How much and how fast will it go back up?

[Guest misterstockwell]

Stock, I'm guessing you were probably not down 50% like many other value managers in 2008.  And if you weren't, did you achieve that result without hedging, shorting or market puts?  Was it done simply by being long on quality businesses at great prices for the long-term?  And having 50% in Fairfax doesn't count.   ;D  Cheers! 

 

No, we weren't down anywhere near that much. Why? Well, taking a page from Fisher's book, we sold our largest position after 10 years because management changed the focus of the company, which I thought a poor choice(it was a 10-bagger). That was January 2008, and I didn't find anything substantial to invest in until October. We still own some Qualcomm bought in 1998, with a basis of maybe a $1 or so. The biggest mistakes I have made came from smaller positions in companies that didn't have unique businesses, or that I didn't do enough "scuttlebutting" on. Too many of those for sure, and not enough of the stocks that I had total confidence in. Different means to the same end for all of us.

 

Take care.

[oec2000]

Let me try to bridge the gap between the two camps on this issue. I'll refer to the camps as Jack's and Sanjeev's (Jack, just fyi, around here, it sounds a bit strange to address Sanjeev as "Parsad.")

 

Firstly, the gap is not all that wide since both camps come from the same Graham-Buffett value school.

 

Secondly, let us not forget that Buffett, while still crediting Graham for shaping much of his investing philosophy, has broken loose from strict Grahamian principles. This is what seems to separate Sanjeev's camp from Jack's camp; the former leaning towards the "Graham and earlier-Buffett (pre-Fisher)" style; and the latter more firmly in the "later-Buffett post-Fisher" style.

 

Under the circumstances, I would have thought that both camps would be able to empathise with each other's views.

 

What Jack is proposing is perfectly reasonable. If you find an investment that you believe can indefinitely meet your return objectives, then you should not sell it even if from time to time Mr Market exuberrantly overvalues it. The logic is clear. At the point of entry, you must have worked out that the investment will, with an adequate margin of safety, provide you with your desired return. If that is the case, there is no need to try and juice up your returns by trading in and out of the stock. In fact, you shouldn't because in doing so, you expose yourself to reinvestment risk.

 

(Sanjeev, your FFH example does not prove anything - you are giving an example that you know worked out with the benefit of hindsight. Many, if not all, of us have experienced the anguish of selling out of a position with the intention of getting back in cheaper only to miss out on a multibagger. I would imagine that there are many BRK or MSFT stories like this. Personal e.g.: I sold Singapore Exchange (SGX) at $4 for a quick double because it went to almost 40x earnings; it kept on going up to $16. Today, even after this bear of a market, the price is still above $4.)

 

To use a "business-style" investing example, say, you decided to invest in a factory because of its projected 20% IRR over 15 years. If after one year, it is performing in line with expectations and someone offers to buy it off you at 2x your original cost, do you sell it? If you do, you expose yourself to reinvestment risk - you might not find something with an equally good return or worse still you might make a bad decision on your next investment.

 

Bear in mind what Buffett has said about how difficult it is to find truly outstanding investment opportunities and you will understand his, and Jack's, reluctance to trade out of such investments for a relatively small and uncertain short term profit. Such a strategy might maximise your gains but it is definitely not optimal to achieving your investment objectives.

 

Sanjeev, of course, introduces the very practical matter of human psychology and emotion, especially in the context of managing OPM. While we can agree on the theoretical wisdom of buy and hold Buffett-style, the reality is that the theory has to survive real world implementation. In the real world, 99+% of investors do not have Buffett's temperament. Add the fact that we don't have the same investment abilities as him (which helps him reduce the volatility of his returns) and we are left with a situation where we may have to opt for the less than optimal buy and trade strategy that Sanjeev advocates.

 

I do the same because I do not like extreme volatility but I do it accepting that I probably will end up with sub-optimal returns. However, I am happy to accept lower returns as a trade-off for the lower volatility. I can understand this part of what Sanjeev is saying in respect of the funds he is managing. What isn't clear is whether Sanjeev's camp is suggesting that buy and trade can actually provide better returns in the long run. To this, I would say we should look to the example of the succesful investors we admire (Watsa, McElvaine, Chou, Cundill, etc) - the evidence is overwhelmingly in favour of buy and hold, imo.

 

One last point. Someone mentioned that since we make buy decisions based on the difference between price and value, we should logically make sell decisions on the same basis.

 

If this strategy were workable in practice, why are there so few successful "value short sellers" and why do so few of the super value investors use long-short strategies? It is because a) the markets can stay irrational for longer than we can stay solvent, b) upside and downside risks are not symmetrical, and c) good businesses have strong growth bias. If we buy a stock and the price goes against us, the improving fundamentals will eventualy bail us out; if you sell out of a stock and the price keeps on going higher, the fundamentals work against you.

 

In summary, I think buy and hold makes sense but buy and trade is a necessary evil (for most people); we also need to consider the evidence more carefully before concluding that buy and trade will provide better returns in the long run. (Buy and hold seems bad only in the light of very recent experience. Can we conclude purely on this basis that buy and hold is dead? How is this different from those who conclude that Buffett (or McElvaine or Chou) is history? Why not, "Equities are dead"?)

[Guest ericopoly]

I would like to frame it as logic:

 

Here is my assertion:

To hold at any price is to buy at any price.

 

Reasoning:

Selling at any price, and getting back in the next second at that price is no different from holding.  Thus, holding is no different from buying after being in cash.

 

Holding is buying, and therefore holding at any price is buying at any price.

 

Hope that helps,

Eric

 

 

Here is a joking thought.  If greater fool theory is paying too much only to hope that somebody else pays more, then value investing is the lesser wise man theory.

[tooskinneejs]

"Someone mentioned that since we make buy decisions based on the difference between price and value, we should logically make sell decisions on the same basis.  If this strategy were workable in practice, why are there so few successful "value short sellers"..."

 

Your response doesn't answer the question.  So I'll pose it once again, this time more directly:  Why does "holding no matter what" make more sense than "making sell decisions based on the difference between price and value?"

 

"In summary, I think buy and hold makes sense but buy and trade is a necessary evil..."

 

Funny that you refer to a decision other than "hold no matter what" as "trading."  Again, is there some kind of virtue in "holding no matter what" that I'm missing here?

