"Macro" Musings

[giofranchi]

Mr. Buffett buys back under 1.2 x BVPS, and yet doesn’t sell one share of his, even when the stock trades above that price. Does he?

 

In truth, this is not fair: not much of what Mr. Buffett does is very relevant to any of us… Ok, I admit that!

 

Yet, an entrepreneur is content to be “vaguely right”… When he finds a good business, he sticks with it, unless its future prospects go irremediably south, or he is offered an obscene price. And the reasons are very clear to me:

1) the knowledge and the experience of everyone are definitely limited,

2) valuation is not an exact science.

And in the long-run I think it is far better to hold a slightly overvalued share, which you know in the end will take you where you want to go!, than to constantly run the risk of making very costly mistakes. But the fact that I might be willing to hold a slightly overvalued share doesn’t mean I would be buying more at those prices, or that I would like management to do that in my stead.

 

Gio

 

[rjstc]

Mr. Buffett buys back under 1.2 x BVPS, and yet doesn’t sell one share of his, even when the stock trades above that price. Does he?

 

In truth, this is not fair: not much of what Mr. Buffett does is very relevant to any of us… Ok, I admit that!

 

Yet, an entrepreneur is content to be “vaguely right”… When he finds a good business, he sticks with it, unless its future prospects go irremediably south, or he is offered an obscene price. And the reasons are very clear to me:

1) the knowledge and the experience of everyone are definitely limited,

2) valuation is not an exact science.

And in the long-run I think it is far better to hold a slightly overvalued share, which you know in the end will take you where you want to go!, than to constantly run the risk of making very costly mistakes. But the fact that I might be willing to hold a slightly overvalued share doesn’t mean I would be buying more at those prices, or that I would like management to do that in my stead.

 

Gio

 

And assuming that ERICOPOLY bought at a good price originally, and taking into account the fact that he says he is paying about 50% combined state and federal taxes in taxable accounts. It would seem like in making capital allocation decisions he would have to take that into account.

1) By selling at full value he reduces his profit by that rate?

2) He says that by holding the stock you are implicitly saying you are buying that stock today. So would that mean you would be immediately taking a loss when you factor in taxes?

[ERICOPOLY]

 

My long term capital gains rate is 33% (same as my dividend rate) and it is only on gains portion.

 

So take BAC... which I bought at "good prices".  My shares might have a cost basis of $6, and today the stock is at $14.50.  So I have a gain of $8.50 per share.

 

Dividends:

Now let's say they pay $1 of dividends.  Okay, my tax on that is 33 cents.

 

Buybacks:

Instead, they buy back shares and I sell an offsetting amount.  My tax on that is 19.33 cents.

 

So less value is destroyed by repurchasing shares.

 

Unless you pretend to claim that 19.33 is greater than 33.

 

 

[ERICOPOLY]

Mr. Buffett buys back under 1.2 x BVPS, and yet doesn’t sell one share of his, even when the stock trades above that price. Does he?

 

In truth, this is not fair: not much of what Mr. Buffett does is very relevant to any of us… Ok, I admit that!

 

Yet, an entrepreneur is content to be “vaguely right”… When he finds a good business, he sticks with it, unless its future prospects go irremediably south, or he is offered an obscene price. And the reasons are very clear to me:

1) the knowledge and the experience of everyone are definitely limited,

2) valuation is not an exact science.

And in the long-run I think it is far better to hold a slightly overvalued share, which you know in the end will take you where you want to go!, than to constantly run the risk of making very costly mistakes. But the fact that I might be willing to hold a slightly overvalued share doesn’t mean I would be buying more at those prices, or that I would like management to do that in my stead.

 

Gio

 

And assuming that ERICOPOLY bought at a good price originally, and taking into account the fact that he says he is paying about 50% combined state and federal taxes in taxable accounts. It would seem like in making capital allocation decisions he would have to take that into account.

1) By selling at full value he reduces his profit by that rate?

2) He says that by holding the stock you are implicitly saying you are buying that stock today. So would that mean you would be immediately taking a loss when you factor in taxes?

 

You are right, I do have to take taxes into account, which changes the calculus of dumping the entire holding.

 

But it does not change the calculus of dividends versus buybacks, because dividends will always be the worse option that destroys more value (unless the cost basis of my shares is $0).

[ERICOPOLY]

I also employ a methodology of buying puts instead of selling appreciated shares.  Then as the puts expire worthless I can take the tax deduction to begin to reduce holdings.  So while I can't dump the entire holding all at once without tax consequences, I can certainly lock in the value all at once without tax consequences.  Unless the shares don't have options traded, but currently I don't have that problem.

