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Seth Klarman


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Been some time since I've posted.  Kudos to those traders who captured the Fed induced jump in the stock market.  Personally -- my position has not changed...the risks remain very high.  On that note, I am passing along an excerpt from Seth Klarman's most recent annual letter.  If you read through my prior posts, you'll see that his views are almost exactly the same as I expressed -- so yes, I am guilty of confirmation bias.  The views of Klarman and others like myself who share his concerns could well prove wrong (the future is unknowable) but they are worth considering.

 

Also Buffett's continued assertion that America's best years are ahead is unequivocally 100% correct but let's put in context.  The best years were by far still ahead of America in January 1861 but the country was soon to enter a brutal civil war.  In June of 1929 America's best years still were ahead, a view likely shared by the majority of men and women in the country.  Just 4 months later the stock market crashed, marking the beginning of the Great Depression.  And the country would engage in a World War before true peace and prosperity would return to the US.  I am not predicting hardship on any such scale for the US in the coming years but when Buffett asserts the best days are ahead, he should add that this reality doesn't mean the US is immune from very difficult times.  And in my opinion, the road ahead is unlikely to be smooth, with the margin of safety currently offered by Mr. Market (in general) not nearly sufficient to offset the risks.  Of course there will always individual opportunities but make sure the margin of safety is high.

 

Klarman:

Government interventions are a wild card for even the most disciplined investors. On one hand, the U.S. government has regularly intervened in markets for decades, especially by lowering interest rates at the first sign of bad economic news, which has the effect of artificially inflating securities prices. Today, monetary easing and fiscal stimulus augment consumer demand, increasing risks not only regarding the integrity and sustainability of securities prices but also those surrounding the sustainability of business results. It is hard for investors to get their bearings when they cannot readily distinguish durable business performance from ephemeral results. Endless manipulation of government statistics adds to the challenge of determining the sustainability – and therefore the proper valuation – of business performance. As securities prices are propped up and interest rates are manipulated sharply lower (thereby justifying those higher prices in the minds of many), prudent investors must demand a wide margin of safety.

   

 

 

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I understand your rationale (I kinda agree and have agreed for a while), but just dont find the way you are playing it out to be rational or realistic. Things are expensive and 10% - 30% cash seems very prudent right now, but I dont think top companies like Coke or Kraft will ever hit 5x Future Cash Flow. Based on your prior posts it appears that that is what you are waiting for.

 

Thats not a pullback, thats Armageddon.

 

Klarman talks about a margin of safety. I could see and have seen him buying companies when he finds that margin. I see you counting cash and talking with Peter Schiff.

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Why don't we use this opportunity to convert a macro discussion into a simple market valution discussion.

 

Munger - what is your estimated intrinsic value of the SP 500 and what are your market exposure guidelines at various levels of under/over valuation?

 

I pose the same question to the rest of the board.

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The IV of the market is irrelevant unless you are buying the market. With that said its on the high side of its valuation per Grantham and Schiller. Both of them have a few people dedicated to calculating this. It bets whatever I am going to end up doing. Grantham or Schiller saw zero returns for the next 10 years.

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Buffett allocated BPL between generals and workouts/controls based on the IV of the market. Can't be that irrelevant.

 

Pabrai was down 70 percent over two years then up 100 percent the third year. My math arrives at a cumulative three year return of -40%. So ya, he ignored the general market level and....

 

As Buffett says many times in his early letters, in a down market, even the most undervalued issues will decline. And Buffett did pairs trading to eliminate the market risk!!! Why would he do that if he didn't care about market exposure??!! Buffett was obsessed with market exposure - why not take that as a lesson?

 

I personally think, as with almost anything, there is a happy medium for the situation. Being 90% or 10% long are both equally unwarranted at these levels. 

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We can trade Buffett quotes all day. Over 40 years he has said quite a bit of things. Doesnt this Buffett guy talk about owning businesses and not stocks,and not caring about getting a quote for 5 years. People kinda like to quote him when it suits their argument and ignore him when it doesnt.

 

For example refer to the original poster. Everyone in the value investing camp agrees the market is on the high side. The question is what to do about it?

