Berkshire buying, position size, cash [from General:What Are You Buying Today?]

[Guest Cameron]

Buffett wants higher taxes so that his future cash piles will be lower so people will stop asking him why he isn't investing it and digging into his words.

 

....Genius.

[Cigarbutt]

Yes he is a genius. Perhaps another way to put it is that he is a complex individual. ???

This line of reasoning is not about identification of lies or deception.

 

Example. He often says that most people should invest in index funds.

The fact that you agree with the above statement does not mean that it is true all the time and does not mean that WB will do the same for himself.

 

The underlying point is that what he says and the way he says it may depend on the forum and to whom the message is directed.

Despite certain shortcomings, I submit that Alice Schroeder's biography does a good job when describing the importance of a favorable public perception for Mr. Buffett and how this may impact his public discourse.

 

Mr Buffett is a hard core capitalist and wants to be perceived as a nice guy. I really admire him but it is hard to persistently score highly on both fronts.

 

The underlying point of this specific post is that the cash position at BH has been increasing for quite some time and it is difficult to reconcile this conclusion with the present notion that stocks are "cheap" as Mr. Buffett remains the key capital allocator at BH.

 

I also enjoy to be greedy when others are fearful. That does not necessarily mean I am proud of it.

 

 

[Dynamic]

When looking through Giovanni Franchi's Twitter feed I came across something he posted which I thought could be illuminating in the discussion over waiting for well-priced opportunities (timing the market or pricing the market) versus investing continuously over long periods.

 

https://seekingalpha.com/article/4113710-timing-market-time-market-part-2-revenge-bargain-hunters

 

It compares various strategies for investing a portfolio to which $2,000 per month (adjusted for inflation) is added and which holds only cash or the S&P500 index.

 

Donna is stricty Dollar-cost-averaging, investing her new cash in the S&P every month without fail.

Peggy buys if the index P/E ratio is below its historic median and otherwise holds onto cash until investing it all when her criterion is met.

Teddy has a strategy based on 10-year Treasury yield + inflation being lower than the sum of long-term EPS growth and dividend yield for S&P.

Hugo, Heidi, Henry, and Helga buy High at 10-year, 5-yr, 3-yr and 1-yr highs respectively

Lisa, Linda, Larry, and Lucas buy Low at 10-year, 5-yr, 3-yr and 1-yr lows respectively

 

The results are clearly in favour of one strategy over the others in general. Most of the buy-low crowd didn't do a lot better than the rest, with only Lisa (buying only on 10 occasions on 10-year lows) and amassing a lot of cash in the meantime showing the second best total return to Teddy (not by much) and a best risk-adjusted return (by a large margin, if you believe 'volatility'=risk) of the group for a period starting in the mid 1990s and ending in 2017.

 

All of them did very nicely, growing their $0.79mn total cash investment to $1.75mn to $2.25mn over the period.

 

None of them ever sold shares, so while Lisa-10 held only a growing pile of cash until 2009 and Teddy held a growing cash pile until 2003, after that their portfolio values followed the markets up and down in a similar way to the others, who were mostly slightly ahead of each of them by the time they made their first purchases, meaning they had to catch up by losing less on future dips.

 

The buy-high strategies with short-term horizons probably avoided buying the dip too soon, but waited until the decline had run its course more often than not. I suspect the shorter buy-low strategies caused people to invest all the accumulated cash before the market had reach the bottom of the dip.

 

Only Teddy's strategy really considered any fundamental valuation metric at all. The rest all looked at timing-based metrics based on various length of previous market history.

 

Obviously, these approaches and the use of the S&P500 and of timing-based metrics are different from opportunistically buying concentrated positions within a small universe of perhaps 10-30 companies that meet high quality criteria when they reach a sufficient discount to IV, as many Buffett-influenced investors prefer.

 

But it might inform discussions about whether, for example, it might be better to have more time invested in a compounding stock such as Berkshire by being willing to invest in it without such a huge discount, versus the option of letting cash accumulate waiting for the next big opportunity to invest cash representing perhaps 20-35% of your portfolio in one hit.

 

Here's a worked example scenario of investment in a company growing IV at 8% CAGR:

 

5 years of 8% compounding amounts to 47% growth, 1.47x the original price.

To get 47% growth after sitting on the sidelines for 5 years and missing out on compounding at 8%, you need to find a position at 68% of its typical valuation and have it return to typical valuation. Holding from the point of typical valuation you'll typically enjoy 8% compounding from then on.

 

10 years of 8% compounding amounts to 116% growth, 2.16x the original price.

To get 116% growth after waiting 10 years you need to buy at 46% of its typical valuation and have it return to typical valuation, enjoying 8% compounding from then on.

 

15 years of 8% compounding amounts to 217% growth, 3.17x the original price.

To get 217% growth after waiting 15 years, you need to buy at 32% of the typical valuation, an extremely steep 68% discount, and have it return to typical valuation, enjoying 8% compounding from then on. And you've got to go into this position with opportunistic conviction to make up for the time on the sidelines.

 

So the sort of discount to IV you demand can determine how long you tend to sit on the sidelines (along with how closely correlated the various companies in your candidate group may be and how likely it is that any will encounter temporary setbacks that you can identify as non-permanent impairments).

 

It's a difficult balancing act to avoid spending too long in cash and missing out on time compounding value. Demanding a reasonable discount to IV reduces likelihood of permanent loss of capital and can lead to rapid gains. Demanding a deeper discount can lead to more rapid gains when opportunities arise. Demanding a deeper discount still can see you sitting on the sidelines without benefiting from the dramatic long-term compounding machine you turned down years before at a price that seemed too steep.

 

But with many different moderately uncorrelated stocks to consider, you'll have more times for them to reach your buy price and more opportunities to trade something more fully-valued for something more deeply discounted and hopefully increase the intrinsic value of your portfolio significantly by such a trade. If the whole market crashes 30-50% however, you may lose out compared to if you'd held cash before the crash, but your intrinsic value probably won't have declined markedly even if the current quotation has.

 

I could see my portfolio losing about 25%-30% from current levels in a crash but probably not a heck of a lot more (with my 9.63% cash growing to around 13% if the stocks lost 25-30%, at which point I'd surely invest that 13% in those cheap stocks). That's probably helped by both AAPL and BRK.B (the bulk of my portfolio) having lots of cash themselves and not being enormously high valued.

[Guest longinvestor]

When looking through Giovanni Franchi's Twitter feed I came across something he posted which I thought could be illuminating in the discussion over waiting for well-priced opportunities (timing the market or pricing the market) versus investing continuously over long periods.

 

https://seekingalpha.com/article/4113710-timing-market-time-market-part-2-revenge-bargain-hunters

 

It compares various strategies for investing a portfolio to which $2,000 per month (adjusted for inflation) is added and which holds only cash or the S&P500 index.

 

Donna is stricty Dollar-cost-averaging, investing her new cash in the S&P every month without fail.

Peggy buys if the index P/E ratio is below its historic median and otherwise holds onto cash until investing it all when her criterion is met.

Teddy has a strategy based on 10-year Treasury yield + inflation being lower than the sum of long-term EPS growth and dividend yield for S&P.