[ERICOPOLY]

1) the knowledge and the experience of everyone are definitely limited,

2) valuation is not an exact science.

And in the long-run I think it is far better to hold a slightly overvalued share, which you know in the end will take you where you want to go!, than to constantly run the risk of making very costly mistakes. But the fact that I might be willing to hold a slightly overvalued share doesn’t mean I would be buying more at those prices, or that I would like management to do that in my stead.

 

The first three things you say, (#1, #2, and then the following sentence), indicate that you might as well buy your current holdings even if you presently didn't own them and held cash instead.

 

The last thing you said doesn't make full logical sense because you have elected not to mention that you can sell an offsetting amount of shares and therefore get your cash all the same without altering your percentage of ownership in the company.  So this argument that you wouldn't be buying MORE is irrelevant, because you are free to manage your percentage ownership of the company.

 

Plus, I said if you hold it today you could go to cash and buy it back -- that has nothing to do with MORE.  It is all about SAME.

[frommi]

This is a really strange way to look at it… It is as if, instead of thinking how to use the new free cash my businesses generate, I would be constantly looking for someone who might be willing to buy those businesses from me… Yes, I might consider to sell a business… but only if it becomes extremely overvalued! This certainly doesn’t mean that I am going to put all the free cash generated by that business back into it! This is clear, isn’t it? I have never done so, and I will never do it… yet, I don’t sell my businesses!

Exactly like it is for my businesses, also for a stock that I bought at BV and that can compound at high rates for many years into the future, I am willing to stick with that business through all the ups and downs. (Unless, of course, it becomes extremely overvalued!) This doesn’t mean I will add to my holdings on the ups… right?

 

Gio

 

I agree with you and Eric on this one, but what is extremly overvalued in your eyes? I currently would sell my "premium" holdings like KO or JNJ at 50% overvaluation, but i am not sure if this is too low. And i want to think about that before it happens, because i know that i would trick myself when that limit is reached and i am not prepared.

[hyten1]

eric i hear ya why you by puts (benefits are hedge, reduce capital gains)

 

but the put is such a small percentage of your entire gains. How do you plan to realize ALL those gains? (this puts strategy is just a little bandaid).

 

- Take the tax hit eventually (obviously timing matter, or spread it out)

- borrow against your portfolio (pay interest to offset the cap gains) - i understand you might not completely ever realize the gain.

- what else?

 

hy

 

I also employ a methodology of buying puts instead of selling appreciated shares.  Then as the puts expire worthless I can take the tax deduction to begin to reduce holdings.  So while I can't dump the entire holding all at once without tax consequences, I can certainly lock in the value all at once without tax consequences.  Unless the shares don't have options traded, but currently I don't have that problem.

[ERICOPOLY]

I have a math degree and you have an engineering degree.  Somebody who knew only those two things about us might guess that you probably prefer doing things by a process so as to be ISO9000 compliant, whereas I make decisions based on whether 19 is less than 33.

[rjstc]

I have a math degree and you have an engineering degree.  Somebody who knew only those two things about us might guess that you probably prefer doing things by a process so as to be ISO9000 compliant, whereas I make decisions based on whether 19 is less than 33.

 

So you don't take any short term taxable gains? Then I can see your point.

[ERICOPOLY]

I have a math degree and you have an engineering degree.  Somebody who knew only those two things about us might guess that you probably prefer doing things by a process so as to be ISO9000 compliant, whereas I make decisions based on whether 19 is less than 33.

 

So you don't take any short term taxable gains? Then I can see your point.

 

Yes, if I'm selling a short-term holding to offset a dividend then I pay a tax rate that puts the dividend at the advantage.  At that point, I wear Buffett's hat and declare a Jihad on managements that don't do what's best for me when they buy stock at high prices.

 

You just have to look at his incentives to predict what that man is going to say.

 

But then I settle down, because the bulk of my holdings are long-term and with my expiring puts they wipe out any such relatively small short term capital gains.  So then I take Buffett's hat off and once again remark how buybacks are the most democratic way of returning cash to investors.

 

[ERICOPOLY]

eric i hear ya why you by puts (benefits are hedge, reduce capital gains)

 

but the put is such a small percentage of your entire gains. How do you plan to realize ALL those gains? (this puts strategy is just a little bandaid).

 

- Take the tax hit eventually (obviously timing matter, or spread it out)

- borrow against your portfolio (pay interest to offset the cap gains) - i understand you might not completely ever realize the gain.

