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

[Dynamic]

Wise words indeed in the last 2 posts.

 

Are things different this time?

I think some things are different, but not enough things to make me comfortable with the general level of market prices. And there are definitely things that make me nervous about the economy in this historically unusual period.

 

For example, looking back over many decades, things are different now. We have interest rates at historically low levels and inflation at much more modest levels than most periods since the industrial revolution. We've had vast amounts of Quantitative Easing - has this merely delayed necessary adjustments to how economic participants behave? We have demographic changes too, including people living far longer past retirement, perhaps retiring later too, and lower birth rates in most countries than in the past.

 

So looking over really long term historical charts, such as Shiller PE (CAPE), one has to be careful not to read too much into how the last 30 years have consistently seen CAPE well ahead of earlier averages when interest rates and inflation were very different. However, today's 31.56x level is clearly unusually high, albeit that it has risen higher in the past, and PE at 25.79x is also very high, especially if reported earnings are somewhat inflated above economic earnings or are juiced by the effects of cheap debt. Price/Sales at 2.20 at present is also worryingly high. It does seem that many market participants are projecting a rosy future or are seeking to jump into what has worked recently.

 

I'd be quite uncomfortable holding, and very uncomfortable buying, stocks at such levels of PE unless I knew that profit was artificially depressed due to aggressive expansion cap-ex or something that was both producing growth in profitability and depressing current reported EPS (e.g. something like Amazon, on which I think I've missed the boat) such that my purchase price expressed as a multiple of non-growth earnings was much lower. I imagine it would be a stretch for me to buy companies at 15x normalised earnings, let alone 25x unless there's an exceptional reason, given that I'm seeking a substantial margin of safety.

 

I'm also uncomfortable with certain sectors, such as Oil/Gas or Coal, unless priced very low, given that I can envisage that they could within a few years quite possibly enter a phase of inexorable, if admittedly gradual decline (at which point prices might become attractive from time to time) as more and more things such as power generation and modes of transport reach a cross-over where renewable energy+storage and battery electric vehicles in particular become lower cost first in terms of total-cost-of-ownership, then even in initial purchase cost in various situations. While this wouldn't wipe out the existing base of customers at once, new plant & new vehicles could decline rapidly, and we could see the installed base decline a lot over a decade or two with potentially severe impact on the market price of these fuels.

 

I think the general level of markets is rather pricy for my tastes - in that it offers a low earnings yield - especially given the run up since 2016.

 

My core individual positions, however, are not, in my opinion, egregiously overvalued - perhaps closer to fair value, particularly as I believe them to be superior companies to the general market. However, there are no tax implications if I sell, so I am fairly free to sell positions when they get pricy without worrying about giving up.

 

Indeed I sold a great core holding, Halma plc at a P/E of 28.8 using the proceeds and cash held to go almost 100% Berkshire at 1.24x BV in Feb 2016. Despite the switch from a highish P/E to a very cheap P/BV, I'm actually only showing a 15.0% relative gain on that trade at present (and a little less if I include dividends foregone), as Halma's P/E is now an eye-watering 35.9 and its foreign earnings converted to GBP received a one-off boost by the increase in USD:GBP, EUR:GBP and other exchange rates after the Brexit vote to match the one-off 'gains' I made by having a portfolio invested in USD but converted to GBP at that time. I expect HLMA's underlying compounding rate to be similar to Berkshire's long term, perhaps a fraction lower, but surprisingly consistent, and would gladly buy back in if it reaches much lower P/E ratios in future. In comparison, I cannot see Berkshire declining as far as Halma could from here in a bear market, and I can see Berkshire benefiting from the cheap asset prices during such a bear market much more than Halma which does not look for opportunities in so many places.

 

I also hold a lot of AAPL. At a trailing 12 month P/E of 19.0x (17.3x excluding cash per share, so an earnings yield of 5.3%-5.8%) it isn't unfeasibly pricy and lags the market P/E. It clearly has room to decline in a bear market, but it also has a good chance of very strong earnings in the year ahead, I believe.