Hugo, Heidi, Henry, and Helga buy High at 10-year, 5-yr, 3-yr and 1-yr highs respectively

Lisa, Linda, Larry, and Lucas buy Low at 10-year, 5-yr, 3-yr and 1-yr lows respectively

 

The results are clearly in favour of one strategy over the others in general. Most of the buy-low crowd didn't do a lot better than the rest, with only Lisa (buying only on 10 occasions on 10-year lows) and amassing a lot of cash in the meantime showing the second best total return to Teddy (not by much) and a best risk-adjusted return (by a large margin, if you believe 'volatility'=risk) of the group for a period starting in the mid 1990s and ending in 2017.

 

All of them did very nicely, growing their $0.79mn total cash investment to $1.75mn to $2.25mn over the period.

 

None of them ever sold shares, so while Lisa-10 held only a growing pile of cash until 2009 and Teddy held a growing cash pile until 2003, after that their portfolio values followed the markets up and down in a similar way to the others, who were mostly slightly ahead of each of them by the time they made their first purchases, meaning they had to catch up by losing less on future dips.

 

The buy-high strategies with short-term horizons probably avoided buying the dip too soon, but waited until the decline had run its course more often than not. I suspect the shorter buy-low strategies caused people to invest all the accumulated cash before the market had reach the bottom of the dip.

 

Only Teddy's strategy really considered any fundamental valuation metric at all. The rest all looked at timing-based metrics based on various length of previous market history.

 

Obviously, these approaches and the use of the S&P500 and of timing-based metrics are different from opportunistically buying concentrated positions within a small universe of perhaps 10-30 companies that meet high quality criteria when they reach a sufficient discount to IV, as many Buffett-influenced investors prefer.

 

But it might inform discussions about whether, for example, it might be better to have more time invested in a compounding stock such as Berkshire by being willing to invest in it without such a huge discount, versus the option of letting cash accumulate waiting for the next big opportunity to invest cash representing perhaps 20-35% of your portfolio in one hit.

 

Here's a worked example scenario of investment in a company growing IV at 8% CAGR:

 

5 years of 8% compounding amounts to 47% growth, 1.47x the original price.

To get 47% growth after sitting on the sidelines for 5 years and missing out on compounding at 8%, you need to find a position at 68% of its typical valuation and have it return to typical valuation. Holding from the point of typical valuation you'll typically enjoy 8% compounding from then on.

 

10 years of 8% compounding amounts to 116% growth, 2.16x the original price.

To get 116% growth after waiting 10 years you need to buy at 46% of its typical valuation and have it return to typical valuation, enjoying 8% compounding from then on.

 

15 years of 8% compounding amounts to 217% growth, 3.17x the original price.

To get 217% growth after waiting 15 years, you need to buy at 32% of the typical valuation, an extremely steep 68% discount, and have it return to typical valuation, enjoying 8% compounding from then on. And you've got to go into this position with opportunistic conviction to make up for the time on the sidelines.

 

So the sort of discount to IV you demand can determine how long you tend to sit on the sidelines (along with how closely correlated the various companies in your candidate group may be and how likely it is that any will encounter temporary setbacks that you can identify as non-permanent impairments).

 

It's a difficult balancing act to avoid spending too long in cash and missing out on time compounding value. Demanding a reasonable discount to IV reduces likelihood of permanent loss of capital and can lead to rapid gains. Demanding a deeper discount can lead to more rapid gains when opportunities arise. Demanding a deeper discount still can see you sitting on the sidelines without benefiting from the dramatic long-term compounding machine you turned down years before at a price that seemed too steep.

 

But with many different moderately uncorrelated stocks to consider, you'll have more times for them to reach your buy price and more opportunities to trade something more fully-valued for something more deeply discounted and hopefully increase the intrinsic value of your portfolio significantly by such a trade. If the whole market crashes 30-50% however, you may lose out compared to if you'd held cash before the crash, but your intrinsic value probably won't have declined markedly even if the current quotation has.

 

I could see my portfolio losing about 25%-30% from current levels in a crash but probably not a heck of a lot more (with my 9.63% cash growing to around 13% if the stocks lost 25-30%, at which point I'd surely invest that 13% in those cheap stocks). That's probably helped by both AAPL and BRK.B (the bulk of my portfolio) having lots of cash themselves and not being enormously high valued.

Great post and reflection. I also tend to think about my portfolio similarly. If you're in a long term compounder, stay in it, without letting your mind play with itself. Your last sentence says it best. It's irrational trying to be cute with quoted price.

[Cigarbutt]

Good stuff.

Keep core holdings. OK.

Bottom up in your universe. OK.

Long term (over 20-30 years), these questions matter much less. OK.

Cash and related only if you find nothing. OK.

It is easier to be optimistic most of the times (all the time?). OK.

It is hard (but not impossible) to show the advantage of opportunistic buying if the future looks like the past. OK?

 

Still, there is a guy inside my head who keeps whispering margin of safety. I may need to work on that.

 

A concurrent thread discusses Mr. Hussman and his strategy to deal with that aspect. I agree that some of his premises are highly questionable but, at this point, it is reasonable to consider the possibility that, for a time-period as long as 10 to 15 years, the forward looking equity premium may be negative. That's unusual. Potential headwinds.

 

To learn, it may be helpful to look at/analyze what happened to the nifty-fifty stocks. Controversial.

 

Potential conclusions (fully invested):

 

-Even if you paid dearly versus IV as potentially suggested by the high PEs, long term, you did at least OK compared to the S&P.

-If you had sufficient insight (careful hindsight) to avoid the big losers and keep the big winners, you did better than the S&P.

-Coming in 1973-4 fully invested however, you had to be ready to suffer (Mr. Munger colorfully described how he felt then).

-But, If, somehow, you were in a position to buy ++ the compounders in the downturn and hold for the long term, you got Buffettesque returns.

 

So, back to the 10-Ks.

 

 

 

[Dynamic]

Interesting topic, and it shows some of the differences across the Value Investing spectrum.

 

1. Graham/Dodd situations where a stock is underpriced relative to some tangible fundamental and the aim is to buy it and wait for that value to be recognized by the market. If the value is recognized fast enough, the annualized return for the brief period of ownership is OK or great even if the business does not provide good returns on equity or assets and is unlikely to offer compound growth to long term investors. A deep discount margin of safety is required in case it takes a long time to out the value. For example, if you typically bought 50 cent dollars and sold at 75 cents, you'd get 15% annualized returns if waiting for 2.9 years and 8% annualized if waiting for 5.25 years to out the value.

 

2. Special Situations in merger arbitrage etc. you typically have a defined timescale and a reasonable handle on the probabilities and the likely market price if the merger goes through or doesn't. This allows a probability-weighted annualized expected return to be calculated given both the expected return and the timescale. If the probability of the positive outcome is high, the potential loss from the negative outcome is small, and the timescale to realise the return is short, the margin of safety or discount to expected value can be modest yet still provide an significant annualized expected return. This reminds me of Charlie Munger investing every penny he could lay his hands on into a near-certain Canadian Government takeover.

 

3. Long-term high quality compounders or other long-term growth stocks look different and invite many different ways to evaluate IV, depending on how far into the future you project the compounding. A rational price can look high based on trailing or forward P/E (or E/P earnings yields or FCF yields) if the internal compounding machine is sound and sure to keep working for many years. What seems like a fair multiple for most average companies could be represent a huge margin of safety for a great compounder with a good future. Buying at an apparently 'fair price' which actually represents a good margin of safety considering the internal compounding in this way can sometime provide rapid gains of perhaps 30-70% in a year or so (e.g. BRK.B at $124 in Feb 2016, AAPL at $95 in May 2016 both demonstrated this) and will probably go on to compound internally at perhaps 8-10% per annum, so can be held quite profitably for many years even if they reach moderately low earnings yields (moderately high P/E ratios).