- what else?

 

hy

 

I also employ a methodology of buying puts instead of selling appreciated shares.  Then as the puts expire worthless I can take the tax deduction to begin to reduce holdings.  So while I can't dump the entire holding all at once without tax consequences, I can certainly lock in the value all at once without tax consequences.  Unless the shares don't have options traded, but currently I don't have that problem.

 

Well, that's the trouble.  Meanwhile, I'll do my best to defer the gains until I can claim tax residency outside of California.

[giofranchi]

But it does not change the calculus of dividends versus buybacks, because dividends will always be the worse option that destroys more value (unless the cost basis of my shares is $0).

 

Well, if it really is like you say, Mr. Brindle is an idiot (sorry, Mr. Brindle, forgive me, because I clearly don’t know what I am saying! :-[ )… and I have invested 20% of my firm’s capital with an idiot! >:(

 

Gio

 

[giofranchi]

I have a math degree and you have an engineering degree.  Somebody who knew only those two things about us might guess that you probably prefer doing things by a process so as to be ISO9000 compliant, whereas I make decisions based on whether 19 is less than 33.

 

Eric,

tell me: do you really think I am the “average engineer”? Do you think the average engineer, the one interested in complying with ISO9000, behaves like I do?

I you think so, I guess you don’t know many engineers! ;)

 

Gio

 

[giofranchi]

The first three things you say, (#1, #2, and then the following sentence), indicate that you might as well buy your current holdings even if you presently didn't own them and held cash instead.

 

The last thing you said doesn't make full logical sense because you have elected not to mention that you can sell an offsetting amount of shares and therefore get your cash all the same without altering your percentage of ownership in the company.  So this argument that you wouldn't be buying MORE is irrelevant, because you are free to manage your percentage ownership of the company.

 

Plus, I said if you hold it today you could go to cash and buy it back -- that has nothing to do with MORE.  It is all about SAME.

 

Eric,

sometimes I have an hard time to understand exactly what you mean… therefore, I do not really know if my answer is pertinent or not… But I will make a try nonetheless…

 

Let’s say that I want to build a 30% position in LRE. And right now I have only a 20% position, and I am holding some cash, surely enough cash to buy the remaining 10%. But I also want to wait for the opportunity to average down, and don't want to build right away a 30% position at prices that might not be spectacular bargains… Yet, who knows for sure if that opportunity will ever come in the future? Not me! Neither you, I guess… So, at today’s price LRE is a wonderful investment, that I am very confident will make a lot of money for my firm, and therefore I hold it. But I also want to leave some room to get greedy, if ever the chance might be presented to me for buying more at a wonderful price.

 

Furthermore, also Mr. Brindle seems to be thinking something similar: he used to buying back shares, when their price was closer to BVPS, while now he returns capital to shareholders through special dividends… I have no doubt that, if LRE’s share price falls enough in the future, he will start again buying back shares.

 

Gio

 

[giofranchi]

I agree with you and Eric on this one, but what is extremly overvalued in your eyes? I currently would sell my "premium" holdings like KO or JNJ at 50% overvaluation, but i am not sure if this is too low. And i want to think about that before it happens, because i know that i would trick myself when that limit is reached and i am not prepared.

 

Well, this whole discussion started with a valuation of the S&P500. Therefore, this not like buying back shares of an undervalued company in a richly priced market… Instead, this is like buying back shares of a richly priced company in a richly priced market! If the S&P500 is priced to return 3%-4% for the next 10 years, what we are talking about here is buying shares of the average company, that are priced to return 3%-4% for the next 10 years. It is nonsense to me… Would you buy the index at today’s prices?! Guess what? I’d rather short it instead! ;)

 

Gio

 

[ERICOPOLY]

 

Eric,

sometimes I have an hard time to understand exactly what you mean… therefore, I do not really know if my answer is pertinent or not… But I will make a try nonetheless…

 

Let’s say that I want to build a 30% position in LRE. And right now I have only a 20% position, and I am holding some cash, surely enough cash to buy the remaining 10%.

 

What I meant is that you could swap that 20% position for cash.  Then you would be in cash, with no position.  But you choose to hold a 20% position, so you implicitly are saying that if you were in cash today and held no position, then you would be a buyer of a 20% position at the current prices.

 

Therefore, if you hold then you are implicitly a buyer of that 20% position at these prices.

 

That's all I'm saying :)

 

Thus, if the management is to buy some shares back, you can hardly fault them as you yourself are also a buyer (implicitly) of whatever you hold.  Unless of course you only hold for tax reasons.  And if you don't want more ownership of the same company for allocation reasons, you just sell an offsetting amount and get the cash without paying as much tax on it (unless you are Buffett).