 

 

[Parsad]

Very good post Oec2000!  I think you straddled both camps well.  You should work for the U.N.!   ;)

 

What isn't clear is whether Sanjeev's camp is suggesting that buy and trade can actually provide better returns in the long run. To this, I would say we should look to the example of the succesful investors we admire (Watsa, McElvaine, Chou, Cundill, etc) - the evidence is overwhelmingly in favour of buy and hold, imo.

 

To answer that question for you, three of the four are very good friends of mine and whom I consider my mentors.  The fourth was a friend and mentor to one of them.  Those three are the best investors I know...I would also dare to throw in Sardar and Mohnish in there (recent results notwithstanding).  I can only hope to be as good as them one day!

 

Of the first three, two are passive and one enjoys active investment management at times.  While they mainly adhere to buy & hold (not unlike myself), they do swing into the buy & trade camp rather regularly.  Who here is going to tell me that the CDS investment was a buy & hold, long-term investment idea?  It was a pure macroeconomic event-based decision, and used to protect the portfolio while reaping stellar gains.  That is more like Soros, than Buffett or Graham.  All three adhere more to Graham than present day Buffett.  Although when markets make it available, they do like to buy quality for cheap.  Prem and Francis are very much old school Graham for the most part.  Don't let the recent purchases of JNJ, KFT and WFC fool you.  They really do prefer hard assets behind their purchases.

 

Neither buy & hold, nor buy & trade are necessarily better than the other.  Neither guarantees better long-term results than the other, as there are many great investors in both camps.  It is completely based on execution and the emotional makeup of the investor.  Is Tiger Wood's golfing philosophy better than Phil Mickelson's?  Is his skill set any better?  I would suggest execution and emotional constitution make virtually all the difference between 14 Major Championships and 3 Major Championships.  Cheers!

[oec2000]

You should work for the U.N.! 

 

Thanks, Sanjeev. However, given my view of politicians and the UN, I have to take this as an insult. :D

 

Holding is buying, and therefore holding at any price is buying at any price.

 

Your exercise in logic works only because it ignores the certainty of taxes and the uncertainty of investing.

 

Firstly, taxation does distort the decision, so holding does not exact = buying. It could = buying significantly cheaper.

 

Secondly, the risk of error in investing is high. Your estimate of IV could be wrong. This risk of error is asymmetric because of the growth bias of IV of a good business (as time elapses, a rising IV increases the risk that your IV estimate is too low). This is compounded by the fact that the consequence of error is also asymmetric - even assuming your sell decision is fundamentally correct (in the sense that your estimate of value is accurate), your upside will rarely be more than 50% (i.e the stock drops and you buy back 50% cheaper) but your opportunity loss could be in the hundreds of %. (There is also an upward bias in markets.) Yet another complication is that a hold decision only requires that decision to be right; a sell decision requires you to be right when selling, and then again when buying back. (You may be right in selling at, say, 100% above IV with the intention of buying back below IV. What if the price never drops to your buy level?) Taking all these into consideration, a sell decision should require a much larger margin of safety; a hold decision should have a much lower hurdle - it's not that the buy and hold guys completely ignore price and value, it's that they realise the greater risk of a selling decision being wrong.

 

Having said all this, I don't think the buy and hold guys believe in a zero portfolio turnover philosophy - presumably they would still switch out of something more expensive into something more attractive provided the margin of safety in the decision is high. Isn't this what Buffett did when he sold JNJ to buy some of the high yield bonds and preferreds?

 

As a practical matter, am I correct to assume that you think that buy and trade will produce superior returns to buy and hold? If true, I'm curious to know how you arrive at this conclusion.

 

Your response doesn't answer the question.  So I'll pose it once again, this time more directly:  Why does "holding no matter what" make more sense than "making sell decisions based on the difference between price and value?"

 

In the first place, I don't think anyone is actually advocating "hold no matter what" so I don't get why you are using this as the alternative. (It's more "hold until there is a very very good reason to sell.") Secondly, I thought I answered the question when I explained that the risks of error are not symmetrical. Anyway, my response to ericopoly above should clarify why I think sell decisions are much tougher and should therefore be approached differently.

 

Funny that you refer to a decision other than "hold no matter what" as "trading." 

 

You are putting words in my mouth. I called one strategy buy and hold and the other buy and trade simply to differentiate the two. Sure, I could have called the 2nd strategy "buy and sell and buy and sell" but it is a bit hard on the fingers and the keyboard. I think it was obvious from the context that I did not use "trade" in a pejorative sense to imply that the "buy and sell and buy and sell" guys are traders and not investors. Maybe you forget that I put myself in this camp also.

 

My points, in case you missed them, are that we should not jump too quickly to the conclusion that buy and trade will produce better returns just because recent experience shows that it has; that the fact better investors than ourselves eschew this strategy should give us pause to reconsider our views; and that if we choose to be buy and traders, we should recognise that we are taking on the reinvestment risk which could negatively impact our returns.

 

More importantly, the overriding point I was trying to make was that instead of taking such an antagonistic approach, the two camps should try and empathise with each other's views. We do come from the same value school, after all, and the only difference seemed to me to be that Jack's camp was happy to accept higher volatility and Sanjeev's camp wanted to try and dampen volatility. Instead of each camp claiming "I'm right, you're wrong. Show me your returns and I'll prove that you are wrong," (which is the direction the discussion seemed to be headed), I was trying to get both sides to see the validity of the other's point of view.

 

 

 

[tooskinneejs]

oec2000,

 

I agree with much of what you said in your last post and I apologize for the tone of mine (not intended).  I do not consider myself a "buy and trade" investor nor do I consider myself a "buy and hold forever" investor.  You said, rightfully so, that the latter is really a "hold until there is a very very good reason to sell."

 

I'm simply saying that a good reason to sell is when value can be fully or more than fully realized through a sale at current market prices.  Obviously, if you've found the homerun investment of the century (say a Coca-Cola in the 1930's) and you know it for sure, you probably don't want to sell at the market's deterimination of intrinsic value because that IV is probably way too low.  But I think this is more the exceptional case than the rule.

 

Thanks for the discussion.

 

 

[Guest ericopoly]

Holding is buying, and therefore holding at any price is buying at any price.

