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What if the cost of capital never rises again?


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Will “real” assets remain permanently undervalued relative to brand and intellectual capital forever?

 

Will the entire business of securities analysis institutionally restructure itself to account for this new reality, prizing other facets of a corporate issuer of securities more highly than projected cashflows and balance sheets?

 

There are no asset managers who represent their strategy to clients as “We buy the most expensive assets, and add to them as they rise in price and valuation.” That’s unfortunate, because this is the only strategy that could have possibly enabled an asset manager to outperform in the modern era. It’s one of those things you could never advertise, but had you done it, you’d have beaten everyone over the ten-year period since the market’s generational low.

 

https://thereformedbroker.com/2019/06/13/when-everything-that-counts-cant-be-counted/

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Its an interesting scenario. I've argued for a really long time that the market isn't really expensive all things considered, people are just looking at things the wrong way. In the spring/summer/fall, I do a lot of fishing. When I go out, I always have a cooler with me for drinks and whatnot. Doing this, I would invariably run through a lot of ice. Spending $2.25 for an 8lb bag will take a long time to add up, but in time it will. Nonetheless I started thinking, and honest to god truth, Yeti coolers are the only coolers that ACTUALLY do as advertised and keep things cold for 6+ days. All the others say they do, but you're lucky to get 24 hours out of them. If in the course of a week I go out 5x, and instead of buying ice 5x, buy it 2x, the payback period is not that long and its actually quite beneficial. So, I was able to find a value proposition in a $250 cooler that my entire life I had thought was grossly overpriced.

 

Your last paragraph is an example of that. Managers are using the wrong tools to evaluate some of these great businesses. Much like Buffett has said about missing Google.

 

Its not, "we buy the most expensive assets and add as they go up", it is "we buy tremendous businesses and they appreciate at a greater rate than crummy ones".

 

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Its an interesting scenario. I've argued for a really long time that the market isn't really expensive all things considered, people are just looking at things the wrong way. In the spring/summer/fall, I do a lot of fishing. When I go out, I always have a cooler with me for drinks and whatnot. Doing this, I would invariably run through a lot of ice. Spending $2.25 for an 8lb bag will take a long time to add up, but in time it will. Nonetheless I started thinking, and honest to god truth, Yeti coolers are the only coolers that ACTUALLY do as advertised and keep things cold for 6+ days. All the others say they do, but you're lucky to get 24 hours out of them. If in the course of a week I go out 5x, and instead of buying ice 5x, buy it 2x, the payback period is not that long and its actually quite beneficial. So, I was able to find a value proposition in a $250 cooler that my entire life I had thought was grossly overpriced.

 

Your last paragraph is an example of that. Managers are using the wrong tools to evaluate some of these great businesses. Much like Buffett has said about missing Google.

 

Its not, "we buy the most expensive assets and add as they go up", it is "we buy tremendous businesses and they appreciate at a greater rate than crummy ones".

 

I think the main issue is it's very difficult to decide whether a stock price is irrational or not. Greg I think you are right to an extent when you say we are not looking at things in the right way. But what is the right way? If you can't go by fundamentals all you're left with is human psychology. That is difficult to quantify.

 

As to your cooler I have a Coleman cooler from the 90's that keeps ice for about 5-6 days. Use it frequently :p Also, Walmart sells a knockoff Yeti and so does RTIC.

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Its an interesting scenario. I've argued for a really long time that the market isn't really expensive all things considered, people are just looking at things the wrong way. In the spring/summer/fall, I do a lot of fishing. When I go out, I always have a cooler with me for drinks and whatnot. Doing this, I would invariably run through a lot of ice. Spending $2.25 for an 8lb bag will take a long time to add up, but in time it will. Nonetheless I started thinking, and honest to god truth, Yeti coolers are the only coolers that ACTUALLY do as advertised and keep things cold for 6+ days. All the others say they do, but you're lucky to get 24 hours out of them. If in the course of a week I go out 5x, and instead of buying ice 5x, buy it 2x, the payback period is not that long and its actually quite beneficial. So, I was able to find a value proposition in a $250 cooler that my entire life I had thought was grossly overpriced.

 

Your last paragraph is an example of that. Managers are using the wrong tools to evaluate some of these great businesses. Much like Buffett has said about missing Google.

