainforesthiker had a similar insight.

 

Of course you can capture the "value premium" without any special insight. That is a perfectly rational way to invest.

[rb]

This sounds like a case study for Fooled by Randomness. If you look at the returns from a selection of other big cap names from that period, you will find that a return of 100% is unexceptional. Compare with UNP, WFC, BAC, AAPL, GOOG, AMZN...

 

The real insight in this case was that the risk/reward was dramatically skewed, relative to the market. Allan Mecham had this insight. He borrowed on margin and made BRK 60% of his portfolio. Rainforesthiker had a similar insight.

 

Of course you can capture the "value premium" without any special insight. That is a perfectly rational way to invest.

You make a great point - at least mathematically speaking. But that's neglecting the margin of safety thingy. At that point in time I also considered all of the (except BAC and AAPL) and looked very deeply into UNP, WFC, and GOOG. I didn't want to get GOOG (of course a mistake in retrospect) and I thought that I get enough of UNP and WFC by owning BRK. I didn't look up how much each of those went up compared to BRK, but my margin of safety in my decision of BRK was pretty large. Much larger than it would have been with any of the other names. That helps me sleep at night and I like a good night's sleep.

 

Also my decision wasn't really an accident. You named a few companies that performed as well. I can probably name 100 more that didn't, so what's so random about that? I don't decry any people that made any money with any of the other names. So what's wrong with a situation where you make a lot of money, safely, in a way you're very comfortable with? Why do I need to worry about the market in a situation like that?