 

My argument is its prudent to raise cash. I plan to do so over the weekend (at least put together a plan). Its just not sane to cling to cash waiting for Coke at 4-5x future cash flow.

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It's crazy to wait for a 5x PE on Coke, I don't support that thinking at all.

 

I was only responding to the claim that the intrinsic value of the market only matters if you own the market. I'm not at all quoting Buffett in a box. 10+ years of letters indicate he managed his exposure based on the general level of the market even when he found opportunities like AXP.

 

 

This Buffett guy says that if you are truly buying something as an investment, then you should not care if there is a quote market for the asset. As a poster said today, that test would eliminate a lot of investment. If everyone was honest, that test would eliminate RSH, SD, CHK, WDC, and STX. As much as these are "value" investments, if everyone was honest, very few people have the ability to feel comfortable judging these companies purely based on the strength of their businesses for the next five years. RSH could be earning 50% of what it is now five years from now; SD and CHK are asset plays that generate no cash flow, hence a position in them is speculation bc it relies on other companies overpaying for their assets; and, to quote another tremendous investor, Charlie Munger says that nobody can truly value a tech company (for memory's sake, he said that if he were to test a group of investors, he would give them a question asking to value a tech company, and would fail anyone who tried). STX earns around $1 billion right now, give or take, yet nobody knows what they will be earning five years from now, hence it is a highly uncertain proposition to estimate a terminal value. I don't know as much about WDC, but it's the same thing - nobody has one frickin clue what they will earn in five years, the industry economics are garbage.

 

I say ALL of that to say that Buffett has extremely good reasons for saying what he does, and using his quotes to defend an investment thesis is like quoting the investment bible. He quotes Benjamin Graham practically every time he is on camera - so yes, I will continue to use this fellow named Buffett as a source for defending sound investment rationale.

 

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Our original poster is waiting for Coke and Kraft at 5x future Cash Flow.

 

I dont agree with that I would hold WDC, SD, and ATSG with or without quotes. ATSG has a fairly bullet proof business model. WDC is a market leader. SD is hedging oil for 3-5 years at greater than 100% and greater than $100. Oil could go to $2 for 3-5 years and they would be fine minus the revolver. They are even pushing out debt. SD has $1 billion in cash flow locked in by 2013 based on hedges and planned drilling. WDC is hardly a tech company inmo. Its basically a parts supplier in an industry with 3 big players. They have R&D but every parts supplier does. I wasnt kidding, if you would loan me $4 billion at a reasonable rate, I would buy the whole company (PM me if the funds are available). Same with SD and same with ATSG. FBK and ATPG probably not.

 

Dont get me wrong I love having the quote and need it due to options positions, but I consider myself an owner in all of these businesses. My partial ownership allows me to trade them when Mr. Market gives me a crazy price or when the prospects for the businesses look grim, and I am eagerly looking forward to that day.

 

Also no one has a clue what any company will earn in 5 years. Buffett doesnt really know what most of his holdings outside of the utilities will earn in 5 years. Does anyone really know what an insurance company will earn in 5 years. Whats FFHs profit for 2016. You dont think Prem Watsa would own FFH without a quote. The man wrote in a letter that when he is dead his kids cant sell his shares. LOL

 

What I am saying is I could spend 1 hour and find 20 Buffett quotes saying 10 minutes on macro is 5 minutes wasting or its important but unknowable so dont spend much time on it. We can trade quotes all day. Close the market, and exercise my options when they run out. I am quite happy with most of my holdings. The markets are ahead of the economy but they are forward looking. Either you like what you own or you dont, like the market or dont. Pick one and go with it.

 

This broken clock will be right one day. But so is every other broken clock. At least they right twice a day.

 

A massive pullback is coming. Probably set off by Oil ($100 oil has a way of ruining a good dance), Politics, Euro Crisis, US Debt, and whatever the hell is going on. Everyone has been saying it for months. Hell I am up 75% and I have been saying it for a few months. All I am saying is going to cash and waiting for Dow 5000 doesnt seem like a reasonable strategy.