 

Its not, "we buy the most expensive assets and add as they go up", it is "we buy tremendous businesses and they appreciate at a greater rate than crummy ones".

 

+1

 

Take a look at the sample of companies where investors have found large margin of safety:

 

Loews

Seaspan

FTP

Sandridge

Sears

Fairfax

Altius

St. Joe

 

The common pattern is they get a large net asset value and market price is at a fair bit of discount to that. This gets many investors excited, they see a large margin of safety, stupid market, etc..

 

The thing to focus on is to look out a few years and see what the earnings are going to be. Maybe 5 years or 10 years. Focus on where the earnings are going to be. Those are the fundamental drivers of a business.

 

Not what discount you are getting to current net asset value.

 

OK. This is the easy one.

 

Take the case of some companies that are currently experiencing problems.

 

You would say, I do look out over the next few years and I am going to capitalize the earnings of the business when they normalize. Fine.

 

Except that many of these businesses are in industries that are getting disrupted.

 

And you do not want to invest in any company that does not sell for less than 10x earnings.

 

So a large portion of the investment universe is out of bounds.

 

I would suggest to look at where value is actually being created.

 

Vinod

 

 

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I think the thing is to understand the fundamentals, but also be aware of the context. If you look some of the great long term compounders, in hind site they are easy to see. Duh. But what is easy to see is also capable of being extrapolated and applied to ones search for current companies with those characteristics. Google, again, just using it as an example, is a dominant, one of a kind company, regardless of where we are in the grand scheme of things, and will be, with almost 100% certainty, in the future. So now that I've determined this to be my foundation for owning a name, next up is price. Which at the end of the day, for a high caliber, established and dominant company, IMO(and I say this with a lot of caution for myriad reasons), is not really all that important in the grand scheme of things; all things considered. Why? Look at how long people have been talking about Amazon being overvalued(I am one of those people). Plot that chart and tell me how many times you could have bought it and how many times, over the long haul, you would have regretted it? Draw downs are just part of the markets glorious opportunity. You could have bought Apple before the GFC, Priceline during the tech bubble, etc. With proper risk management(averaging in slowly, a bit of diversification, continued diligence making sure you continue to own quality) the odds of getting hurt are very, very, small, if not, dare I say, almost nonexistent. Versus just sitting on a large pile of cash and being the grumpy old man that complains about why things are so expensive... It always makes sense to own great assets. The prices paid for them changes with the times. If you stay flexible with your ability to adjust(going overweight/underweight) as the price paid changes, you will make out quite well. But I have a hard time convincing myself it EVER makes sense, not to own ANYTHING of a great company.

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Its an interesting scenario. I've argued for a really long time that the market isn't really expensive all things considered, people are just looking at things the wrong way. In the spring/summer/fall, I do a lot of fishing. When I go out, I always have a cooler with me for drinks and whatnot. Doing this, I would invariably run through a lot of ice. Spending $2.25 for an 8lb bag will take a long time to add up, but in time it will. Nonetheless I started thinking, and honest to god truth, Yeti coolers are the only coolers that ACTUALLY do as advertised and keep things cold for 6+ days. All the others say they do, but you're lucky to get 24 hours out of them. If in the course of a week I go out 5x, and instead of buying ice 5x, buy it 2x, the payback period is not that long and its actually quite beneficial. So, I was able to find a value proposition in a $250 cooler that my entire life I had thought was grossly overpriced.

 

Your last paragraph is an example of that. Managers are using the wrong tools to evaluate some of these great businesses. Much like Buffett has said about missing Google.

 

Its not, "we buy the most expensive assets and add as they go up", it is "we buy tremendous businesses and they appreciate at a greater rate than crummy ones".

 

+1

 

Take a look at the sample of companies where investors have found large margin of safety:

 

Loews

Seaspan

FTP

Sandridge

Sears

Fairfax

Altius

St. Joe

 

The common pattern is they get a large net asset value and market price is at a fair bit of discount to that. This gets many investors excited, they see a large margin of safety, stupid market, etc..

 

The thing to focus on is to look out a few years and see what the earnings are going to be. Maybe 5 years or 10 years. Focus on where the earnings are going to be. Those are the fundamental drivers of a business.

 

Not what discount you are getting to current net asset value.

 

OK. This is the easy one.

 

Take the case of some companies that are currently experiencing problems.