 

3a. Trading IV If one long-term high quality compounder is trading at a rich valuation while another is very cheap, there is the option of selling some or all of the position in the former and buying a position in the latter (sometimes using cash awaiting investment too). This way one is hoping to trade a position with a smaller Intrinsic Value for one with a higher IV currently available for the same money. But if you trade a 20% internal compounder for a 10% internal compounder, you could sorely regret it in years to come unless you get an extremely rich valuation for the 20% compounder you're selling. Even more so if you have a high rate of Capital Gains Tax to pay on the sale.

 

To some extent this is also possible when one stock is moderately cheap and the other is very cheap, especially if there's no tax due on the sale (as is the case in my UK ISA and my wife's for which no tax is payable on Capital Gains of any duration, and I only seem to pay foreign withholding tax on my US dividends). I feel the need to have quite a lot appearing to be in my favour to pull the trigger on this sort of trade.

 

For us, we held about 90% of our portfolio in BRK.B priced at $142 per share in May 2016, having topped up to almost 100% at $124 in Feb 2016 (I consider BRK.B sufficiently diversified internally to happily hold 100%). With AAPL at $95 that May, I felt it was a steal with a 9.5% trailing earnings yield and $10.04/share in cash, yielding 10.5% trailing earnings on the non-cash portion of its price, and that I could justify a 25% position and still feel sufficiently diversified, especially as I could see new iPhones being introduced soon and that the extremely good sales from 2015 wouldn't long make 2016/17 look so bad in comparison for much longer.

 

In the 17 month since then BRK.B has gained 31.5%, but I don't feel too sore, as AAPL has gained 64%. That doesn't mean I was right in the long run, but I do still feel comfortable holding AAPL without profit-taking. I think the scales were weighted in my favour at the time I made that trade thanks to the extra large margin of safety in AAPL at the time compared to moderate margin of safety in BRK.B at $142 in my opinion.

 

I think Apple's internal compounding machine can probably match or exceed BRK.B's for the next decade, though it has higher uncertainty and might yet 'do a Nokia', so I'm happy to maintain my position knowing that if it does go south, BRK.B should reliably preserve value and provide for my retirement.

 

If the AAPL P/E reached 25-30 or AAPL came to represent 40%+ of my portfolio, or if BRK.B went on sale at $150 or some combination of similar swings creating a similar disparity in valuation, I might seriously consider at least lightening my AAPL position if not selling entirely (given I have no tax to pay), but I think the margin of safety of one position over the other would have to be quite significant before I'd pull that trigger.

 

So the upshot of that is that I think I am still cautious to avoid buying without a reasonable margin of safety, so I'm happy to accumulate cash while waiting for fairly high margin-of-safety opportunities.

 

Another lesson from my past is revealed by the notes that in recent years I have put alongside my copy of my account's Client Ledger, some of which were informed by forum posts I made years ago outlining my thinking. I'm not sure how this UK-specific corporate action compares to what's permitted elsewhere in the world, but it highlights another value in Margin of Safety:

 

4th July 2003: Sold PIZ at 387.53p after fees. NOTES & COMMENTS: Pizza Express Takeover at 387p was imminent and confirmed, so made a fraction above takeover price and kept the proceeds in the ISA. I had purchased originally at 655p for a small stake (before I really understood margin-of-safety), then when it fell below 300p about Sep 2002, I bought a large holding at 299p after costs, bringing my average purchase price to about 390p and having half my portfolio in PIZ. That 299p earned 32% in 10 months, roughly making up for the loss on the smaller stake purchased at 655p. Valuable lesson learned. You don't control takeovers, a good margin of safety helps you make a reasonable return even if you get taken over below your estimated intrinsic value. Also I should have sold moderately undervalued PIZ a few months previously to buy Halma HLMA below my entry price (8.5% FCF yield). Still did well on HLMA, but could have had a much larger position.

 

I ended up buying my original long-standing position in BRK.B 11 days later (equiv $49.71/share post-split) with the proceeds of this PIZ position making up 45% of that BRK.B purchase, newly added cash about 36%, plus 19% from another two positions of which I had changed my opinion (or thought them inferior to BRK.B).

 

I then became quite an inactive investor for most of the next 10-11 years just keeping up with the annual filings of 2 or 3 positions, adding no new money to my account and selling one position at a loss after its multiple local newspaper monopolies were eroded by the internet in 2007-9. I think my do-nothing returns averaged about 10-12% annualised for that period. Then we put the family business up for sale in 2014 and I got a more normal job and got married and began to save more cash (eventually a LOT more) and invest more actively.

 

Then in Feb 2016 we went almost 100% BRK.B at $124:

HLMA (ex div) sold for 808.2406p (GBX) or 3.46% EPS yield, P/E = 28.8. in Feb 2016 to fully load-up on BRK.B at $124 along with saved cash in both mine and wife's accounts.

 

So going through all those decisions and lessons, I still feel the need to have margin of safety, but if, say, AAPL was trading at $220 with BRK.B at $186 right now I might start to be getting nervous about AAPL and be willing to contemplate switching some back to BRK.B even if BRK.B isn't deeply undervalued. I'd probably still ride it out until it was much more of clear-cut switch though, again underlining that I cannot let go of Margin of Safety.

[Cigarbutt]

Thanks for your time.

I also use 3 separate evaluation grids for scenarios #1, #2 and #3.

Historically, had to focus more on #1 and #2 when #3 did not yield buying actions. 

But I prefer #3. Hopefully, going forward, either because the markets will adjust or because I will, buy and hold will apply.

 

"and I got a more normal job and got married and began to save more cash"

I guess this was about a margin of safety too. :)

 

"I then became quite an inactive investor for most of the next 10-11 years."

Since this post is about the dynamics of position sizing, if you have time or think it is relevant, how did you manage in 2008-9 when indexes were going down.

Did you just ride it out? Did you buy more of the most battered stocks? Did you do #3a?

[Dynamic]

In 2008/9 when markets were in chaos, I had my main holdings as BRK.B (the majority) and Halma HLMA and I was pretty much working all hours in the family business with little time to look into other investments.

 

Halma was still doing OK in various fields of engineeringm and BRK.B which was poised and ready and was busily making great opportunistic  long-term investments amid the chaos. I just sat there watching and thinking how much the positions in Goldman Sachs, Bank of America etc. were going to be worth in the long run.

 

I don't think I felt very comfortable in valuing banks at the time, so I'm sure I did miss out on some really beaten down stocks. And there was more besides. I suppose BRK.B held up pretty well, being one of the more defensive stocks. I was also on these boards, mostly lurking as I have since the MSN days, reading about Fairfax and Prem's wonderful bet against the CDO/Property bubble. I continue to watch FFH from the sidelines.

 

So I'm sure I missed out on quite a bit of opportunity that I might have been able to capitalise on if I'd been better prepared, but also felt as though my main investments would come out of the carnage even more valuable, which turned out to be the case. I think I ended up outperforming the markets by just sitting there, but I'm sure I could have enhanced my returns if I was as prepared as I am now.

[Jurgis]

Interesting topic, and it shows some of the differences across the Value Investing spectrum.