 

Your exercise in logic works only because it ignores the certainty of taxes and the uncertainty of investing.

 

Firstly, taxation does distort the decision, so holding does not exact = buying. It could = buying significantly cheaper.

 

Secondly, the risk of error in investing is high. Your estimate of IV could be wrong.

 

Two issues to address:  1)  taxation  2) uncertainty

#1  Taxation:

The tax issue is real unless you are doing this in an IRA, 401k tax-deferred account.  I actually have 25% of my family's wealth in such accounts.  So this comes up as a practical matter for me all the time -- I treat the holdings there differently than the ones in my taxable account.  Hold there is logically a decision to buy from cash.  So there is no hold in that account, only buy and sell.  For those with substantial capital gains, you are correct.  However, there exists the case I mention where there is no tax issue.  There are also places in the world where there are no capital gains taxes (or extremely small taxes).

 

 

 

#2 Uncertainty (isolated from taxation to just address the one point):

If you cannot safely buy from cash at the current price due to uncertainty, then you also cannot hold due to uncertainty (they are logically the same thing).  So I believe it is a non-issue after proving that holding is no different from buying.  The act of going to cash and back into the stock shows that for the person holding the stock the uncertainty risk is no higher than for the person buying the stock.  One should quit active management altogether if one cannot determine any approximate valuations when anticipating a purchase.  Truth is, every day you hold the stock you carry the same risk as the person buying it from cash.

 

 

 

 

 

 

 

[Guest ericopoly]

Holding is buying, and therefore holding at any price is buying at any price.

 

Your exercise in logic works only because it ignores the certainty of taxes and the uncertainty of investing.

 

Firstly, taxation does distort the decision, so holding does not exact = buying. It could = buying significantly cheaper.

 

Secondly, the risk of error in investing is high. Your estimate of IV could be wrong.

 

Two issues to address:  1)  taxation  2) uncertainty

#1  Taxation:

The tax issue is real unless you are doing this in an IRA, 401k tax-deferred account.  I actually have 25% of my family's wealth in such accounts.  So this comes up as a practical matter for me all the time -- I treat the holdings there differently than the ones in my taxable account.  Hold there is logically a decision to buy from cash.   So there is no hold in that account, only buy and sell.  For those with substantial capital gains, you are correct.  However, there exists the case I mention where there is no tax issue.  There are also places in the world where there are no capital gains taxes (or extremely small taxes).

 

 

 

#2 Uncertainty (isolated from taxation to just address the one point):

If you cannot safely buy from cash at the current price due to uncertainty, then you also cannot hold due to uncertainty (they are logically the same thing).  So I believe it is a non-issue after proving that holding is no different from buying.  The act of going to cash and back into the stock shows that for the person holding the stock the uncertainty risk is no higher than for the person buying the stock.  One should quit active management altogether if one cannot determine any approximate valuations when anticipating a purchase.  Truth is, every day you hold the stock you carry the same risk as the person buying it from cash.

 

 

 

The model I have for thinking of this is the Riemann Sum.

 

For those of you who took lower math, there are some graphical drawings here:

http://en.wikipedia.org/wiki/Riemann_sum

 

The Riemann Sum is a method for approximating the area under the curve by drawing rectangles under the curve and taking the sum of their areas.  As you make the rectangle width narrower as you increase the quantity of the rectangles out to infinity, you get an ever more accurate result.

 

Now, instead of areas under a curve, let's talk about holding periods for a stock.  You could substitue sell/cash/buy cycles for rectangles -- it becomes a visual understanding in my mind that the holding period (area under the curve) is really just a logical constant flow of sell/cash/buy (if there were no taxes or commissions, you would not be able to distinguish the difference). 

[uncommonprofits]

You can do that with your own personal account, but not if you are managing other people's money.  Take a look at all of the value investors who have gotten completely hammered in the last year.  Many are complete Graham/Buffett/Fisher acolytes, who had impeccable track records and hold investments for the long term.

 

Sanjeev, this is rear view mirror thinking.  I have mentioned this before -- one of the best/honest long term investor's was Bill Ruane.  If we were having this discussion at the beginning of 1975 --- you would have been saying the same thing: that Ruane and other long term value types had 'gotten completely hammered'.  After all a $10,000 investment in Sequoia on Dec 31/72 would have been worth $6,355 on Dec 31/74.  The S&P 500 would have been worth about $6,270.  Looking in the mirror, there was little evidence that Ruane's strategy was working at that point in time.  However, two years later (Dec 31, 1976) that $6,270 turned into $17,730 ---- the S&P 500 had barely returned to it's value 4 years previous (it would have been worth about $10,675).

 

A couple hidden things with Sequoia.  Firstly, compare the typical 20% (or more) incentive charge to Sequoia's straight 1% management fee structure.  And the thing that does not show up in the record is the very friendly tax treatment due to a longer term 'investor vs trader' type of thinking. 

 

When one buys Wells Fargo at $9.50 and sells it at $17.00 it doesn't reflect the tax consequence.  Many partners are in high tax brackets -- the reality is they might only see $14 (or less).  [Actually strip out a 20-25% incentive fee and they might only see $12.00-$12.50 -- but this is beside the point].  Now, granted, if this could be done every two weeks --- it's still going to net some tremendous results.  But you and me know this will not be the norm. 

 

The bottom line is that all great wealth accumulators in this world did so by holding longer term.  Some held longer than others --- but no one has proved to make a lot of money by doing quick flips.  Yes, there are special situation plays that can be shorter term and have proved very profitable .... but the core strategy for the very successful has been thinking long term -- it's a common theme. 

 

UCP / DD

 

[oec2000]

However, there exists the case I mention where there is no tax issue.  There are also places in the world where there are no capital gains taxes (or extremely small taxes).

 

Given where most of us live, it should be a fair assumption to assume taxes. It should also be a fair assumption that all of us frugal value guys would have at least some, if not most, of our investments outside tax-deferred accounts.  

 

If you cannot safely buy from cash at the current price due to uncertainty, then you also cannot hold due to uncertainty (they are logically the same thing).  So I believe it is a non-issue after proving that holding is no different from buying.

 

You are simply saying here that "All men are human beings." (All buys are holds. No one disputes this.) Your original assertion is stronger - it is that, to continue using my bad analogy, "All human beings are men." (All holds are buys.)