 

Hold em, fold em, or ....

Either you own companies which you know, understand, and like or you own pieces of paper which move up and down each day.

Pick one. I own both, and can honestly say that. Alot of people here like to pretend they own businesses, but freight because Mr. Market has gotten a bit excited with everything but his business.

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Don't you guys feel happy about doubling your money in the last 2 years?

 

Personnally, I feel quite good about it.  And the way I see it is that I don't have to work an extra 40 hours a week to get an extra 1% but risk losing 30%.

 

I'm spending a lot less time researching investing because there is just a lot less opportunities. Just not worth the return on time.

 

BeerBaron

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Don't you guys feel happy about doubling your money in the last 2 years?

 

 

Lol I am just wise the original number was a bit bigger. A little x 2 is still a little lol.

There are 2 - 3 items I want to dig into. MBIA and 2 other stocks. I just dont have time between work and Q4 updates and studying / gym / personal. Perhaps I should post a bit less.

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Saying the market is 10% overvalued is not a timing thing, it's a pricing thing. I have absolutely no clue what will happen with the macro picture, not even the slightest. If we were amidst world war 3 right now and the SP 500 was at 900 I would say the market is roughly 75% of fair value, and I would be around 75% long. We're a little over FV here and I'm a little less than 50% long. I'm not timing the market by doing that, I am simply managing exposure based on the market's price. It doesn't need to be one or the other. 

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Don't you guys feel happy about doubling your money in the last 2 years?

 

 

Lol I am just wise the original number was a bit bigger. A little x 2 is still a little lol.

There are 2 - 3 items I want to dig into. MBIA and 2 other stocks. I just dont have time between work and Q4 updates and studying / gym / personal. Perhaps I should post a bit less.

 

Myth, that's the advantage of part time investors. We can get in and out of the fight without actually going crazy.

 

If you were reading 10-k all year long maybe after 1 year you would start reducing your criterias and increase your risk tolerance. But the part time investor has the piece of mind with him, if he can't find good opportunities then beat it, he will spend some time with friends and family instead. This avoid being obsessed with your relative return and also has the advantage of making him socially accepted :)

 

BeerBaron

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We can debate all years for this. Heck, I am even debating with myself on this - is the market expensive or not? - if market is expensive, should I go cash or should I hedge with index puts?... Some sectors are cheap.. Some sectors are expensive.. the market in general is not too crazy is my thought.

 

Should I move to blue chips like WMT, JNJ... should I buy USD against CDN as hedge?

 

Then I see companies worth 40-50 bucks trading at teens.. or things like FBK that is quietly becoming debt free.

 

How can you buy banks without doing macro thinking...  it's tough to fellow every rules he or she said... find your styles and if you screw up. tune it. After all, Buffett at 30 is not Buffett at 80. And we are dealing with much more info and competition our there now than before.

 

Sorry for a post without key message or (many if you're me).

 

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It's not about knowing EXACTLY what earnings will be in 5 years - nobody ever said that. It's about finding something that you can predict within a narrow range of probabilities what earnings power will be 3, 5, and 10 years from now. My circle of competence does not include WDC or SD, but Myth, those are obviously within your circle, thus you are able to get comfortable with the long-run value of those plays, because even though you hold them short-term, the intrinsic value is based on long-run earning power (obviously the Street is very short-term focused and would consider one year of $5 EPS "normalized" despite the high probability EPS in 3 years will be $2 on a hypothetical company). I cannot get comfortable with the long-run earning power of a WDC due to the lack of pricing power, capital intensity, and potential for changing technology.

 

I have not studied SD at all other than looking at the financials on Google Finance just now, so I could be completely off here, but....

 

The highest operating cash flow in the last four years was ~$580mm, and let's say maintenance CAPEX is ~$300mm, that brings us to ~$280mm of normalized FCF to equity. At the current market cap of $4.56B, the PE is 16.28X. I've gone through this exercise with CHK, and tried to justify holding something at such a multiple due to the implied value of the assets, but I just can't get comfortable. The capital reinvested back into these companies is just incredible, and given the high exposure to NG and the uncertain future regarding the supply/demand picture for NG and hence the future returns on this massive reinvestment, it's more of a speculative situation. But I have been watching it ever since around $7.50 a share all the way up to where it is, so it's my loss.

