IV... and your estimation

[twacowfca]

The logic in this thread is deeply flawed in the arguments that IV is what it turns out to be in the future.  The flaw is the unstated assumption of no arbitrage.

 

The arbitrage is part of that future.

 

It is often possible to arbitrage in the present the indeterminate future state.  Financially, the present IV might be half of Schrodinger's Cat.  Or about 500 live cats out of 1000 whose future state is indeterminate.  :)

 

I don't think it is possible to do anything that does not belong in the future.  Once the connectors in my brains start firing time has already elapsed.

 

 

Here's a commonsensical example of how IV can change. Lets work the same idea backwards.  Lucky Joe has a dollar while standing at the crap table when a rare circumstance presents an even money bet. The intrinsic value of his dollar is . . . one dollar.  He lays his dollar down on the even money bet. After the roll of the dice, the intrinsic value of that wager is definitely going to change.  It will be worth zero or two dollars, but definitely not what it was worth before the roll of the dice. :)

[ERICOPOLY]

The logic in this thread is deeply flawed in the arguments that IV is what it turns out to be in the future.  The flaw is the unstated assumption of no arbitrage.

 

The arbitrage is part of that future.

 

It is often possible to arbitrage in the present the indeterminate future state.  Financially, the present IV might be half of Schrodinger's Cat.  Or about 500 live cats out of 1000 whose future state is indeterminate.  :)

 

I don't think it is possible to do anything that does not belong in the future.  Once the connectors in my brains start firing time has already elapsed.

 

 

Here's a commonsensical example of how IV can change. Lets work the same idea backwards.  Lucky Joe has a dollar while standing at the crap table when a rare circumstance presents an even money bet. The intrinsic value of his dollar is . . . one dollar.  He lays his dollar down on the even money bet. After the roll of the dice, the intrinsic value of that wager is definitely going to change.  It will be worth zero or two dollars, but definitely not what it was worth before the roll of the dice. :)

 

That entire sequence of events is Joe's cash flow.  It has a singular intrinsic value that never changed.  Upfront we lacked clear details on how the narrative would unfold.  The passage of time may have surprised us, but Joe's cash flow was his gambling winnings.  And all future gambling winnings discounted to the present has a singular real IV -- we just can't for the life of us accurately assign it a precise figure.

[JBird]

After the roll of the dice, the intrinsic value of that wager is definitely going to change.  It will be worth zero or two dollars, but definitely not what it was worth before the roll of the dice

 

Intrinsic value is the number that if you were all knowing about the future, and could predict all the cash that a business would give you between now and judgement day, discounted at the proper discount rate- that number is what intrinsic value is. - Buffett speaking to UGA students

 

Intrinsic value is the number that if you were all knowing about the future, and could predict all the cash that a crap table wager would give you between now and judgement day, discounted at the proper discount rate- that number is what intrinsic value is.

 

 

[wknecht]

 

I thought this simple example got to the heart of the point.

 

 

Yeah me too (that's why I thought of it  ;D).  Then I realized it was much more nuanced than I intended.

 

In any case, we will lose money (on average) if we pay more than $0.50 and make money (on average) if we pay less than $0.50. (Note I'm obviously ignoring time value.)

 

What should we base such decisions on if not mathematical expectation? As a corollary, how could IV be anything other than $0.50?

 

When we think of a business selling at IV, wouldn't we still expect to see a profit by purchasing the company at IV?  Why would you/what investor would pay the expected cash flow?  You would always require a profit.  Therefore, the IV needs to exclude $.50. 

 

Now, what is the right amount to pay?  There is a large variance in the outcomes, so what price is appropriate to subject your capital to the variance?  The Kelly Criterion comes into play here.  The larger your bankroll, the closer to $.50 you should pay.  The smaller your bankroll, you should pay closer to $.00.  So here the value depends. 

 

I am not sure how this applies to share structures though so that's why I said we might be getting off topic.

Was trying to get to an agreement on value first. As you mentioned price and value are two separate questions (or in Buffett's words, "Price is what you pay, value is what you get"). Suppose we didn't pay, but were given the right to participate. Prior to the toss, what did we "get"?

[wknecht]

 

I thought this simple example got to the heart of the point.

 

 

Yeah me too (that's why I thought of it  ;D).  Then I realized it was much more nuanced than I intended.

 

In any case, we will lose money (on average) if we pay more than $0.50 and make money (on average) if we pay less than $0.50. (Note I'm obviously ignoring time value.)