 

<snip>

 

That's a nice writeup, Dynamic.  8)

[John Hjorth]

Where is the drill down to this in a downturn, ladies and gents?

 

-Let's take a historical  look at the four US commercial banks for a moment [attached].

 

[Lots af flaws [dividends] connected to the graphics - however, I still think the point stands.]

 

- - - o 0 o - - -

 

It is - to me - all about sustainable, and profitable, business models, - executed the right way.

[Dynamic]

The Intelligent Investor mentions three general types of stock price drivers. I don't recall the exact wording, but these are:

 

A. Stock-specific drivers - perhaps newsflow, shifts in sentiment or financial results specific to the company in question change people's opinion.

 

B. Sector-specific movements - newsflow and shifts in sentiment relating to the majority of companies in a certain industry. For example, tobacco stocks, tech stocks, oil & gas, banking have all had well-known positive or negative sentiment swings and sometimes a sector-wide crisis.

 

C. Market-wide movements - General market over-optimism or panic, political of fiscal influences (e.g. inflation, interest rates, war fears etc.) and sometime a rush of new market participants entering or exiting positions.

 

You might imagine it as three levers driven by opinion, all exercising a degree of influence on an individual stock price.

 

At one time such as the Global Financial Crisis bear market, market-wide movements may have been huge, but equally sector-specific worries were hitting the banking/financial sector very hard indeed, and specific rumours about a company's danger or resilience against certain risks could affect a specific company even more or limit the decline compared to its competitors.

 

The whole thing can work the other way too, such as during the dot-com boom or other bull markets.

 

When market wide movements dominate there may be a rush to or from non-equity assets like cash and precious metals. If you're in equities, having so-called 'defensive' stocks is believed to limit your upside in 'good times' but protect you in 'bad times' perhaps letting you switch into more beaten-down sectors. The other choice is to switch to cash ahead of perceived trouble, but potentially missing out on gains or dividends by doing so, especially if you turn bearish far too early.

 

When individual stocks or sectors are in-favour or out-of-favour there can be opportunities for value trading from an over-valued position to an under-valued position (or a low-dividend yield to a higher yield). The danger is in getting the long term valuations wrong and trading out of a position set for strong fundamental compound growth and into a position set for weaker growth whose relative IV we have not estimated well. (Or for switching for yield just before a dividend cut).

 

And when we have cash, we can just wait for great opportunities offering margin of safety however they arise. As I'm in the saving phase, this is almost a permanent position.

 

And when we hold stocks that get to nosebleed prices offering presumably small gains looking forward, we can sell and hang on to the cash. (I've never really done this - I've always switched to another equity position almost as soon as I've sold, but I am prepared to do so).

 

And if we seek to spend our invested savings, such as in retirement, we could have a blend of three sorts of options:

1. Look for healthy dividend yield to automatically withdraw some of the earnings stream rather than reinvest it.

2. Look to sell some of our positions - either spread across our portfolio or strategically, perhaps avoiding sales of things we feel are deeply undervalued or focusing sales on positions that are more fully-valued or even overvalued.

3. Sell most or all of our equities and obtain lump sums to make large purchases such as property or buy annuities.

 

I'd be interested everyone's thoughts about downturns.

 

Perhaps we should include how we think about preparing in advance and what actions if any to take. Perhaps the options depend on whether we have specific information such as realising the state of mortgage delinquencies leading into the GFC (which Prem Watsa and others worked out how to profit from), or just a general feeling that valuations are too high or that all the gains in the market are concentrated in a small number of stocks such as the FAANGs and that this is predictive of an imminent bear market (was it Semper Augustus's letter that took this as a strong bearish sign?).

 

And then, we could discuss what to do once the downturn has taken hold. Should we go for the most troubled beaten-down sectors (e.g. banks in 2009) or just look at our circle of competence and wait for good margin-of-safety opportunities within our usual universe of stocks? Should we actively try to learn about the beaten down sector if we don't already know so that we're armed to make reasonably good decisions?

 

My only active downturn: The only downturn I was fairly active in was October 2001 a month after 9/11 attacks. Fear of war and potential inflation was in the air, and a number of quality companies I'd been looking at in the London market reached my buy price. I had accumulated a good deal of cash, and pulled the trigger on quite a few, sowing the seeds of a reasonable portfolio. The argument that resonated with me at the time was a sort of Buffett/Phil Fisher one that inflation if it came as a result of war spending would erode the purchasing power of cash over time, but quality companies with moats sufficient to let them raise prices in line with inflation should be able to increase their profits in line with inflation, so at these reduced prices offering FCF yield of maybe 8.5% of more and decent dividend yields, that was a good time to buy. I had accumulated a fair amount of cash awaiting investment by then at the maximum saving rate then allowed into UK ISAs and had an idea of minimum position size to keep my dealing costs and other frictional losses down, so I was able to make quite three of four decent purchases in Oct 2001 to add to the purchases I'd previously made without sufficient regard to valuation and margin of safety.

 

I think some of these gained about 30% in around a year, and by then I wasn't so convinced about the quality and resilience of their moats in a couple of cases. I'd also saved some more money by then and developed my strategy for buying more, so while I retained Halma (highly resilient moats that compounded my return at about 14%p.a. over 14¼ years) and Johnston Press (mostly local newspaper monopolies I couldn't see the internet destroying) I sold a couple of positions to end up with 50% of my portfolio in PIZ (Pizza Express) at 299p amid reduced sales in the City of London, hit by the bear market. My badly priced purchase of my smaller stake at 655p a couple of years earlier meant that my average price was about 390p, so I roughly broke even by the time of the management takeover at 387p in July 2003. By that time I had switched to a broker that allowed me to buy US stocks in my ISA and I decided to buy Berkshire Hathaway with the proceeds, plus cash, and I also sold a high-risk low-probability position, being content with a high certainty of a good return in the long run (BRK.B) rather than a low chance of a great return (TRK.L). As an engineer/physicist I liked that company and saw it had about a low probability of making some serious money over a 10-15 year window of opportunity before patents expired and before I imagined electric cars might make it obsolete, but you don't get rewarded for degree of difficulty in investing, unlike in Olympic diving, as Warren Buffett says. It turns out they're now valued about 1/160th of the 2003 share price I sold at, so I'm very glad I took the loss and didn't try to make it back the way I lost it!

 

By this stage, the bear market was over and I then stayed quite passive due to the family business and having no new money to invest in stocks. I passively watched the GFC bear market in 2008-9 and sat tight. I had a few corporate actions to raise funds for the local newspaper company, and wasted some of my accumulated dividends there. I finally saw the writing on the wall in 2014 as I took more control of my investments and closed that thankfully modest position at a loss, probably having lost 80% of the money I'd ever put into it, thankfully dwarfed by the gains in Berkshire and Halma.

 

 

[Cigarbutt]

In a way, investing makes most sense when it is business-like. Would you shut down your business simply because a downturn may be around the corner? Sustainable businesses through ups and downs often show financial flexibility, useful in both scenarios.

 

What is fascinating in money management though is that you don't need to sell assets, terminate leases or fire employees if you want to change course, you just need to press on a button. I think that is also a form of flexibility that comes with its own risk-reward profile.

 

What is also fascinating (think of the Graham-Doddsville theme) is that there are many "right" ways to deal with position sizing based on your investing style and personal temperament.

 

"Perhaps we should include how we think about preparing in advance and what actions if any to take."