 

The latter assertion is tenuous. Let me use your "logic" exercise to illustrate. If every hold decision is effectively a buy decision, then you should never have any cash in your portfolio except for the unique case when you are 100% in cash. If you have less than 100% in cash, you are holding some stocks. If you are holding these stocks, you must think they are buys. If they are buys, then you should use any cash that you have to keep on buying your holds.

 

Say, you decide to hold on to FFH when the price went above $300. Since it was a hold, and therefore also a buy, at that price, you should have kept on buying as long as you had cash. You should not have had any idle funds to buy more FFH when it fell to $220.

 

My point about the uncertainty of investing was to show that investment decisions are not black and white binary decisions. Even for someone as logical as you, I find it difficult to believe that you have a precise point, say $350.37, at which FFH morphs from a buy into a sell with no grey area in between. Surely you can see the validity of a view that holds that FFH is a screaming buy at $150, a strong buy at $200, a buy at $250 and a hold at $350.

 

Once you accept this inherent uncertainty, you should be able to accept my broader point which is that buying or holding involves less uncertainty than selling because of asymmetry (the range of outcomes is not normally distributed but skewed) with the implication that sell decisions should not be evaluated the same way as buy decisions.

 

As for your remark about active management, you misunderstand my position because you may have misread my posts. I am unequivocal about being able to successfully buy stuff below intrinsic value. It is the sell decision that I question and doubt because of upward biases working against the seller. This is why I pointed to the dearth of successful value short sellers around. If "value selling" were as easy as "value buying," we should expect to see a lot more value sellers since the space is clearly less crowded and potentially more profitable than the buy space.

 

Ask yourself why you are a not a long-short investor. After all, using your logic, every sell should also be a short, right?

 

 

 

 

[oec2000]

I agree with much of what you said in your last post and I apologize for the tone of mine (not intended). 

 

Tooskinneejs,

 

No offence taken and no apologies needed. I've long realised that the curse of successful investors is that they are opinionated - you need strong convictions to go against the herd. I only take offence with people who feel free to criticse others but get all upset when they are at the receiving end.

 

I enjoyed the debate and, as I suspected, our views are not that far apart and that was the point of my original post. (I couldn't get what all the fuss was about.)

[Uccmal]

Sanj, This may have been said above already.  I dont think it is appropriate to handicap yourself by taking the FFH options out of your pre-partnership investment results.  They are an intrinsic part of what makes us better than average investors.  We didn't just indentify an under priced company, we also leveraged via options to make those mouth-watering returns.  If it hadn't worked out you wouldn't have been saying my past results aren't accurate because I lost 100% on my FFH investment. 

 

A.

[uncommonprofits]

One other point about wealth accumulation -- wealth accumulation is a result, NOT a process.  If you are Ingvar Kamprad -- are you worried that the value of IKEA might be less if you tried to sell it today?  Of course not -- you are focussed on the business execution.  The success or lack thereof will dictate the resulting direction of wealth accumulation.  The business execution is the process and inspiration -- wealth accumulation is the result.  Unfortunately, for many -- short term emotions and/or greed interfere and they think of it the other way around.

 

Now I enjoy value just as much as the next guy (heck I even buy most of my clothes from a second hand shop for cents on the dollar!!).  From a value investor's point of view this is a tremendous opportunity.  Since all asset classes are on sale one can have the pick of the litter.  When I was accumulating Ingersoll Rand -- others here were buying BNI, KO, WFC or whatever.  In the end you take this rare opportunity to pick up something great that you think you understand.  I started out doing this in 1992 and I can tell you that this is by far the most fantastic opportunity thus far.  Perhaps it's not on par with 1982 but it's still very good.  I am hopeful there will be a couple more of these in my lifetime --- but I view it as a rare opportunity that one does not want to miss.  It would be very hard for me to sell at a bit of a pop for the hope that this kind of opportunity will happen again soon.   

 

UCP/DD

[basl1]

  When I was accumulating Ingersoll Rand -- others here were buying BNI, KO, WFC or whatever.  In the end you take this rare opportunity to pick up something great that you think you understand.  I started out doing this in 1992 and I can tell you that this is by far the most fantastic opportunity thus far.  Perhaps it's not on par with 1982 but it's still very good.  I am hopeful there will be a couple more of these in my lifetime --- but I view it as a rare opportunity that one does not want to miss.  It would be very hard for me to sell at a bit of a pop for the hope that this kind of opportunity will happen again soon.   

 

UCP/DD

 

Share with us why you and buffett like ingersoll rand so much

[UhuruPeak]

UCP, we don't see enough of you around here :)

[Parsad]

As a practical matter, am I correct to assume that you think that buy and trade will produce superior returns to buy and hold? If true, I'm curious to know how you arrive at this conclusion.

 

I don't think either one necessarily provides better returns than the other.  George Soros, Peter Lynch, James Simmons...Buffett, Schloss, Fisher...there are examples of both types that have provided great returns.  My point is that you don't use a driver, when you are sitting in sand forty feet from the hole.  

 

More importantly, the overriding point I was trying to make was that instead of taking such an antagonistic approach, the two camps should try and empathise with each other's views. We do come from the same value school, after all, and the only difference seemed to me to be that Jack's camp was happy to accept higher volatility and Sanjeev's camp wanted to try and dampen volatility. Instead of each camp claiming "I'm right, you're wrong. Show me your returns and I'll prove that you are wrong," (which is the direction the discussion seemed to be headed), I was trying to get both sides to see the validity of the other's point of view.

 

I agree with you on this point wholeheartedly!

 

One should quit active management altogether if one cannot determine any approximate valuations when anticipating a purchase.  Truth is, every day you hold the stock you carry the same risk as the person buying it from cash.

 

Absolutely correct...outside of the issue of taxes.

 

Sanjeev, this is rear view mirror thinking.  I have mentioned this before -- one of the best/honest long term investor's was Bill Ruane.  If we were having this discussion at the beginning of 1975 --- you would have been saying the same thing: that Ruane and other long term value types had 'gotten completely hammered'.  After all a $10,000 investment in Sequoia on Dec 31/72 would have been worth $6,355 on Dec 31/74.  The S&P 500 would have been worth about $6,270.  Looking in the mirror, there was little evidence that Ruane's strategy was working at that point in time.  However, two years later (Dec 31, 1976) that $6,270 turned into $17,730 ---- the S&P 500 had barely returned to it's value 4 years previous (it would have been worth about $10,675).