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Guest Bronco

Bmi, I often go thru a similar analysis to what you just did.

 

The problem is this is one way to value a business.  But if chk can sell all their assets for 100 billion, the valuation fails.

 

If I own a building worth 10 million and it only generates $300 of cash flow, would you pay 5 million for the building?  Of course you would. 

 

The challenge is determining what a buyer would pay for underlying assets.  In addition, there may be some reliance on the greater fool theory (why are u staring at me?)

 

I am going thru valuations right now for work, using similar concepts.

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Exactly - reliance on the greater fool theory immediately renders the position speculatve because you are not relying on the asset to generate your return. That is fine though - some are better than others at speculation, I just am not one of them.

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It's not about knowing EXACTLY what earnings will be in 5 years - nobody ever said that. It's about finding something that you can predict within a narrow range of probabilities what earnings power will be 3, 5, and 10 years from now. My circle of competence does not include WDC or SD, but Myth, those are obviously within your circle, thus you are able to get comfortable with the long-run value of those plays, because even though you hold them short-term, the intrinsic value is based on long-run earning power (obviously the Street is very short-term focused and would consider one year of $5 EPS "normalized" despite the high probability EPS in 3 years will be $2 on a hypothetical company). I cannot get comfortable with the long-run earning power of a WDC due to the lack of pricing power, capital intensity, and potential for changing technology.

 

I have not studied SD at all other than looking at the financials on Google Finance just now, so I could be completely off here, but....

 

The highest operating cash flow in the last four years was ~$580mm, and let's say maintenance CAPEX is ~$300mm, that brings us to ~$280mm of normalized FCF to equity. At the current market cap of $4.56B, the PE is 16.28X. I've gone through this exercise with CHK, and tried to justify holding something at such a multiple due to the implied value of the assets, but I just can't get comfortable. The capital reinvested back into these companies is just incredible, and given the high exposure to NG and the uncertain future regarding the supply/demand picture for NG and hence the future returns on this massive reinvestment, it's more of a speculative situation. But I have been watching it ever since around $7.50 a share all the way up to where it is, so it's my loss.

 

Commodities business with high growth and capex - you need to do projections. SD is especially hard but the numbers are all screw.

CHK is an assets play - the hold more lands than they can drill all at once. So, they JV and sell some. They are going for liquid too.  It's like SD 2 years ago in a much large scale.

 

At the end, IMO, invest commodities is a macro call, especially for play like SD 1-2 years ago - you are forecasting that econ won't tank and cheap oil is gone. Now, SD is probably hedging oil like mad with $100+ and their cost is low.  So, the fact that Prem is in SD in a big way is telling...

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I agree. Definitely have to have a macro opinion for commodities. I like how depressed nat gas is right now, which depresses CHK, but I like at the same time how it's shifting to oil. I'll probably regret not getting in.

See with my conservative bent, I am looking at Dominion as a way to play the Marcellus area as they are investing billions at an almost guaranteed 12% roe. But someone will prob do far better in CHK or SD.

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Saying the market is 10% overvalued is not a timing thing, it's a pricing thing. I have absolutely no clue what will happen with the macro picture, not even the slightest. If we were amidst world war 3 right now and the SP 500 was at 900 I would say the market is roughly 75% of fair value, and I would be around 75% long. We're a little over FV here and I'm a little less than 50% long. I'm not timing the market by doing that, I am simply managing exposure based on the market's price. It doesn't need to be one or the other.  

 

Agreed we just have different styles. I dont adjust my cash based on the market. I adjust it based on whats out there and what I find. If you found a security that contained safe high quality liquid assets of $100 million, selling for $25 million would you not buy alot of it because the market was overvalued? I think Buffett would make the same argument.