 

Maybe, we can expand on that using principles or specific examples but, for now, I will give you a short answer.

I understand that you are from the UK and maybe hockey is not your thing but a guy named Wayne Gretzky, who was called "the Great One", apparently candidly explained his successes by saying that he tended to go not where the puck was but more where the puck will be.

Simple but not easy.

 

[Cigarbutt]

This position and cash post is a component of the alpha that we try to obtain through "active" investing.

 

Relevant link.

http://www.marketwatch.com/story/americans-are-still-terrible-at-investing-annual-study-once-again-shows-2017-10-19

 

The article is about fund investing but I would bet that conclusions can be generalized to specific investments pickers.

 

In the end, this is a zero-sum game. It's comforting that people on this Board are part of the group in positive territory. ;)

[Dynamic]

Thanks, Cigarbutt.

An aside: I am aware of Wayne Gretsky in much the way that non soccer fans are aware of Lionel Messi, David Beckham or Pele, even though I usually see nothing more than Olympic ice hockey (and for that matter Olympic field hockey). The "skate where the puck is going" idea is easy to understand in many sports, but less easy to achieve. I'm also well aware of Buffett's analogy with that baseball player who divided the places the pitch could arrive into a grid to choose which pitches to swing at and of how these apply to investing and circle of competence, no called strikes etc. I've been to two baseball games in my life but the analogy applies pretty well to cricket too, where game theory actually throws in interesting complexities where riskier behaviour is rational - but I won't discuss the brilliant Duckworth-Lewis Method here!

The Marketwatch story of fund investors and their psychological biases causing them to buy high and sell low and project the recent past "performance" into their assumption of the future, and more biases besides, is interesting.

 

I think investing as a whole is a positive sum game (as the underlying companies do earn profits and make distributions to shareholders). Also, given the risks involved it is expected that equities would be priced for a higher yield than low-risk investments.

 

However, I do understand the point you're making is that the concept of the obtaining alpha* (or at least excess return over and above the market return) is essentially a zero-sum game where we as investors attempt to act when the odds are in our favour, which is usually when the majority of market participants are acting in ways we perceive to be irrational (including investors withdrawing from funds or individual stocks when markets have dropped lately and piling in when they've risen to extraordinarily high levels lately)

 

I agree that I suspect a lot of the psychological shortcomings evident in the study do indeed carry across to individual stock-pickers as well as fund investors.

 

And I agree that participant on this Board seem to be obtaining market-beating absolute returns over long periods at least, mainly thanks to having a rational variant perception of stock prices and values, their movements and what they represent compared to the perception that the market participants on aggregate seem to act upon, presumably misled by less rational heuristics and emotional responses.

 

*Technically as most of you know, alpha actually applies to risk-adjusted return, where risk is considered to be linked to beta, a measure of short-term volatility versus broad market volatility in the recent past.

I reject this concept of risk as a long-term investor aiming for high total return over a much longer time period, and would happily accept and ride out short-term volatility in exchange for beating the broad market in the long run, though I have no intentional bias for or against volatile stocks, so wouldn't deliberately choose them over slightly higher quality companies than might happen to have less volatile stock, though the low prices occasionally brought about by volatility might produce an unintentional selection bias.

I happily accept broad-market volatility too, as a source of opportunity to buy or sell at favourable prices, as well as volatility in individual stocks or sectors giving an opportunity to trade high-price-to-value securities for low-price-to-value securities.

Some market participants may attempt to maximise alpha while aiming for a lower beta (often because they've been asked about their risk profile and have a different meaning of risk in their minds), perhaps using the CAPM to achieve this, usually by placing part of their portfolio exposure into less volatile instruments such as cash, commodities, real-estate or short-term bonds, but possibly at times by using 'defensive' equities that are less correlated with the broader market or by using long-short hedging. Nonetheless, the equity portion of their portfolios contributes to the equity markets and participates in the zero-sum game of seeking excess returns that Cigarbutt refers too, but also the positive sum game of investing in equities and receiving their distributed profits over the long term.

[Cigarbutt]

I enjoyed reading about the D-L method.

At this point, I find that game theory has been much more helpful than all the CFA stuff that you refer to.

Since we're into sports, you may be interested in the odds of a squeeze play in base-ball. There's a safety squeeze and a suicide squeeze.

It's all about risk management. And there's nothing like doing it for real.

 

Back to the position sizing and this post, I understand that a lot of participants have sizable positions in Berkshire Hathaway.

One of the obvious advantages is that one benefits from the equity return of a firm with good prospects.

 

If one thinks that better results can be obtained without BRK in the portfolio, maybe, a periodic retrospective look over the long term is necessary to verify that assumption.

 

However, I would submit that one of the reasons to hold BRK may be related to a concept that can be derived from the efficient frontier (despite being obviously flawed with the definition of risk) where holding an "uncorrelated" asset will drive down the volatility. In this case, holding BRK in a downturn, may give rise to loss of proportional correlation with markets as (rightly so I think) BRK is likely to fall less.

 

The [shadow=red,left]potential[/shadow] bonus is that BRK [shadow=red,left]may[/shadow] rebound more than the market after.

When reading the early partnership letters, Mr. Buffett describes this phenomenon as being related to his investing mindset. And he is still at the helm.

And this may have something to do with the rising cash position.

So, I would say that it is more relaxing to hold BRK as a core holding because, otherwise, the hurdle becomes to beat BRK over the complete cycle.

Perhaps, this may become easier going forward.

Simple concept, easier maybe but still not easy. 

 

[Dynamic]

I agree with the feeling of security holding BRK in a downturn, and in seeing BRK making big bold very profitable investments at times of crisis.

 

Likewise, I felt very confident holding BRK during big years for megacatastrophes (e.g. Katrina), knowing that its demonstrated ability to pay out promptly and the strong prospect of hardening insurance rates would be very good news for Berkshire for years to come, even if they had a major impact on current-year earnings. I was also assured that the losses to any one megacat were limited to about $10bn.

 

It is important to compare other approaches against this in a variety of conditions.

 

While on the subject, I'll quote a post on the Tesla thread:

 

Also, there's a lot of discussion of Elon Musk in this excellent podcast interview with Tim Urban (Wait by Why):

 

http://investorfieldguide.com/urban/

 

I really enjoyed that podcast interview. The podcast is called "Invest Like The Best" for anyone who wants to search for the feed on their podcast app. I think Tim Urban's one is the best of the three or four episodes I listened to yesterday.

 

They also had an interesting one from the guy, Seides, on the 'wrong side' of the famous 10-year long-bet with Buffett - whether the S&P500 or a 5 Funds of Funds would win after fees over 10 years ending later this year. Interesting even though I tend to disagree with him on the whole. He was of the opinion that he would have won if the S&P500 hadn't had such an unusually strong run.

 

He also made comments about the behaviour of typical investors reviewing fund performance quarterly or annual - be they individuals or treasurers/trustees for institutional funds - would have been more likely to sell the S&P500 early on in the bet after a 50-60% haircut during the GFC based on recent performance, but might have stuck with the funds of funds who had lost less (maybe 30-50%) thanks to their reduced direct long exposure to the market, so would have overcome their self-destructive instinct to "get out before they lost even more" at precisely the wrong time. So he argued that the real world experience of many investors taking the active approach would have been superior to that of those taking the passive approach.