 

What should we base such decisions on if not mathematical expectation? As a corollary, how could IV be anything other than $0.50?

 

When we think of a business selling at IV, wouldn't we still expect to see a profit by purchasing the company at IV?  Why would you/what investor would pay the expected cash flow?  You would always require a profit.  Therefore, the IV needs to exclude $.50. 

 

Now, what is the right amount to pay?  There is a large variance in the outcomes, so what price is appropriate to subject your capital to the variance?  The Kelly Criterion comes into play here.  The larger your bankroll, the closer to $.50 you should pay.  The smaller your bankroll, you should pay closer to $.00.  So here the value depends. 

 

I am not sure how this applies to share structures though so that's why I said we might be getting off topic.

 

wknecht,

The real IV of the coin toss is either 0 or it's $1.00.  There is no other possible outcome.  (hey, you asked how IV could be anything other than 50 cents  ;)) You either get $0 if it's heads, or $1.00 if it's tails.  There is absolutely no chance in hell that IV could be 50 cents.

ironically though, estimated IV is just like you say, .50c because we have no other tool than predictive powers (and we have a lot of confidence in the equal heads/tails weightings).  So we have no hope but to assign an estimate that we know for certain will not be correct in one iteration of the coin toss.  In estimation efforts, we do our best.

.

I'm quite sure we're saying the same thing. Just quibbling about arbitrary words we use to define things.

 

But just in case, my bid is a generous $0.25 and ask is $0.75.

[ERICOPOLY]

After the roll of the dice, the intrinsic value of that wager is definitely going to change.  It will be worth zero or two dollars, but definitely not what it was worth before the roll of the dice

 

Intrinsic value is the number that if you were all knowing about the future, and could predict all the cash that a business would give you between now and judgement day, discounted at the proper discount rate- that number is what intrinsic value is. - Buffett speaking to UGA students

 

Intrinsic value is the number that if you were all knowing about the future, and could predict all the cash that a crap table wager would give you between now and judgement day, discounted at the proper discount rate- that number is what intrinsic value is.

 

+1

 

The key word:  omniscient.  Advance knowledge of all future events and risk free interest rates will produce a singular real IV.

 

The idea that an omniscient being is going to engage in a range of potential outcomes or probabilities is ludicrous.  Why do you think the omniscient being will spend any time predicting what he already knows?

 

[ERICOPOLY]

They flutter behind you your possible pasts

Some brighteyed and crazy some frightened and lost

A warning to anyone still in command

Of their possible future to take care

 

A very underrated album.

 

Don't those lines seem especially well suited to investors?  This is the kind of stuff Bill Gross would add to his newsletter for color.

 

Intrinsic value is The Final Cut!

 

[jay21]

Was trying to get to an agreement on value first. As you mentioned price and value are two separate questions (or in Buffett's words, "Price is what you pay, value is what you get"). Suppose we didn't pay, but were given the right to participate. Prior to the toss, what did we "get"?

 

We would get an expected value of $.50 cents.  I agree there.  But does someone ever calculate the IV of something but using its expected value?  Usually people discount the expected cash flows ("ECFs") in order to arrive at IV.  The discount rate is never the risk free, it is the risk free plus something (a premium).  The premium used compensates you for the variance in ECFs.  If the ECFs are guaranteed to be one value, you should probably use the risk free rate (even this is a debatable assumption).  If the ECFs are not guaranteed, you will require a premium. 

 

In our example, the toss is pretty much instantaneous, so for all intents and purposes we can set the risk free to zero.  But there's a variance in outcomes.  Isn't the value of the proposition lower because of the variance?  I.e. shouldn't you demand a premium or discount factor?

[jay21]

After the roll of the dice, the intrinsic value of that wager is definitely going to change.  It will be worth zero or two dollars, but definitely not what it was worth before the roll of the dice

 

Intrinsic value is the number that if you were all knowing about the future, and could predict all the cash that a business would give you between now and judgement day, discounted at the proper discount rate- that number is what intrinsic value is. - Buffett speaking to UGA students

 

Intrinsic value is the number that if you were all knowing about the future, and could predict all the cash that a crap table wager would give you between now and judgement day, discounted at the proper discount rate- that number is what intrinsic value is.

 

+1

 

The key word:  omniscient.  Advance knowledge of all future events and risk free interest rates will produce a singular real IV.

 

The idea that an omniscient being is going to engage in a range of potential outcomes or probabilities is ludicrous.  Why do you think the omniscient being will spend any time predicting what he already knows?