 

I dont think there is anything wrong with timing the market. I attempt to do it with most investments lol. I just dont agree with this whole armagedan is coming I want 100% cash mantra. My issue is you are focused on the level of the market vs. the IV whatever you are interested in. I react similar to Soro, im fidgety and nervous, and bothered when the markets are high. The only way I end up getting peace  is by selling something and holding cash. I just dont agree with 100% cash, then back in and then back out. You find yourself like our original poster. Missing great 2-3 month rallies on cheap securities. Again different styles, yours is a fair one.

 

Exactly - reliance on the greater fool theory immediately renders the position speculatve because you are not relying on the asset to generate your return. That is fine though - some are better than others at speculation, I just am not one of them.

 

I think you misunderstand here, Assets have value because they can produce cash flow. A piece of land doesnt rely on the greater fool, it relies on the fact that the land has an intrinsic value because it can be put to a better use which generates cash flow. You are confusing all non cash flow generating assets with gold inmo. An empty building still has value, and so does a patch of land with oil on / in it.

 

It's not about knowing EXACTLY what earnings will be in 5 years - nobody ever said that. It's about finding something that you can predict within a narrow range of probabilities what earnings power will be 3, 5, and 10 years from now. My circle of competence does not include WDC or SD, but Myth, those are obviously within your circle, thus you are able to get comfortable with the long-run value of those plays, because even though you hold them short-term, the intrinsic value is based on long-run earning power (obviously the Street is very short-term focused and would consider one year of $5 EPS "normalized" despite the high probability EPS in 3 years will be $2 on a hypothetical company). I cannot get comfortable with the long-run earning power of a WDC due to the lack of pricing power, capital intensity, and potential for changing technology.

 

I have not studied SD at all other than looking at the financials on Google Finance just now, so I could be completely off here, but....

 

The highest operating cash flow in the last four years was ~$580mm, and let's say maintenance CAPEX is ~$300mm, that brings us to ~$280mm of normalized FCF to equity. At the current market cap of $4.56B, the PE is 16.28X. I've gone through this exercise with CHK, and tried to justify holding something at such a multiple due to the implied value of the assets, but I just can't get comfortable. The capital reinvested back into these companies is just incredible, and given the high exposure to NG and the uncertain future regarding the supply/demand picture for NG and hence the future returns on this massive reinvestment, it's more of a speculative situation. But I have been watching it ever since around $7.50 a share all the way up to where it is, so it's my loss.

 

Well CHK and SD are interesting. They are asset plays which are turning into cash flow plays overtime. SD and CHK rely on the same premise that Burlington Northern did. Higher energy prices over the long term. Pickens, Watsa (guessing here), Buffett, Grantham, and many other value investors believe in the premise. CHK is gas, SD is oil. Supply and demand for Gas are not good, they look great for oil though over the long term. I will be the first to say oil is getting ahead of itself but the supply fears with the mid east are real.

 

SD is hedging 100% of production over the next 4-5 years at these prices. Not found in Google Finance 2010 numbers are 1 million acres in what may be the best oil play in America. SD paid $200 an acre for the land, while others are paying $5k to $10k per acre for similar though less good acreage. All cash will go to drilling, and all additional cash will go to drilling, they will convert reserves to cash flow and find new reserves. If you think over the next 10 years oil will go higher then the reserves value and cash flow will increase. If you think oil is a bubble and should be $40 then you would be a fool to buy.

 

At $85 Oil SD is worth north of its current share price. You have to make a macro call on energy prices, similar to what Buffett did with Burlington. Its not speculative. You do your research, make your bet, and you are either wrong or right. Its all a bet, hopefully we are simply making educated ones and are right more often then not.

 

Bet when you think you have an edge, and bet within your circle of confidence, finally bet at the right price.

 

I dont do banking bets, just dont get them yet. I can understand why Buffett avoids direct bets on commodities and tech, but that doesnt mean a 20 something should follow directly in his footsteps.

 

I agree. Definitely have to have a macro opinion for commodities. I like how depressed nat gas is right now, which depresses CHK, but I like at the same time how it's shifting to oil. I'll probably regret not getting in.

See with my conservative bent, I am looking at Dominion as a way to play the Marcellus area as they are investing billions at an almost guaranteed 12% roe. But someone will prob do far better in CHK or SD.