 

He made a comment towards the end that appears to be correct - he had a feeling that BRK.B's stock performance over the 9 years or so, had lagged that of the S&P500 Total Return Index. I did a quick look up, and it seems to be right, though it's not what the bet was about.

d/m/y date format

1/1/2008 BRK-B=$ 94.80, SP500TR=2273.41 at open

1/1/2017 BRK-B=$164.34, SP500TR=4303.12 at open,  BRK-B factor=1.733 (cagr=6.3%), SP500TR factor=1.893 (cagr=6.7%)

24/10/17 BRK-B=$189.78, SP500TR=4989.56 at close, BRK-B factor=2.002 (cagr=7.3%), SP500TR factor=2.195 (cagr=8.3%)

 

For a counterfactual, looking at the timeframe from my own original purchase of BRK-B, BRK-B comes out well ahead, showing how the price you buy at matters, even though I didn't think I bought BRK-B especially cheaply, just reasonably cheaply, in my 2003 purchase when the market was working its way out of a bear market:

15/07/03 BRK-B=$ 31.24, SP500TR=1448.02 at open,  BRK-B factor=4.584

24/10/17 BRK-B=$189.78, SP500TR=4989.56 at close, BRK-B factor=4.584 (cagr=11.3%), SP500TR factor=3.446 (cagr=9.1%)

 

And of course, BRK-B only lagged the S&P500 by a little, so handily beat the fund of funds over the almost 10 years of the bet.

[Cigarbutt]

While we are on the bet aspect, here is a potentially interesting article about another aspect of Berkshire Hathaway.

 

https://www.fool.com/investing/2017/07/23/an-interesting-chart-about-berkshire-hathaway.aspx

 

What do you "see"?

 

-If you believe in cycles and occasional divergence from intrinsic value, BH may be well positioned to increase the distance of the two curves for some time. There may be circumstances when a Fort Knox type balance sheet will fetch a much higher value.

 

-If you believe in diminishing returns due to size, there will be an increasing tendency for the two lines to converge.

 

Buy, hold and prosper?

 

 

 

 

[Dynamic]

My personal impression is that Berkshire Hathaway's long-term internal rate of compounding, its forward rate of growth in Intrinsic Value (and by proxy, Book Value) is probably going to be around 8-12% for the next decade or two assuming general inflation of around 2%.

 

In other words, I could see it growing IV and BV at about 6-10% compound annual growth rate in real terms. The low end is perhaps if opportunities to deploy cash are rare, and the top end is if great opportunities arise to deploy large amounts of cash at highly attractive rates of return when the company is awash with cash, perhaps 2 or 3 times over 20 years.

 

I'd say that the SP500TR's growth rate over similar time scales is likely to be 5-9% assuming 2% inflation, or 3-7% CAGR in real terms (which I prefer to use for my calculations). Due to the long time scales, I'm thinking that changes in the ratio of Market Price to Intrinsic Value of the SP500TR would be negligible to the CAGR, though they could quite possibly have a -1% to -2% affect on Market Price CAGR over 20 years depending on interest rate and inflation environment, given that the market is arguably a little pricey right now. (0.99^20 = 0.82, 0.98^20 = 0.67, so I'm allowing for a reduction in general market multiples of maybe up to 33% over 20 years).

 

Looking into my crystal ball regarding the Market Price of Berkshire, I'd guess that the Market Price to Intrinsic Value ratio of BRK after 20 years might fall in the range of about 0.75x its current figure (-1.4% CAGR due to "multiple contraction") to 1.20x its current figure (+0.9% CAGR due to "multiple expansion"). It could also be a moderately bumpy ride, given that the death or retirement of Warren Buffett is virtually inevitable during the next 20 years, though I'd be very surprised to see market value drop below 1.1x Book Value or 1.2x Book Value for more than a few months, and would personally think such prices would be a steal even without Warren at the helm. Back in 2003, I thought it much more likely than not that Warren would still be in charge 10-15 years later. Now, I'd say it's a little more likely than not that he won't be in charge in 10 years, and very much more likely than not that he won't be in 15 years, but that doesn't materially affect my margin-of-safety valuation of BRK.

 

The recent past growth rate in Market Price of BRK isn't way above the growth rate in SP500TR (and sometimes dips below it), so people aren't likely to be 'excited' enough about BRK's prospects to pay anything like the premium they would have been willing to pay in previous decades. Likewise, the 1.2x Book Value provides a fairly well-known soft floor and valuation yardstick, so even amid stock-market turmoil I'd be very surprised to see BRK.B fall far below $145 at present (and that floor is likely to compound upwards at 8-12% per year, meaning it will catch up with the price you pay in a few years).

 

In a bear market the BRK look-through stock portfolio might decline, hitting reported Book Value a little more than Intrinsic Value and adding to potential price declines in BRK. Nonetheless I see the potential percentage market price decline in a bear market to be less for BRK than for SP500TR starting from present valuations, giving the opportunity to trade BRK for more deeply discounted stocks to enhance portfolio return.

 

That does make BRK look more attractive than SP500TR for me, and the graph shown seems to support the idea that SP500TR is potentially a little pricey right now, is likely to revert to mean at some point, and isn't such an attractive prospect in future.

 

Looking at the 5-year moving average 'alpha' graph from that Motley Fool article, I'd probably expect it to oscillate around an average of about 2-4% or so over the next 20 years, reflecting my view that BRK is likely to outperform SP500TR by about that amount on a CAGR basis over 20 years. In bull markets, BRK is likely to oscillate toward values below that range, and in bear markets and perhaps in recovery phases after a bear market, my guess is it will move above that range, subject to the time-delay on that moving average. This pretty much accords with the value investing ideas that we tend to outperform in bear markets and underperform in bull markets.

[Dynamic]

Speaking of Bull and Bear Markets and so on, I was riffling through the Motley Fool BRK board for interesting posts I hadn't been keeping up with.

 

One thread from August 2017 started with an article put out by a Fund Manager to say why the bull market isn't likely to end soon, which looks too much like cherry picking the data to suit your preferred conclusion to me (not that I'm calling an imminent bear market either - I'm simply saying I don't know, and that's why I'm staying invested to participate in the compounding of intrinsic value for quality companies priced below IV, but waiting to put new cash to work until I find compelling value).

 

Jim 'Mungofitch' - one of my favourite contributors on the Fool BRK board when I find the time to visit them - made an interesting reply about a metric he follows - trading days since latest market index High (he uses it more to avoid jumping in too early before buying on every little price decline than to really use momentum as a strategy rather than valuation and margin of safety).

 

http://boards.fool.com/i-was-hoping-to-see-someone-makes-a-post-related-32814108.aspx

 

I'll quote just a little, but click through to see his series of figures which present a remarkably smooth gradation relating Number of Days since broad-market high to the subsequent 6-month return of the market index (converted to annualised CAGR) excluding dividends. I'd love to have seen the standard deviation on those averages too, or the percentage of occasions the return was positive or negative for each line, but it seems a bit late to resurrect the thread.

 

Conversely, if you want a good signpost of the end of the bull market, my own suggestion is to see

how long it has been from the last time the S&P 500 hit a fresh recent high.

Lately = still a bull market, as now.

The longer it has been, the more likely the bull is over. You can put your "give up" line at maybe 4-6 months.

That seems like a long time, but almost all market tops are pretty rounded...typically you could

get out of the market several months after the index top and still look like a genius in the depths of the bear.

Phrased another way, it's extremely rare for the market to drop very much very soon after a fresh high.