It's at a price where I can easily imagine it showing a substantial gain within the next year, especially if earnings are indeed strong. Should it do so, I will certainly have to consider whether I can justify holding it at all, or at least lightening my exposure, either switching to something else, or holding cash. On the other hand, a bear market or economic crisis could see a substantial decline too, perhaps to as little as 60% of current prices, wiping out most of my paper gains if I hold on.

I also have a hard time estimating AAPL's compounding rate long-term, so this makes me want to limit my exposure especially as it gets more fully valued. I think it's moat is more durable than Nokia and Blackberry and my purchase price was sensible, but the higher the price goes, the more I am concerned that I would rather put that money somewhere else where I'm less exposed to potential loss.

 

So, yes I'm nervous about the market and I'm prepared that I might see some red on my portfolio some time soon. But I'm not quite convinced I should sell either of my main holdings either.

[Dynamic]

I have a modest correction to make to some things mentioned in previous posts on these boards. I have on occasions referred to my original purchase of BRK.B (old) on 15 July 2003 at the post-split equivalent of $31.24 USD which I stated was not purchased at a huge margin of safety, but a fairly modest discount to IV. I track this purchase and compare it to the S&P500 Total Return index.

 

An error has made me overstate my CAGR by about 1.4%.

 

Having looked at a historical chart, this didn't look right and I've gone back to my annotated Ledger to check and realised this was in fact an error. The equivalent price post-split was $49.71 USD, and £31.24 GBP was the figure I'd used because I was comparing the price converted to GBP today with the price in GBP at time of purchase forgetting about the exchange rate change since 2003. The SP500TR figure I use was in USD all along. (My pre-split purchase price for BRK.B_OLD was £1,562.88 GBP or $2,485.42 USD at 15 Jul 2003 exchange rates and the 50:1 split happened in 2010)

 

The decline in GBP (and strengthening of USD) since that time (USD:GBP has risen from 0.6284 to 0.7626), means that my returns expressed in USD over that time are slightly lower, and my outperformance of the S&P500TR from that tranche of BRK.B stock is lower too.

 

I've now ensured I adjusted for exchange rates at beginning and end, and now show about 0.64% outperformance of the S&P500 Total Return Index in either currency. The London Stock Exchange FT All Share Index (not a Total Return Index) is also shown, but the dividend effect should add at least 2-3% .

 

15/07/2003 - 02/11/2017 performance of Original tranche of BRK.B

    BRKnow/2003  CAGR | SP500TRnow/03  CAGR Outperf | FTAS(noTR)/03  CAGR Outperf

>USD 3.74733454  9.68% | 3.445877819  9.04%  0.64%  | 1.689186155  3.73%  5.94%

>GBP 4.54729521  11.17% | 4.181671811  10.52%  0.65%  | 2.049875967  5.15%  6.02%

 

I had previously compared the 11.17% CAGR, now on the second line, to the 9.04% CAGR on the top line in error, which was influenced more by +21% cumulative currency effects than by the +8.8% cumulative advantage that BRK has had over an ideal, cost-free, tax-free SP500TR tracker in those 14 years.

 

The dividend reinvestment effect for S&P500 is also worth pointing out.

 

Staying in USD for simplicity, using SP500CG to denote Capital Growth without dividends reinvested:

The SP500TR has grown 3.45x over 14¼ years or so = 9.04% CAGR

The SP500CG has grown 2.57x over 14¼ years or so = 6.83% CAGR

 

The dividend effect has added about 2.22% to the CAGR over that time period.

 

The FT All Share CAGR would probably need something around 2.0-2.5% added to give the Total Return CAGR - but historic data from 2003 on the Total Return Index is harder to come by for the FT All Share, so I haven't located accurate figures.

 

Anyway, sorry if my incorrect figures misled anyone.