 

Hence my first comment:

 

"Only if you are a stout determinist could this possibly be true.  I.e.  If it is possible that the future only has one potential outcome and that outcome is knowable, then there could only be one IV.  Since the second condition is undoubtedly false, it is much better to assume a range of IVs.

 

Additionally, even if you knew the CFs the company will generate, you still could make the argument that there are multiple IVs based upon different discount rates."

 

Quantum indeterminacy casts doubt about fixed futures and therefore knowable futures.

[valueorama]

OK I couldn't resist. I have been following this discussion and wanted to throw my 2cents.

 

The key distinction between what Eric is saying versus others seems to be,  IV estimates vs actual IV.

 

As we get new information, our estimate of IV changes. As Buffett says, his estimate need not be same as Charlie's estimate of IV.

 

Is it as simple as above or am I missing anything?

 

 

 

 

[Kraven]

They flutter behind you your possible pasts

Some brighteyed and crazy some frightened and lost

A warning to anyone still in command

Of their possible future to take care

 

A very underrated album.

 

Don't those lines seem especially well suited to investors?  This is the kind of stuff Bill Gross would add to his newsletter for color.

 

Intrinsic value is The Final Cut!

 

I prefer:

 

So you run and you run to catch up with the sun but it's sinking

Racing around to come up behind you again.

The sun is the same in a relative way but you're older,

Shorter of breath and one day closer to death.

 

[boilermaker75]

They flutter behind you your possible pasts

Some brighteyed and crazy some frightened and lost

A warning to anyone still in command

Of their possible future to take care

 

A very underrated album.

 

Don't those lines seem especially well suited to investors?  This is the kind of stuff Bill Gross would add to his newsletter for color.

 

Intrinsic value is The Final Cut!

 

I prefer:

 

So you run and you run to catch up with the sun but it's sinking

Racing around to come up behind you again.

The sun is the same in a relative way but you're older,

Shorter of breath and one day closer to death.

 

Me too, and I often quote the line, "And then one day you find ten years have got behind you. "

[RichardGibbons]

Why, with multiple futures, is there but one past?

There isn't one past.  Suppose at this moment you flip a coin.  One universe is created where the result is heads, and one is created where the result is tails.  Do it again.  Now you have 4 universes.  There are some parts of the past that are in common, and some parts where the past is not in common.

 

The problem with your argument is that you're saying that when you flip that coin and it comes up heads, that means that in your universe, it was always going to be heads.  That's not true, because the alternative universe, where it came up tails, is also your universe and also contains the same you.  Each Ericopoly in each universe could argue that the coin was always fated to come up heads/tails, but it doesn't make any sense to completely ignore the other universe which is also you, and where the opposite result occurred.  It's still you.

[ERICOPOLY]

Why, with multiple futures, is there but one past?

There isn't one past.  Suppose at this moment you flip a coin.  One universe is created where the result is heads, and one is created where the result is tails.  Do it again.  Now you have 4 universes.  There are some parts of the past that are in common, and some parts where the past is not in common.

 

The problem with your argument is that you're saying that when you flip that coin and it comes up heads, that means that in your universe, it was always going to be heads.  That's not true, because the alternative universe, where it came up tails, is also your universe and also contains the same you.  Each Ericopoly in each universe could argue that the coin was always fated to come up heads/tails, but it doesn't make any sense to completely ignore the other universe which is also you, and where the opposite result occurred.  It's still you.

 

That's creative but I contend that a new universe is not created when I flip a coin.  Others disagree.  Separately, remember the idea of multiverse is hypothetical, yet you state it as if stating fact.  By the same token, the concept of singular universe may also be hypothetical  :) 

 

Regardless, I will be happy to restate my claims as the following:

One past sequence of events per universe.

One future sequence of events per universe.

Each business has but one real intrinsic value per universe.

The claims I make in this discussion pertain to the universe that we are presently communicating within.

 

The question then of one or many universe is irrelevant no matter which universe you live in, as you have a workable model that fits your universe.

 

I would be happy to think of a single universe as similar to a single instance of a computer application.  The application has global data structures that always have a single value assigned within their process space.  Yet there may be multiple instances of this application running at the same time, and each may have a separate value assigned for those same global data structures.  The logic within the program knows only the values of the global data structures belonging to that single instance, and for all intents and purposes of that program these are the only real values.  The existence of other instances is irrelevant.

[ERICOPOLY]

Furthermore, the omniscient one knows of all future universes, and he knows the singular intrinsic value for each universe.  Thus for the one we live in there is a singular intrinsic value.