Exuberance takes time to fade, it seems; the buy-on-every-dip crowd needs a few little rounds of negative feedback before they give up their habit.

 

There was another great post of his about the trading range of Berkshire Hathaway, which might be of interest to those wondering about the 'soft floor' of the buyback threshold and apparent upper bounds of the trading range.

 

He posted about a Decade Chart about a year-and-a-half ago at http://boards.fool.com/decade-chart-32224907.aspx linking to this interesting chart, showing how prices compared to various changing valuation metrics:

http://stonewellfunds.com/BuybackChart.jpg

 

And after 2017Q2 he posted about his latest 2.5 column valuation here: http://boards.fool.com/two-and-a-half-column-32801095.aspx

This shows 2017Q2 BVPS or BRK.A to be $182,814 and his 2.5 column valuation to be $280,490 (1.53x BVPS).

 

Today's price is $282,810, though 2017Q3 has ended and both valuations are likely to be elevated accordingly once the 10-Q comes out, but it's certainly looking like it's near the top of the trading range that has been evident since about 2006. That doesn't mean that BRK won't be a good long-term investment from here or that we should sell. The 2.5 column valuation is still a price that capitalizes earnings at 10% and it's only slightly above the average Price/Book ratio seen since year 2000. To quote 'mungofitch':

The "two and a half column" figure below uses 1 times investments per share + 10 times adjusted earnings before tax - .3 times float per share for the cash drag.

In the chart, the fall in Book Value and 2.5 Column Value lag slightly behind the market crash in 2008-9, which isn't shown, but is essentially at the same time BRK's market price drops. Both of these values incorporate the Market Price of the Securities Portfolio held by Berkshire Hathaway, so when the market drops suddenly, the next quarter's Book Value figure will be marked to market similarly.

 

There might also be other items marked to market such as those long-duration redeem-on-expiry derivatives that were repriced each quarter against various market indexes (under GAAP/FRS rules) despite being nowhere near expiry, causing the reported GAAP earnings and BV to fluctuate along with market swings. I think they looked at the time, when he received the premium in advance with no need to post meaningful collateral, to be a good bet on the future of stocks when many were fearful and wanting insurance against a decline over the next decade or more, and really underlined that Buffett thinks long term and doesn't care about quarterly numbers. This FT alphaville articles shows the mark-to-market's oscillating effect on reported earnings:

https://ftalphaville.ft.com/2013/12/19/1729152/the-buffett-difference-derivatives-edition/?mhq5j=e6

 

Anyway, I thought they were an interesting collection of posts, even though we might see BRK exceed mungofitch's 2.5 column value meaningfully if, for example, people are prepared to pay a good deal more than 10x earnings by capitalizing at lower rate of return, which is possible though certainly not a sure thing given the low interest rate environment.

 

Edit: Another question I'd have is trying to determine whether shock events would cause a more sudden market collapse after a recent market high, e.g. what if North Korea bombed South Korea or something similarly terrible? Sep 11 2001 isn't a simple example, as the markets had reach their bottom in roughly March 2001. I was able to make some great quality purchases at good prices in Oct 2001, but it was already a fairly bearish market after the dot-com exuberance disappeared. It's mostly academic interest. I'm not going to change my investing significantly based on geopolitical matters.

[Cigarbutt]

Dynamic,

 

I appreciate your posts. One of the reasons for participation on these boards is to improve.

 

Some of the ideas implied by the posts and related links help with that.

 

Your posts are also uncomfortable. My opinions sometimes differ. But you may be right.

 

My return assumptions for the Market as a whole over the next ten years are based on more restrained optimism. Counter-cyclical macro focus has worked for me in the last 20 years but that may change.

 

It’s a numbers game played in an animal spirits environment. Crystal ball versus the rear view mirror.

 

As you say the best answer is I don’t know. Still.

 

In the past, spent some time understanding the VaR concept. Not because I felt it was useful but because it seems that it was a fundamental flawed concept used by large financial players and which played a key role leading in the 2007-9 global liquidity crisis. A contention I make about present conditions is that the future may not look like the past and one may have to discount the possibility of thunderstorms even in sunny skies.

 

One of the concerns I have is the disconnect between the average Joe and the privileged top. On this Board, there are discussions about the real estate environment. There’s a description of a real estate deal for a house in Vancouver and I try to connect that story with what my nephew (average Joe) is experiencing.

 

Here’s a link.

http://www.mymoneyblog.com/hours-work-required-to-buy-sp-500.html

 

As one of your suggested links implies : « as with any chart, there is a clear and present danger of reading too much into it. » and the warning may be particularly relevant for this last link but, still, this raises interesting questions.

 

Maybe, the chart shows an artificial and irrelevant correlation. Maybe we will just muddle through. Maybe wages will eventually catch up. But maybe there is the possibility that the imbalance disappears through a lower level for the S&P. It’s happened before.

 

Keeping in mind the discount of various possibilities these days, I submit that cash has value and firms with strong balance sheets and enduring strength such as Berkshire Hathaway also.

 

Maybe I just need to get rid of concerns. Not there yet.

 

[Dynamic]

Thanks, Cigarbutt.

 

I appreciate the opportunity to discuss ideas and modes of thinking and listen to others with their own ideas and approaches and hopefully learn from them.

 

I specifically chose to mainly focus on a 20 year horizon for my 3-7% above inflation estimate because I'm a little wary about the next 10 years being affected by a bear market, though I don't know when.

 

I don't feel I have any real ability to predict macro events, particularly with regard to timing, though I'm aware that there will be cycles of bear markets and bull markets, recessions and booms, and I do have some sort of feeling of where we might be in the cycle but with very low certainty, especially with regard to timing. I'd be interested to know how your counter-cyclical macro focus has worked for you over time and how you use it to make decisions.

 

Likewise, inflation and interest rates may vary, and I feel I have little ability to predict them. My tendency is to seek a return of around 10%+ p.a. from my purchase price to give a decent margin of safety, but I could change that if rates increase dramatically.

 

That lack of forecasting ability makes me particularly reluctant to switch to cash in a big way if my positions are not overvalued, especially if I expect them to be compounding machines.

 

For example, that logarithmic graph from mungofitch that I posted above showing the changing buyback threshold (blue line, now 1.2x BV, but 1.1x BV in ) and mungofitch's ceiling 2.5 column value and 1.55x BV lines (yellow and green lines) show that a price at the high valuation marks in 2013 is reached by the buyback threshold in 2016 (roughly three years). So even with today's BRK.B price at 1.58x BV (using Q2 BV), just above the yellow line (although BV will be adjusted upwards for Q3 shortly, likely making today's price look nearer to the yellow line). I wouldn't be surprised if we found that the buyback threshold around year 2020 Q2 or Q3 is about today's price of $188, a 32% increase, representing something like 9.5% cagr in buyback threshold and implying that the chance of losing money over 3 years would be modest. Of course, a bear market will see a mark-to-market decline in Book Value, so perhaps a little over 3 years - perhaps 4 or 5 - might be required to break even if there's a bear market.

 

The question of how likely do I think a bear market or a significant decline in BRK.B is over the next 3 years then seems to be relevant to the question of whether I think I should sell some or all of my BRK.B and go to cash.