 

You would say, I do look out over the next few years and I am going to capitalize the earnings of the business when they normalize. Fine.

 

Except that many of these businesses are in industries that are getting disrupted.

 

And you do not want to invest in any company that does not sell for less than 10x earnings.

 

So a large portion of the investment universe is out of bounds.

 

I would suggest to look at where value is actually being created.

 

Vinod

 

Many here would rather own those listed companies, because the understanding of being a badge wearing "value investor", is buying shitty companies, or at best, ones with questionable fundamentals, at a big discount to IV(while forgetting that maybe, just maybe, that discount is warranted)

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A simplified conceptual way to make money with investments is either to buy cheap stuff and sell it when it gets to intrinsic value or to pay a reasonable price for stuff that will grow intrinsic value over time. The initial article which refers to William Bernstein alludes to the cost of capital.

 

A possibility is that the wall of cheap money is larger than the wall of worry and, intuitively, this suggests a tendency for general valuation levels to rise and a necessary forward-looking underlying assumption is that the cost of capital needs to continue to be low.

 

Cheap capital or cheap money either means the crowd is getting brighter or dumber and I would submit that the jury is still out.

http://www.efficientfrontier.com/ef/adhoc/coc.htm

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"Here’s the perfect business idea for this environment: Open a Hundred Dollar Bill Store™. You sell hundred dollar bills for ninety dollars each. You’ll lose ten dollars per transaction but you’ll do a trillion in revenues in year one. Maybe you show an ad to everyone who walks into the store and you break even. User growth with be on the order of 1000% per month. A billion users. You’ll be the biggest IPO of all time when Goldman’s underwriters get wind of that growth rate. Go public and let someone else worry about a competitor selling hundred dollar bills for eighty-five."

 

That was called MoviePass  ;D

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"Here’s the perfect business idea for this environment: Open a Hundred Dollar Bill Store™. You sell hundred dollar bills for ninety dollars each. You’ll lose ten dollars per transaction but you’ll do a trillion in revenues in year one. Maybe you show an ad to everyone who walks into the store and you break even. User growth with be on the order of 1000% per month. A billion users. You’ll be the biggest IPO of all time when Goldman’s underwriters get wind of that growth rate. Go public and let someone else worry about a competitor selling hundred dollar bills for eighty-five."

 

That was called MoviePass  ;D

 

Moviepass?  That is funny!  I had a couple of different names in mind!

 

if the cost of capital were a few percentage points higher, a lot of these megabillion dollar companies losing money never would have gotten any traction.  The investment environment would look a lot different today.

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The answer is in Josh Brown’s newest article https://thereformedbroker.com/2019/06/13/when-everything-that-counts-cant-be-counted/?utm_source=dlvr.it&utm_medium=twitter.

 

There are no asset managers who represent their strategy to clients as “We buy the most expensive assets, and add to them as they rise in price and valuation.” That’s unfortunate, because this is the only strategy that could have possibly enabled an asset manager to outperform in the modern era. It’s one of those things you could never advertise, but had you done it, you’d have beaten everyone over the ten-year period since the market’s generational low.

 

 

Spoiler alert: This is ultimately unanswerable, but we will know more after the next recession.

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The answer is in Josh Brown’s newest article https://thereformedbroker.com/2019/06/13/when-everything-that-counts-cant-be-counted/?utm_source=dlvr.it&utm_medium=twitter.

 

There are no asset managers who represent their strategy to clients as “We buy the most expensive assets, and add to them as they rise in price and valuation.” That’s unfortunate, because this is the only strategy that could have possibly enabled an asset manager to outperform in the modern era. It’s one of those things you could never advertise, but had you done it, you’d have beaten everyone over the ten-year period since the market’s generational low.

 

 

Spoiler alert: This is ultimately unanswerable, but we will know more after the next recession.

 

That used to be called momentum investing and it was an acceptable strategy for a while. It’s still done by computers. The managers just don’t state it quite like that.

 

I read an interview with an investor lately who does arguably just this, but states it more like a value investor would — the companies will earn XX in five years and be worth YY so it’s undervalued — but strip away the verbiage, and he owns a group of unprofitable companies trading at massive valuations that are constantly increasing, in the hope that they’ll go higher. It’s just not saleable as momentum investing anymore.

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