 

Simply stated, in our universe there is a singular real intrinsic value.  Should we worry about another universes' intrinsic value, they ought to tell us to just stick to our own knitting.

[boilermaker75]

If the intrinsic value of a company never changes, then all companies that ever existed, exist today, or will exist in the future have the same IV. Eventually they will all be worth zero.

[wknecht]

After the roll of the dice, the intrinsic value of that wager is definitely going to change.  It will be worth zero or two dollars, but definitely not what it was worth before the roll of the dice

 

Intrinsic value is the number that if you were all knowing about the future, and could predict all the cash that a business would give you between now and judgement day, discounted at the proper discount rate- that number is what intrinsic value is. - Buffett speaking to UGA students

 

Intrinsic value is the number that if you were all knowing about the future, and could predict all the cash that a crap table wager would give you between now and judgement day, discounted at the proper discount rate- that number is what intrinsic value is.

 

+1

 

The key word:  omniscient.  Advance knowledge of all future events and risk free interest rates will produce a singular real IV.

 

The idea that an omniscient being is going to engage in a range of potential outcomes or probabilities is ludicrous.  Why do you think the omniscient being will spend any time predicting what he already knows?

Maybe this concept is interesting to discuss from a philosophical point of view, but I'm afraid I don't see any practical use for decision making. Do you?

 

Perhaps to look back for measurement, but even then you run the high risk fooling yourself. You could easily convince yourself that you made a good decision when in fact you made a bad one (paying $0.75 for the coin flip), or vice versa.

[ERICOPOLY]

If the intrinsic value of a company never changes, then all companies that ever existed, exist today, or will exist in the future have the same IV. Eventually they will all be worth zero.

 

However, before they are worth zero, they potentially will distribute earnings. 

[boilermaker75]

If the intrinsic value of a company never changes, then all companies that ever existed, exist today, or will exist in the future have the same IV. Eventually they will all be worth zero.

 

However, before they are worth zero, they potentially will distribute earnings.

 

That is true, but as they distribute earnings the IV changes.

 

One thing for sure, the IV of all companies will cease to exist the day I die!

[ERICOPOLY]

If the intrinsic value of a company never changes, then all companies that ever existed, exist today, or will exist in the future have the same IV. Eventually they will all be worth zero.

 

However, before they are worth zero, they potentially will distribute earnings.

 

That is true, but as they distribute earnings the IV changes.

 

One thing for sure, the IV of all companies will cease to exist the day I die!

 

The Berkshire model of sweeping the earnings and allocating it to purchases of new businesses reduces the chance of zero.  The more independent businesses they own, the less likely that they will all be zeros at the same time.

 

Now, if Berkshire instead were to buy back shares with the earnings, they would be doing nothing to reduce the probability of the shares being worth an absolute zero.

 

[boilermaker75]

If the intrinsic value of a company never changes, then all companies that ever existed, exist today, or will exist in the future have the same IV. Eventually they will all be worth zero.

 

However, before they are worth zero, they potentially will distribute earnings.

 

That is true, but as they distribute earnings the IV changes.

 

One thing for sure, the IV of all companies will cease to exist the day I die!

 

The Berkshire model of sweeping the earnings and allocating it to purchases of new businesses reduces the chance of zero.  The more independent businesses they own, the less likely that they will all be zeros at the same time.

 

Now, if Berkshire instead were to buy back shares with the earnings, they would be doing nothing to reduce the probability of the shares being worth an absolute zero.

 

Until the sun red giants and they are all burnt to a crisp, lol.

[ERICOPOLY]

Maybe this concept is interesting to discuss from a philosophical point of view, but I'm afraid I don't see any practical use for decision making. Do you?

 

Perhaps to look back for measurement, but even then you run the high risk fooling yourself. You could easily convince yourself that you made a good decision when in fact you made a bad one (paying $0.75 for the coin flip), or vice versa.

 

Well, I see a lot of value in knowing that there is one single IV.  It helps in scoring whether or not you are actually being a value investor, or whether you are just well intentioned to be a value investor but are following the wrong path.

 

The idea is to buy at a discount to the one true IV, not just an imagined one that's way off the mark!