 

Hi Uncommon, I'm not suggesting that what Ruane did, or any buy & hold investor does, is incorrect.  Not in the slightest.  I'm a buy & hold investor myself...through and through.  But I bet you Ruane, like many investment managers today, lost a significant number of clients during that period.  And that is not his fault, since he was adhering to the philosophy he completely subscribes to...partners be damned.  The system works and it works very well over long periods of time.  

 

But there is nothing wrong with selling a position, paying the taxes and holding cash until you can find more undervalued investments.  If the market is trading at six times earnings, why would you own a business that is valued at twelve times earnings?  Buffett was selling investments trading at three times earnings to buy stuff trading at two times earnings in the early 80's.  Recently he sold JNJ because he found more undervalued investments.  If you want to mitigate portfolio risk, then it is pure folly to hold onto investments trading at a significantly higher valuation than other available investments.  If you found a ten-year note selling at a discount that would give you a 20% return over the next ten years, and there was a high certainty of return on capital, why would you not sell Coca-cola to buy it?  If you would do that, then why not an equity investment providing the same return?

 

The bottom line is that all great wealth accumulators in this world did so by holding longer term.  Some held longer than others --- but no one has proved to make a lot of money by doing quick flips.  Yes, there are special situation plays that can be shorter term and have proved very profitable .... but the core strategy for the very successful has been thinking long term -- it's a common theme.

 

I don't disagree with that at all.  Although, there have been as many people who have lost great wealth by doing the same thing...think Hank Greenberg right now with his decimated investment in AIG, or anyone who held Citigroup stock like Prince Al-Walid.  Those are just a couple of the larger, more glaring and recent examples.

 

Sanj, This may have been said above already.  I dont think it is appropriate to handicap yourself by taking the FFH options out of your pre-partnership investment results.  They are an intrinsic part of what makes us better than average investors.  We didn't just indentify an under priced company, we also leveraged via options to make those mouth-watering returns.  If it hadn't worked out you wouldn't have been saying my past results aren't accurate because I lost 100% on my FFH investment.

 

Al, you're correct but it depends on what you are comparing your results to.  If you are comparing your numbers against any investor, then fine you can include it.  But if you are comparing your results to mutual funds, where they are handicapped by how much they can put into any one idea, then it probably isn't fair.  Apples to apples, oranges to oranges.

 

Mark Sellers returned almost 25% a year since 2003, yet he put nearly 100% of his fund in Contago last year and look what happened.  Risk of the portfolio go hand in hand with how results are achieved.  Cheers!

 

 

 

 

 

 

 

 

 

 

[Guest ericopoly]

Given where most of us live, it should be a fair assumption to assume taxes. It should also be a fair assumption that all of us frugal value guys would have at least some, if not most, of our investments outside tax-deferred accounts.  

 

Yes, it is fair to assume taxes.  However, most of us also have accounts with deferred taxation and the conversation can me moved into that sandbox if it makes you more comfortable (if you cannot have a theoretical discussion on the logic of "hold" without the distraction of taxes).  One might say, in a tax-deferred account, to hold and to buy are the same choice; then we can continue without the distracting tax concern.  I try to keep things simple in order to focus in on the basic idea, not to artificially strengthen my assertion.  I am perfectly happy if we just frame it as an application of tax-deferred situations.  That's still a big area!  For most people, the primary savings (if they have any) are invested via 401k or IRA plans (but perhaps this board is different).  For example, I know that from discussions with my prior coworkers they would save heaviy in their 401k and IRAs, but they didn't have enough left over in their paycheck to also be saving in a taxable brokerage account.

 

For most of my investing life the bulk of my money has been in tax-deferred accounts.  This only changed in the last few years when I was able to amplify a meager sum in my invididual taxable account into a relatively great sum (through enormous amounts of leverage in FFH calls).  I was not able to take advantage of that in my 401k due to a restricted choice of mutual funds or employer stock (so that account got left in the dust).  Today, I have now fully rolled that 401k account into a RothIRA where taxes will never be paid -- it's truly the case where I should only hold stocks if I'd be happy to buy at that price.

 

 

If you cannot safely buy from cash at the current price due to uncertainty, then you also cannot hold due to uncertainty (they are logically the same thing).  So I believe it is a non-issue after proving that holding is no different from buying.

 

 

You are simply saying here that "All men are human beings." (All buys are holds. No one disputes this.) Your original assertion is stronger - it is that, to continue using my bad analogy, "All human beings are men." (All holds are buys.)

 

If they are buys, then you should use any cash that you have to keep on buying your holds.

 

Say, you decide to hold on to FFH when the price went above $300. Since it was a hold, and therefore also a buy, at that price, you should have kept on buying as long as you had cash. You should not have had any idle funds to buy more FFH when it fell to $220.

 

 

To a certain extent, yes, you are getting my meaning clearly.  I say "to a certain extent" because it seems as though you are advocating something which I was not prepared to do -- and that is to overweight a position.  The position should have been a full one already, so to take it "more full" via continuing purchases doesn't really make sense.  However, if it was a 20% position at $300 and you feel comfortable with a 20% position... then, should you inherit a windfall in cash and plan to reinvest it, then you could feel happy to put 20% into FFH at $300 as you still consider it to be a buy (you would have sold if not because a hold is a buy decision).

 

Then again, if it is a 20% weighting and goes up to a 50% weighting after a price rise I will sell some for diversification of downside risk (investor uncertainty) even though I would be a buyer otherwise.  I did this yesterday, sold some FFH calls in my Roth IRA and wrote some July $12.50 WFC puts with the proceeds to attempt to capture another 20% in the next 4 months (another speculative gain).  I had purchased additional calls when the stock went under $220, and so yesterday I merely locked in a speculative gain.  I was not willing to add more calls at $250 on the way down, and likewise I'm not willing to hold the extra calls at $250 on the way up.  I will look to buy them again for sure under $220.  Otherwise, I have 130% notional upside in my remaining calls.