 

SD is getting 120% returns on hedged oil in the Miss. You are correct though, its hard as hell to get your mind around where they are going. They have made it much easier with the investor day.

 

With that said, I would be looking to sell oil now or after the next big spike if there is one. Im in a bad position though, I think SD and ATPG are still severally undervalued. These oil prices will have to break down at some point, but if Ward is hedging I am willing to hold. I may end up hedging if I can find a cheap way to and if we see another $150 oil spike. Basically SD will rally until it doesnt, and then will trade down when energy prices fall as they will and as they should. I dont know when it will stop rallying, dont know when it will fall, do know oil is out of wack, but will hold. Perhaps it goes to $20 and falls to $15, below IV but well above here, perhaps we see $7.50. Who knows. I dont. If you do please send me a PM.

 

Finally the last downturn Ward and his team were able to add perhaps more than $2 - $4 billion of value to SD. They bought Forest, Arena, and the Miss play on the cheap with oil from $40 - $80. If the Miss works out then we are talking perhaps several billion in value. Beerbaron and many others were able to add several $s to their networth. Downturns arent all bad  :).

 

The world is just a better place with $90 oil, going up 5% to 10% a year. I believe we will have to deal with peak cheap oil, just hope we deal with it with a less fragile economy.

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"I dont think there is anything wrong with timing the market. I attempt to do it with most investments lol. I just dont agree with this whole armagedan is coming I want 100% cash mantra. My issue is you are focused on the level of the market vs. the IV whatever you are interested in. I react similar to Soro, im fidgety and nervous, and bothered when the markets are high. The only way I end up getting piece is by selling something and holding cash. I just dont agree with 100% cash, then back in and then back out. You find yourself like our original poster. Missing great 2-3 month rallies on cheap securities. Again different styles, yours is a fair one."

 

I never said 100% cash - right now i'm 50% cash, 50% long. And no I did not miss the rally beginning Sep 1, 2010 - I actually do pay attention to short-term market indicators via this investment firm in Ohio (James Investment Research) that provide extremely good short-term market analysis. So within my exposure guidelines (i.e. 50% long when the market is at FV, 75% long when the market is at 75% of FV), I will take advantage of short-term rallies such as the one those guys called back at the beginning of Sept. So I will admit I am a lot more nimble with my portfolio than I am probably indicating. Just wanted to clarify though that I am not at all 100% in cash right now.

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I never said 100% cash - right now i'm 50% cash, 50% long. And no I did not miss the rally beginning Sep 1, 2010 - I actually do pay attention to short-term market indicators via this investment firm in Ohio (James Investment Research) that provide extremely good short-term market analysis.

 

No prob. I believe the original poster has held greater than 75% cash since early 2010.

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"I think you misunderstand here, Assets have value because they can produce cash flow. A piece of land doesnt rely on the greater fool, it relies on the fact that the land has an intrinsic value because it can be put to a better use which generates cash flow. You are confusing all non cash flow generating assets with gold inmo. An empty building still has value, and so does a patch of land with oil on / in it."

 

IMO, if I purchase an asset that does not generate cash flow, then in order to generate a return on my investment, I am relying on the price action of the asset. Whether that price action is dependent on fear (i.e. gold), demand for RE development (land), or industrial output (oil), I consider depending on the price action of the asset to be speculation. There are obviously varying degrees of intelligent speculation - I would much rather speculate by purchasing a barrel of oil versus an ounce of gold b/c the demand for oil (industrial use) is far more tangible than the demand for gold (fear). But the fact of the matter is that both are considered speculation. Holding a barrel of oil generates $0 of cash flow - the only cash flow generated is when you sell that barrel of oil to someone who has a better use for it. Same with land - if JOE does not develop the land it holds into a cash flow-generating asset, then JOE will generate $0 return on its holdings until it is SOLD to someone else who is willing to pay a greater (or less, as Einhorn is arguing) price than JOE paid for it. Regardless of what type of use JOE's land can be used for, JOE is speculating that a future buyer will pay more for it (if JOE does not develop it), or if JOE decides to develop the land, then that original investment was a call option on a future investment (that is how CHK describes the cost of its acreage, as a call option on oil - I assume SD does the same).