 

So when we hear people saying that the IV of RIMM was something really high early on when they first bought the shares, but that the IV then collapsed, we know that what really happened is they bought at a discount to an IV they pulled out of their imaginations.  Then their imaginations created a new one after time passed.  Etc... etc...  Is that value investing when you pick a target that is extremely difficult to get right due to the high degree of unpredictability?  It might be good speculation, but I am going to say it's not value investing if you readily admit upfront that you haven't really got a good chance of getting the IV right.  You may argue that the price is low enough to compensate you for the uncertainty, but I still throw that in the speculation pile.  The uncertain businesses have too much potential for your estimates to be wrong, and thus it's unclear if that discount is really there.  Yet still there may be a right price -- it's just too hard for me anyway to call that anything but speculation.  I'm a speculator though if you measure my past behavior by this standard. 

 

Once you get into the "wide range of outcomes" businesses and start assigning probabilities to each outcome, this is where you are most likely to get it wrong because your bias has an influence on the probabilities that you assign.  So it's inherently unreliable given that you are human.  I think a better path is the one that Buffett and Munger follow where they study the long term durability of the business and reduce their chance of bias being a weakness by only sticking with businesses that are nearly certain to last a long time.  Rather than trying to assess the odds of RIMM being around in 5 years, they'd rather just narrow their universe of stocks to the relatively few that almost certainly will be around in 5 years, and either buy them today or wait for a discount in them.

 

I think Buffett and Munger have evolved to become true value investors in that they seek to get as close as possible to the one true IV and they stay away from businesses where they have too variable of outcomes.  That's why they would never invest in RIMM -- "too hard" pile means that it's too hard to get a (relatively) highly reliable estimate of the one true IV.  They have deep religion, almost like monks. 

 

Me, am I a true follower of this religion?  I hope to be, but my past record is one of speculator.

[RichardGibbons]

OK, so an argument like, "Stock always go up (provided we exclude from the sample set any stock that goes down)", or "Newtonian gravity represents perfectly the way the universe works (assuming we ignore the big or the small)", or "All swans are white (assuming Australia doesn't exist)".

 

Basically, your proposition is built on asserting that the universe doesn't have any properties that refute your proposition.  So it's kind of an approximate model for the universe with huge known flaws rather than actually trying to represent the real universe.

 

Ok, in that case your proposition is true, other than the time issues boiler raises.  (You could just go all the way and say that the intrinsic value of every company is zero, since, at the heat death of the universe, all stocks and all distributed earnings of those stocks would be worthless.  But I'm guessing that you wouldn't like either.  I kind of like that one though, because it says that the intrinsic value of every company is fixed and knowable, which is kind of cool.)

 

[boilermaker75]

If the intrinsic value of a company never changes, then all companies that ever existed, exist today, or will exist in the future have the same IV. Eventually they will all be worth zero.

 

However, before they are worth zero, they potentially will distribute earnings.

 

That is true, but as they distribute earnings the IV changes.

 

One thing for sure, the IV of all companies will cease to exist the day I die!

 

The Berkshire model of sweeping the earnings and allocating it to purchases of new businesses reduces the chance of zero.  The more independent businesses they own, the less likely that they will all be zeros at the same time.

 

Now, if Berkshire instead were to buy back shares with the earnings, they would be doing nothing to reduce the probability of the shares being worth an absolute zero.

 

How do you think about the IV of BRK? Did the IV change when Buffett bought BRK? I believe Buffett has referred to his purchase of BRK as an investment mistake. So did the chance event of Buffett buying BRK change the IV? Did BRK go from a possible zero IV to whatever it is today?

[ERICOPOLY]

If the intrinsic value of a company never changes, then all companies that ever existed, exist today, or will exist in the future have the same IV. Eventually they will all be worth zero.

 

However, before they are worth zero, they potentially will distribute earnings.

 

That is true, but as they distribute earnings the IV changes.

 

One thing for sure, the IV of all companies will cease to exist the day I die!

 

The Berkshire model of sweeping the earnings and allocating it to purchases of new businesses reduces the chance of zero.  The more independent businesses they own, the less likely that they will all be zeros at the same time.

 

Now, if Berkshire instead were to buy back shares with the earnings, they would be doing nothing to reduce the probability of the shares being worth an absolute zero.

 

How do you think about the IV of BRK? Did the IV change when Buffett bought BRK? I believe Buffett has referred to his purchase of BRK as an investment mistake. So did the chance event of Buffett buying BRK change the IV? Did BRK go from a possible zero IV to whatever it is today?

 

You need to think about the meaning of omniscient.  It's clear what my answer will be once you do this, as the omniscient being knew that Buffett would buy BRK and he knew everything that Buffett would do up until this day.