 

 

My point about the uncertainty of investing was to show that investment decisions are not black and white binary decisions. Even for someone as logical as you, I find it difficult to believe that you have a precise point, say $350.37, at which FFH morphs from a buy into a sell with no grey area in between.

Surely you can see the validity of a view that holds that FFH is a screaming buy at $150, a strong buy at $200, a buy at $250 and a hold at $350.

 

I am not the one in support of "buy and hold forever", don't forget.  I am a trader.  I think of myself as a trader because I seek to earn speculative returns (realized) in addition to the underlying business performance -- however I try to buy at prices that offer me investment gains that will make me happy even if the speculative thesis does not work out -- this means that I try to buy far below intrinsic value (otherwise it wouldn't offer me adequate investment gains because I am greedy). 

 

The screaming buy is the price that offers both the highest attractive investment returns and the highest speculative returns (at the same time!!), the "hold" offers less of both (so the motivation to sell it should be the same as the reason not to want to buy it -- it no longer "does it" for the greedy side of me).

 

The purpose of my logical exercise is to show that if you are willing to hold at any price (not me) then you should also be willing to buy at any price (not me for the same reason) as the two (excepting taxation) are logically indistinguishable.  People don't feel this way because they are anchored to the price they paid (they often point out that their cost basis is lower and so they have a big cushion before taking losses), and so even though the market offers them the opportunity to walk with cash at any price they stubbornly refuse to believe their gains are as real as cash ("You can't count the gains until they are realized.")  The gains of course are real, as even at the moment those words are spoken the gains are as real as a sell order.  Any retreat from that price, and the losses are as real as for the person who bought at that price.

 

 

Once you accept this inherent uncertainty, you should be able to accept my broader point which is that buying or holding involves less uncertainty than selling because of asymmetry (the range of outcomes is not normally distributed but skewed) with the implication that sell decisions should not be evaluated the same way as buy decisions.

 

The odds of getting a deep speculative loss instead of a deep speculative gain goes up as the price increases faster than business performance.  There is a tipping point where I won't buy -- at that point I won't hold either.

 

This logical discussion is bigger than my own behavior.  It is a logic that encompasses us all (outside of taxes).  I think it would be of benefit to follow it through mentally, as that intermediate step in sell/cash/buy is "cash", the last step is a choice to reinvest in the same issue rather than everything else the market is offering at that instant.

 

 

As for your remark about active management, you misunderstand my position because you may have misread my posts. I am unequivocal about being able to successfully buy stuff below intrinsic value. It is the sell decision that I question and doubt because of upward biases working against the seller. This is why I pointed to the dearth of successful value short sellers around. If "value selling" were as easy as "value buying," we should expect to see a lot more value sellers since the space is clearly less crowded and potentially more profitable than the buy space.

 

Ask yourself why you are a not a long-short investor. After all, using your logic, every sell should also be a short, right?

 

No no no.  Every sell should not be a short. 

 

Shorting uses up your capital when you could instead put that capital to work buying the next long position with potential for both investment returns and speculative returns.

 

Don't forget that short is speculative returns only -- not nearly on par with long-only potential.

 

[Guest JackRiver]

OEC2000

 

It's hard to hold a conversation or debate a topic if people keep lobbing out non sequiturs and strawman arguments at you. 

 

Yours

 

Jack River

[Parsad]

OEC2000

 

It's hard to hold a conversation or debate a topic if people keep lobbing out non sequiturs and strawman arguments at you. 

 

Yours

 

Jack River

 

That's a two way street Jack.  Generally, I find that everyone does a pretty good job of respecting others and debating a topic, while providing real arguments on subjects here.  Best advice, engage if you find the discussion worthwhile, otherwise ignore it.  Cheers!

[uncommonprofits]

But I bet you Ruane, like many investment managers today, lost a significant number of clients during that period.  And that is not his fault, since he was adhering to the philosophy he completely subscribes to...partners be damned.  The system works and it works very well over long periods of time.  

 

I am sure it happened --- but for those that were loyal they would have been quite pleased by the end of '76 (and beyond) -- quite the oppositie of your worries at present.  Ruane as leader and captain knew what was best for the clients.  Would he retain them all?  Of course not -- you never do.  Could GM have retained all their clients over the years?  No -- but they sure could have done a better job by developing products that were in the client's long term interest rather than the client's short sighted ones.  Doing what is best for the client (even if they don't know it at the time) works -- even for money managers!!  

 

 

 

But there is nothing wrong with selling a position, paying the taxes and holding cash until you can find more undervalued investments.  If the market is trading at six times earnings, why would you own a business that is valued at twelve times earnings?  Buffett was selling investments trading at three times earnings to buy stuff trading at two times earnings in the early 80's.  Recently he sold JNJ because he found more undervalued investments.  If you want to mitigate portfolio risk, then it is pure folly to hold onto investments trading at a significantly higher valuation than other available investments.  If you found a ten-year note selling at a discount that would give you a 20% return over the next ten years, and there was a high certainty of return on capital, why would you not sell Coca-cola to buy it?  If you would do that, then why not an equity investment providing the same return?

 

Buffett did not sell Coca Cola in that early 1980 era --- in fact he added significantly.  I would bet that his investment in KO outperformed the theoretical ten-year 20% return note.  And the beauty was he avoided a lot of taxes compared to the gains that would have had to be claimed on the note.  Look, I am not saying there is not a time to sell -- but investor's ought to have a long term core strategy.  I am not saying to buy KO -- and in fact I have never owned it -- but I will say that over the 17 years of doing this, KO is certainly the best bargain I have seen it at.  

 

Are there better bargains for the small investor -- in the 3x PE variety?  Sure there are especially in some small cap names -- there's lots of usual junk too but there are some high quality ones in the fold especially if one takes into account an assumption or two.  Certainly far from a small cap -- but a question was asked about Ingersoll-Rand (I will try to answer this in a little more detail when I get a chance -- perhaps on another thread).  When it was at around $12 -- I had it figured at a 'normalized' PE of 3x.  By 2012 there is a strong chance of IR earning $5-$7/share and doing it in a more consistent manner -- there is a lot of pent up demand from the down-turn and synergies to be flushed out from a recent acquisition.  Value line has it rated with the same Safety factor as KO.  Personally, I would downgrade it a notch or two from KO until they have their ducks in a row --- but with it's current and near term cash generation (compared to the price) it comes with an added layer of safety.  Over 10 years --- IR will hopefully outperform that 20% total return note.  