[ERICOPOLY]

Suppose you fat fingered when you were logged into your account and somehow instructed the broker (by accident) to sell everything.

 

Then you would be in cash.

 

Are you saying you wouldn't buy back everything you currently hold once you realized your mistake?  If you would, then you are a buyer at these prices, obviously, because you would in fact be buying at these prices.

 

And wouldn't this be true at any valuation?  On any day that such a fat fingered mistake is made?

 

Taxes aside of course.

[obtuse_investor]

Suppose you fat fingered when you were logged into your account and somehow instructed the broker (by accident) to sell everything.

 

Then you would be in cash.

 

Are you saying you wouldn't buy back everything you currently hold once you realized your mistake?  If you would, then you are a buyer at these prices, obviously, because you would in fact be buying at these prices.

 

And wouldn't this be true at any valuation?  On any day that such a fat fingered mistake is made?

 

Taxes aside of course.

 

 

I don't think it is that black and white.

 

If I estimate that a business is worth $100, I would be willing to open a position at 50 or below, but if my position was accidentally liquidated at $85, I wouldn't reopen it.

 

I am a buyer at <=50, but a holder at 85 and a seller at >=95

 

[ERICOPOLY]

Not behaving purely rationally is being human.

[hyten1]

 

- if you didn't accidentally liquidate at $85 you would keep it

- but if you accidentally liquidate at $85 you would not buy it back

 

(assuming no tax consequence and transaction cost is $0)

 

interesting :)

 

i have to be honest, i too behave this way. but if you really think of it logically, its not logical. (but in the real world tax and transaction cost does exist, which makes this even harder)

 

which one of the human faults (or multiple) does this fall under.

 

hy

[ERICOPOLY]

 

which one of the human faults (or multiple) does this fall under.

 

hy

 

During the summer of 2008 I read one of Jim Cramer's books.  The only interesting thing I found in there is that a trader once taught him to periodically just sell everything, go to 100% cash.  Then, reconstruct the portfolio.  The idea being that you tend to hold some positions just for psychological reasons that are no longer there once you are in cash.  It clears your head was his point.

[hyten1]

i know, i was wondering. what if the rule/law is you are force to covert to cash at the end of everyday and start afresh every morning (with no tax or transaction cost consequence of course)

 

that would be interesting.

 

i personally, periodically would do this same excercise mentally (it is not easy). I ask "what if i start fresh today, what would i buy, TODAY" forget about what i have.

 

i try to do this every so often, but its not easy and taxes clouds the thinking or make it less straight forward.

 

folks, is there some sort of general rule due to tax (I can prob figure this out, but i am being lazy) that is stock is over value by X% you should sell even taken into account taxes. what is X%?

 

 

 

hy

 

 

 

which one of the human faults (or multiple) does this fall under.

 

hy

 

During the summer of 2008 I read one of Jim Cramer's books.  The only interesting thing I found in there is that a trader once taught him to periodically just sell everything, go to 100% cash.  Then, reconstruct the portfolio.  The idea being that you tend to hold some positions just for psychological reasons that are no longer there once you are in cash.  It clears your head was his point.

[obtuse_investor]

 

- if you didn't accidentally liquidate at $85 you would keep it

- but if you accidentally liquidate at $85 you would not buy it back

 

(assuming no tax consequence and transaction cost is $0)

 

interesting :)

 

i have to be honest, i too behave this way. but if you really think of it logically, its not logical. (but in the real world tax and transaction cost does exist, which makes this even harder)

 

which one of the human faults (or multiple) does this fall under.

 

hy

 

I know that it isn't rational. It is downright illogical.

 

But this illogical way of acting is because in this game of investing, we are sorrounded by probabilities that are always less than 1.0

 

Quite simply, the margin of error or safety is very small at $85 compared to $50.

 

Knowing this obvious human tendency, I sometimes lighten my positions when it going hovers close to that $85 mark. I probably have walked away from a lot of potential profit because of this-- and I am OK with that.

 

 

[giofranchi]

"Back to German Bashing" by Charles Gave

 

"The euro in action" graph is just terrific!! Italian IP vs. German IP experienced wild fluctuations from 1960 to 2000, but on averaged kept improving. Instead, from 2000 until today it simply cratered! And apparently with no end in sight! Our industrial base is slowly but inevitably suffocating… Difficult to see how this could end well.

 

Gio

Daily+11.14.13.pdf