 

I do think that a decline to perhaps 85-90% of today's levels (roughly $160 to $170) has a realistic but not overwhelming probability in the next year, and a decline to as low as 77% ($145 - my rough estimate of 1.2x BV for 2017Q3) is pretty unlikely unless we have a bear market in the next few months or something happens to Warren. Otherwise, I could see 1.2x BV exceeding $150 within about 6 months from now, making $145 really very unlikely to ever be seen again.

 

If BRK at $145 to $150 were available now, I would almost certainly go back to a 100% BRK.B weighting in my portfolio (currently at 56%) unless I had to sell something even more undervalued to do so, at least.

 

Perhaps contrary to what I've been posting in this thread lately, I tend to try to view my portfolio usually from a mildly pessimistic view based on my own "low-end valuation" which is a figure I estimate based on fundamentals, more than the market price. I do that especially when I project my future returns. I usually assume that the low-end valuation of my portfolio will grow at 3.5% above inflation in the long term (hopefully not an unreasonable expectation, especially given that the Low-End Valuation of my portfolio is currently 74% of the Market Valuation and that BRK seems to be growing Book Value at about 8-10% in recent times, albeit assisted by a run up in mark-to-market gains on stocks held). That Low End might decline somewhat in the short term, especially if the low-end valuation of a particular stock is based on a multiple of unusually depressed earnings, less so for the portion based on 1.2x Book Value of BRK.B, but I'd hope it's a more consistent estimation of real value than a market price affected by the emotions of Mr Market.

 

However, when considering whether to sell, I'm either:

• looking to obtain a lot more value by switching from a more fully valued stock to a cheap one (and thus, usually to increase my low-end valuation as well as my expected intrinsic valuation)

• or I'm considering that it seems a bit pricey even in a moderately optimistic scenario, and thus I should lighten up my position or sell the lot.

• ...or if I felt I could predict it, I might sell now in the anticipation of buying back considerably cheaper in the future.

 

So, sometimes I will consider the 'average expectation' of what my stocks could be worth, or even an 'optimistic' valuation, as well as the 'low end' valuation which is closer to my 'buy price' where I think the margin of safety is high, the probability of permanent loss of capital is low, and the probability of outsized returns is fairly high.

 

But I am somewhat reluctant to give up fairly certain attractive long-term gains (e.g. BRK's compounding machine applied over a decade or two) for the hope of juicing my returns by trading in and out.

 

I have done some value-trading however, selling a large chunk of my BRK.B stake in May 2016 at $142 to take a 25% position in AAPL at $95, which I felt was the maximum exposure I could take in AAPL. Apple is up 76% and BRK.B is up 33% since then, giving a 43% apparent advantage to having made that trade to date (based on Market prices alone). It might not take too much decline in BRK.B or too much increase in AAPL to consider the gap in my perception of value to be sufficient, and the increased security against loss in holding BRK.B to be worth a partial or complete switch out of my AAPL position into BRK, even if I still think they're both somewhat undervalued.

[Cigarbutt]

"I'd be interested to know how your counter-cyclical macro focus has worked for you over time and how you use it to make decisions."

 

Common themes:

-no forecasting or timing ability

-essentially  bottom up, looking for long term compounders

-anchor holdings

-concentrated investments

 

Differences:

-very conservative intrinsic value appraisal

-very large requirement for margin of safety

-will tend to sell securities when IV reached (deep value and event driven stuff)

-have adjusted positions in core holdings, with a net advantage even with tax effect included

-Have not held BRK as I continue to assume that I will do better…

-often high cash balance

-so far absence in the markets more than compensated by opportunistic dipping

-when cash reach high balance, still look at an expanding opportunity set but time spent looking at macro side, otherwise the macro stuff is just for fun

-comfortable contrarian with what seem to be very awkward positions at times

 

In terms of cycles,

-went through the dot-com bubble with a conventional portfolio and no hype stocks

-coincidentally in 2007-9, went all in with leverage

-now back to similar profile as in 2006-7

 

Now,

Trying to expand opportunity set

Debating if high cash level is because I’m wrong or because the Market is wrong

Mostly long term optimist

Hoping to opportunistically invest in 5 to 7 holdings for the long run and keep cash balance at less than 5%

 

 

 

 

 

[Dynamic]

Thanks. That's very interesting. I hadn't really got my ideas together at the time of the dot com boom/bust. And I think I may be lacking in high conviction ideas though I dare say I could come up with 5 to 7 given a bear market and much lower prices in general now that I'm back to investing more actively now. I suspect I'd go in holding quite a lot of BRK and accept a decline, but hopefully smaller than the general market decline, then trade into more deeply undervalued positions I feel I understand. I should probably prepare by studying and valuing more companies that I'd like to own ahead of time. No doubt I'll find out soon enough, and if I haven't prepared sufficiently to take advantage I expect I'll be able to earn a more than sufficient return to retire securely through my position in Berkshire alone.

 

 

[Cigarbutt]

From Seth Klarman:

 

"You might think that the increasing percentage of investor funds managed by professional ("professional"?) money managers would serve as a check on market excess. If you did, you would be seriously wrong. Very few professional investors are willing to give up the joy ride of a roaring U.S. bull market to stand virtually alone against the crowd, selling overvalued securities without reinvesting the proceeds in something also overvalued. The pressures are to remain fully invested in whatever is working, the comfort of consensus serving as the ultimate life preserver for anyone inclined to worry about the downside. As small comfort as it may be, the fact that almost everyone will get clobbered in a market reversal makes remaining fully invested an easy relative performance decision. Isn't this what always happens at the top of historic bull markets? The answer, of course, is of course.

 

Investors and the financial media, always eager to grasp at straws, however slim and brittle, jumped on the year-end shareholder letter of legendary investor Warren Buffett as fodder for the bull case. The Dow immediately rallied 200 points. What Buffett, Chairman of Berkshire Hathaway, said is that at today's level of interest rates, and assuming prevailing levels of corporate profitability, in his view U.S. equities as a whole are not overvalued (and, just as assuredly, not undervalued.) Virtually no one explored his real message, equally prominent, suggesting that today's unprecedented level of corporate profitability may well be unsustainable; future profits may fall far short of today's lofty expectations. The U.S. stock market is extremely vulnerable to disappointments; nothing short of perfection is built into today's prices. And Buffett confesses that it has become increasingly difficult for him to find bargains in the current market environment."

 

That was in 1998.

 

From the Oracle:

 

"Today's price levels, though, have materially eroded the "margin of safety" that Ben Graham identified as the cornerstone of intelligent investing."

 

Also from 1998.

 

I'm not saying that markets are overvalued.

I'm just asking: Is this time different?

 

[KinAlberta]

Jeremy Grantham has also spoken up a few times about the problem professional managers face in having to satisfy their clients by capturing every last percent of the upside while protecting capital.

 

 

Five!!! Five (5) years of fishing.  :-)

 

bolding is mine:

Warren Buffett--In 1974

 

Swing, You Bum! 

 

Buffett is like the legendary guy who sold his stocks in 1928 and went fishing until 1933. That guy probably didn't exist. The stock market is habit-forming: You can always persuade yourself that there are bargains around. Even in 1929. Or in 1970. But Buffett did kick the habit. He did "go fishing" from 1969 to 1974. If he had stuck around, he concedes, he would have had mediocre results.

 

https://www.forbes.com/2008/04/30/warren-buffett-profile-invest-oped-cx_hs_0430buffett.html

http://csinvesting.org/wp-content/uploads/2016/03/2_Buffett-and-Graham-Call-the-1974-Market-Bottom.pdf

 

[