 

 

The bottom line is that all great wealth accumulators in this world did so by holding longer term.  Some held longer than others --- but no one has proved to make a lot of money by doing quick flips.  Yes, there are special situation plays that can be shorter term and have proved very profitable .... but the core strategy for the very successful has been thinking long term -- it's a common theme.

 

I don't disagree with that at all.  Although, there have been as many people who have lost great wealth by doing the same thing...think Hank Greenberg right now with his decimated investment in AIG, or anyone who held Citigroup stock like Prince Al-Walid.  Those are just a couple of the larger, more glaring and recent examples.

 

They lost great wealth because they focussed on wealth accumulation rather than what was important.  They invested in risky ventures --- we know the result.  

 

UCP / DD

[Parsad]

I am sure it happened --- but for those that were loyal they would have been quite pleased by the end of '76 (and beyond) -- quite the oppositie of your worries at present.  Ruane as leader and captain knew what was best for the clients.  Would he retain them all?  Of course not -- you never do.  Could GM have retained all their clients over the years?  No -- but they sure could have done a better job by developing products that were in the client's long term interest rather than the client's short sighted ones.  Doing what is best for the client (even if they don't know it at the time) works -- even for money managers!!

 

Doing what's best for the client is to not lose money.  How do you explain to a 75-year old investor that his life savings is now diminished by 50%?  Wait five years...you should have known better than to put so much with us...you've invested for the long-term...I feel really bad for you...I'm closing access to your money to protect you from it!

 

Buffett did not sell Coca Cola in that early 1980 era --- in fact he added significantly.  I would bet that his investment in KO outperformed the theoretical ten-year 20% return note.  And the beauty was he avoided a lot of taxes compared to the gains that would have had to be claimed on the note.  Look, I am not saying there is not a time to sell -- but investor's ought to have a long term core strategy.  I am not saying to buy KO -- and in fact I have never owned it -- but I will say that over the 17 years of doing this, KO is certainly the best bargain I have seen it at.

 

Buffett as recently as a few years ago said that he should have sold Coca-cola in 1998 when it was overvalued.  He just sold JNJ after holding it for a short period of time.  I'm not sure how this discussion has devolved into me being a buy & trade investor where I have no core holdings.  I just said that at times I am willing to sell even my core holdings, if I find things significantly cheaper relative to their quality and after paying taxes.  That is no different than what Buffett does.  And per Berkshire's mandate not to ever sell a private business they buy, he cannot sell any of their businesses regardless of the price they are offered...otherwise you might see a different outcome.

 

They lost great wealth because they focussed on wealth accumulation rather than what was important.  They invested in risky ventures --- we know the result.  

 

I beg to differ.  While AIG's CDS business was overly leveraged, many of their other businesses would have fit in nicely inside Berkshire, Fairfax or many other companies.  Some of Citi's businesses are also of the utmost quality. 

 

What about the guy who built a terrific business over his lifetime, but lost it all because the investment bank he dealt with put his company's cash into AAA-rated credit obligations?  He did what he thought was correct...yet he suffered!  Are you going to simplify it and say that he was focused on wealth accumulation and not what was important?  He got caught up in a mess that was not entirely of his own making.  Everything he built from day one, was lost in a few months. 

 

Doesn't Buffett focus on the right things?  Yet, he made a mistake buying COP early, as well as the amount of exposure they have in the S&P puts he sold.  Berkshire's AAA-rating was the crown jewel of the company, yet there is a distinct possiblity they may now lose it.  Focusing on the right things and the long-term reduces risk, but it never completely eliminates it.  Cheers! 

[uncommonprofits]

Doing what's best for the client is to not lose money.  How do you explain to a 75-year old investor that his life savings is now diminished by 50%?  Wait five years...you should have known better than to put so much with us...you've invested for the long-term...I feel really bad for you...I'm closing access to your money to protect you from it!

 

With all the 'know thy client' rules out there now --- how does someone like this become a client without being aware of the risks.  What is a 75-year old investor doing with his life savings exposed to the market -- particularly if he has a short term purpose for these funds.  I own a small bit of Tims fund --- when I signed up there was something in the documents that said 'I could lose ALL my money' ---- it was not in small print either --- very bold.  There was also some bolded out language that stated to 'read the document'.  If after the fact this 75 year old still signs on what can you say --- he was prepared to take the risk just like anyone else.  Informing the client of the risks before hand is very controllable. 

 

When I play hockey on Monday nights there are still a lot of guys that don't wear face shields - I don't know how informed they are but if they were --- they certainly are doing so at their own risk.  And so am I by simply playing the game.  You can't control all the hazards but you sure can control the information.

 

Funny that you bring this up -- because my dad just turned 75 today!!  I manage most of my parents funds and have always kept aside a very safe segment (staggered AAA Canada and AA Provincial bonds) for their anticipated needs for at least the next 5 years.  Yes, their equity side has been impacted on paper but they will not need these funds for at least 5 years.  We of course hope they live much longer --- what they don't realize is what inflation could do to their buying power.

 

Lets keep in mind that in the Ruane example I mentioned is that the original purchase was back in the black within 3 years from the onset of the '73 bear market.  By the time the complaining (and some client withdrawls) would have started --- things were probably very much on the mend (at least for Sequoia).  Whether or not that will be the case for the smart value types in todays instance who knows ---- but what I do know is that with Tim's fund in particular there will be no incentive fee paid until the fund is back to break even. 

 

I would bet Focusing on the right things and the long-term reduces risk, but it never completely eliminates it.  Cheers! 

 

I don't disagree --- you will never completely eliminate risk.  Whether it is wearing a seat belt or a helmut --- or making intelligent business decisions you will never completely eliminate risk.  Never.  But there sure are some wonderful businesses that do a terrific job --- unfortunately only a select few in Canada that are publicly traded.  So to participate in the breeding ground for such company's in the states we as Canadians have another risk called 'currency' --- and unfortunately another problematic one when doing a lot of trading.