 

 

SD & CHK are definitely highly interesting asset plays, and I can almost guarantee I am going to regret not taking a position - I have been debating CHK ever since a board member wrote about it at $23.

 

I don't mind speculating on the price of oil/commodities/dollar etc..., but I think Buffett's use of Burlington was brilliant b/c essentially regardless of the price of oil, Burlington will be carrying goods AND has pricing power. A safer, and albeit lower risk/lower return play than a CHK or SD.

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Hey Myth,

I like your posts but you are putting words in peoples mouths (er, words in their posts ;)) which were not there.

The original poster never wrote anything about what cash flow he is looking for or others are not saying anything about what % the "market" will go down etc etc.

Just that everyone values their investments differently - some using Macro to make it easier etc etc.

That is all - I just wanted to point that out because it urks me, for instance, when some assume something between the lines that is no there.

 

Carry on, and thanks for your posts. :)

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If oil goes to $20 BNSF will have been a poor investment just as SD and CHK will. Different assets ,same drivers, ultimately same outcome. Having something go from 20x earnings to 8x makes you look like a genius, having it go to 50x earnings due to low energy prices has to kinda reverse that doesnt it. SD, CHK, XOM wont disappear at $20 oil, they will just be repriced downward similar to BNSF.

 

Assets have value - you can buy something and use it to generate cash. You can buy an empty house, fix it up, and rent it out at 12% -20% cash on cash returns. No speculation, no greater fool. As I said not every none cash flow asset is like gold.

 

The only way Coke generates income is when it sells its Sugar Water to someone who has a better use from it. By your logic, investors are speculating on the price of Sugar Water and hoping that Coke can sell increasing volumes of fizzy drinks at higher prices. JOE is not speculating on anything. Neither is Berkowitz. Neither is Einhorn. They all have different ideas of what the land is worth thats it. 3 investors, 3 ideas (well 2 now 1 got fired), and 2 different valuations. Its not speculation because there is no cash flow. There is a cash flow valuation, and a net asset valuation. A building in the middle of New York City is not a speculation because it has no tenants. LOL

 

But thats my opinion. We can just agree to disagree.

 

Speculation has more to do with the investor than the Asset. An asset could have 5 stakeholders going long / short. 5 people could have 2 investors, 2 speculators, and 1 idiot. Its more about the mindset and knowledge of the person than the asset inmo.

 

-----

 

Smazz - some of those words are a carry over from about 6 prior doom and gloom conversations which went back and forward quite a bit. Unless I am thinking of the wrong poster. I find the Macro posts interesting and useful actually. They serve as a trigger to get me to reconsider things.

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"Its not speculation because there is no cash flow. There is a cash flow valuation, and a net asset valuation."

 

You cannot have one without the other. Companies sell below book value b/c their cash flow generation is not commensurate with the carrying value of their assets. An asset's value MUST be supported by its cash flow. If an asset is carried on the books at $1 billion and the required return on that asset is 10% but it only earns 5%, the market value of the company MUST be $500 million in order for investors to earn their required return on capital.

 

If I buy a piece of land for $1 billion and do nothing else (i.e. I do not develop it), that piece of land generates ZERO cash flow. So if I want to generate a return on my investment, how will I do that if there is no cash flow being thrown off? The only possible way for me to generate a return, without putting more money into the project via development, is to sell the land for a price higher than I bought it for.

 

Yes that land has utility, hence it very well may be a good investment; but without additional investment to develop it, literally the only way for me to generate a return is to sell it for higher than I bought it for. So if I buy a piece of land for $1 billion, and let's assume the market for land is perfectly efficient, then that $1 billion represents the present value of all future cash that can be extracted from the land. Because land in and of itself does not throw off cash, the future cash that can be extracted from the land MUST be from a future sale. So using easy math, if I think the land will sell for $2 billion in 10 years and my discount rate is 7.2%, then the PV of that future cash flow is $1 billion.

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