 

Buffett did not sell Coca Cola in that early 1980 era --- in fact he added significantly.  I would bet that his investment in KO outperformed the theoretical ten-year 20% return note.  And the beauty was he avoided a lot of taxes compared to the gains that would have had to be claimed on the note.  Look, I am not saying there is not a time to sell -- but investor's ought to have a long term core strategy.  I am not saying to buy KO -- and in fact I have never owned it -- but I will say that over the 17 years of doing this, KO is certainly the best bargain I have seen it at.

 

Buffett as recently as a few years ago said that he should have sold Coca-cola in 1998 when it was overvalued. 

 

The point I was making was with your theoretcial ten-year 20% note bought in the 1982 period and the 3x pe's available at the time that Buffett was also buying.  I just pointed out that during this time he also bought or added to KO -- and I would guess that the return over 10 years probably beat the 20% total return on the theoretical note.  10 years later would have been around 1992 --- so the KO investment could have cumulated tax free for another 6 years before Buffett in hindsight would have sold it.

 

UCP / DD

 

[Parsad]

With all the 'know thy client' rules out there now --- how does someone like this become a client without being aware of the risks.  What is a 75-year old investor doing with his life savings exposed to the market -- particularly if he has a short term purpose for these funds.  I own a small bit of Tims fund --- when I signed up there was something in the documents that said 'I could lose ALL my money' ---- it was not in small print either --- very bold.  There was also some bolded out language that stated to 'read the document'.  If after the fact this 75 year old still signs on what can you say --- he was prepared to take the risk just like anyone else.  Informing the client of the risks before hand is very controllable.  

 

Not all investors have the same investment acumen or emotional constitution.  The "Know Your Client Rules" are a joke!  Virtually every questionnaire is standardized with a few simple questions, and millions of investors each year get into products they probably shouldn't. 

 

When I play hockey on Monday nights there are still a lot of guys that don't wear face shields - I don't know how informed they are but if they were --- they certainly are doing so at their own risk.  And so am I by simply playing the game.  You can't control all the hazards but you sure can control the information.

 

If one of those guys playing with you gets hit in the eye with a puck, you're not going to tell him "you should have worn a visor" while he's lying on the ice writhing in pain, thinking he may lose his eyesight, right?  There are alot of investment managers out there looking their clients in the face, many of whom are close to retirement, and telling them that eventually markets rebound.  Sound advice, but probably not much help to those clients.

 

The point I was making was with your theoretcial ten-year 20% note bought in the 1982 period and the 3x pe's available at the time that Buffett was also buying.  I just pointed out that during this time he also bought or added to KO -- and I would guess that the return over 10 years probably beat the 20% total return on the theoretical note.  10 years later would have been around 1992 --- so the KO investment could have cumulated tax free for another 6 years before Buffett in hindsight would have sold it.

 

He did.  Well over 24% annualized till 1998 or so.  Tell me how much it has grown since.  :o  How many investors, even die hard Buffett/Fisher acolytes, would hold for 11 years with a 50% loss, and then still hold another 5-6 years to get to breakeven...perhaps longer!  Cheers!

 

[oec2000]

I try to keep things simple in order to focus in on the basic idea, not to artificially strengthen my assertion.

 

Then, please practice what you preach. The only reason I repeated the tax assertion was to respond to your remark that "there are also places in the world where there are no capital gains tax." (You'll get my meaning if you see what I had pasted prior to making the point about most of us living where tax matters.) In any case, my argument does not rely on the tax issue alone. If you cannot handle two issues at a time, then you can ignore my tax comment - my second point does not rely on it. It is just my preference to discuss issues in a real world setting - theoretical discussions can get distorted completely out of whack with reality. To paraphrase a really smart guy, we should keep things as simple as possible, but no simpler thnn that.

 

Your tax situation is as irrelevant as mine (which happens to be the polar opposite of yours - hardly anything in tax-deferred accounts) unless the aim is to artifically strengthen your assertion that tax doesn't matter.

 

I was not prepared to do -- and that is to overweight a position.

 

This is a valid argument and I accept it. However, I also read your explanation to mean that if you decide to buy something, you will buy the full weighting immediately (assuming there is enough volume) - if it's a buy, then you should keep on buying till you are full. In this case, can you please explain why you were happy to hold your, presumably, full FFH position at $300, choose not to add at $250 but then decide to add below $220?

 

You also say that you were not prepared to buy FFH calls at $250 on the way down and that's why you are not prepared to hold the extra calls on the way up. But, by your own original argument, did you not say that it you are unwilling to buy, you should also be unwilling to sell? That being the case, you should logically sell out completely your FFH position at $250. In fact, you were also unwilling to buy at $230 - so why did you not sell out at $230?

 

The screaming buy is the price that offers both the highest attractive investment returns and the highest speculative returns (at the same time!!), the "hold" offers less of both (so the motivation to sell it should be the same as the reason not to want to buy it -- it no longer "does it" for the greedy side of me).

 

I think this is what Jack meant by non-sequitur. You don't directly address my question as to whether there is a precise point ($350.37!) at which FFH changes from a buy to a sell for you. If there is, I would love to learn how you arrive at it.

 

Shorting uses up your capital when you could instead put that capital to work buying the next long position with potential for both investment returns and speculative returns.

 

Don't forget that short is speculative returns only -- not nearly on par with long-only potential.

 

Why is short speculative return only if your short/sell decision is based on the same price-value criteria as your longs?

 

Both long and short positions use up capital. If, as you believe, the sell decision is as easy as the buy decision, shouldn't you be indifferent as to how you deploy your capital as long as you make money. If anything, having a mix of shorts and longs should reduce your risk without reducing your returns.

 

Let me explain by giving a crude example why I believe buy, hold and sell decisions can and need to be distinguished.

 

To me, something is a buy when it has a big margin of safety - i.e. estimated discount to IV - and the perceived risk/reward trade-off is favourable (better than 1:1). This could mean a 30-50% discount to IV.

 

It becomes a hold when it is closer to estimated IV (and because it is estimated, it cannot, for me, be an exact point like $350.37). There is insufficient MOS for me to buy and there is also inadequate MOS to sell. In this case, price would be in the range of, say, 50-300% of IV.

 

A sell is when the price is so far above IV that I have a comfortable MOS to sell and switch into a better alternative (which could include cash). Remember, the buy and holders are not "buy and hold no matter what." They are "buy and hold until there is a very very good reason to sell."