Author Topic: berkshire - cheap?  (Read 51569 times)

longinvestor

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Re: berkshire - cheap?
« Reply #230 on: July 11, 2018, 04:21:40 PM »
Semper Augustus does a much better job than this CNBC article in laying bare how incredulous the status quo really is. No, it is not a one quarter headline grabbing event.


Cigarbutt

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Re: berkshire - cheap?
« Reply #231 on: July 11, 2018, 06:37:35 PM »
Interesting exchange between longinvestor and Dynamic.

A way to resolve the issue may simply be to apply what Spekulatius said today when commenting on "The Margin of Safety" by Seth Klarman:
"I found Howard Marks book unremarkable too. I know he is revered here, but I really didn‘t get much from his book, other than the idea to think about where we are in a cycle. Even with respect to the latter, it might just be better not to think about cycles at all and look at all Investments case by case and forget about the large picture."  (my bold)

Some suggest (like Mr. Klarman) that there may be value in trying to understand the general context. If found to be valuable, one can decide for himself how to integrate this concept into investment decisions (stay fully invested, delegate the responsibility to a third party (like you eloquently explain in reply #225 of this thread (see quote below) or hold the responsibility yourself).

"All in all, I think Berkshire should be very likely to perform at least as well as the index in the long run and likely to outperform it by a percent or two per annum in the long run, partly thanks to the float leverage and partly thanks to rational opportunism." (my bold)

Dynamic, I agree that there may be an element of statistical distribution but your fluid dynamics explanation does not take into account human nature.

To complement what longinvestor has provided, here's a link:
http://integratinginvestor.com/value-investing-is-life-imitating-art/

Value investing means different things to different people but I would not include momentum. I think this aspect is one of the fundamental reasons that Mr. Buffett tends to underperform a little in bull markets but overperforms in bear markets.

I really like it when momentum is on my side but try to dissect it out of my investment decisions.

To paraphrase Oscar Wilde: what is found in life and nature {and markets} is not what is really there but is that which has been taught to people to find there.

Crowds are not always right.

Dynamic

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Re: berkshire - cheap?
« Reply #232 on: July 11, 2018, 11:03:29 PM »
Semper Augustus does a much better job than this CNBC article in laying bare how incredulous the status quo really is. No, it is not a one quarter headline grabbing event.

I think maybe i went a little too far the other way actually on reflection, but I did have some difficulty accepting Semper Augustus's view that index investing was exacerbating the thinning out of the distribution of returns so that tech names contributed almost all the gains. Their Berkshire analysis later in their letter was the best I've read.

Anyhow, while I like to remember how probability distribution trails work and avoid cherry picking, I was too strong implying that cherry picking accounted for all of it. There is some real skewing going on and the returns so seem unusually concentrated even if we should always expect concentration in gains.

rolling

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Re: berkshire - cheap?
« Reply #233 on: July 12, 2018, 12:52:55 AM »
Semper Augustus does a much better job than this CNBC article in laying bare how incredulous the status quo really is. No, it is not a one quarter headline grabbing event.

I think maybe i went a little too far the other way actually on reflection, but I did have some difficulty accepting Semper Augustus's view that index investing was exacerbating the thinning out of the distribution of returns so that tech names contributed almost all the gains. Their Berkshire analysis later in their letter was the best I've read.

Anyhow, while I like to remember how probability distribution trails work and avoid cherry picking, I was too strong implying that cherry picking accounted for all of it. There is some real skewing going on and the returns so seem unusually concentrated even if we should always expect concentration in gains.

indexing effects (in my thinely informed opinion) can be best understood if you imagine only two active investors exist and all others just index: every time those two agree in an above market purchase, all others will follow and bid the stock up  while dumping all other stocks to normalize the weighting. This two pronged move will feed on itself until the two investors act again.

Applied to the real market: companies in favour to active investors (be it because of momentum or real increase in value) will be bid up by indexing and the remaining will be sold down. Only active investors can stop this trends and will do so only after the first have risen further and the second have fallen further down.
My usual portfolio: Highly concentrated (up to 3 or 4 positions) in smallcaps and microcaps.

Dynamic

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Re: berkshire - cheap?
« Reply #234 on: July 12, 2018, 01:47:12 AM »
Cigarbutt, I'd agree that momentum is a very real effect. Unlike momentum or intertia in physics however, it can reverse very quickly, so don't assume that a stock with high momentum will continue moving upwards albeit more slowly and then gradually reverse direction in the event of bad news or results. It might be better to call it speed or velocity than momentum, as momentum is velocity x mass. Stocks don't tend to have much mass or inertia, but some of them maintain a pretty steady speed of price movement for quite a long time unless a force acts upon them, but a fairly moderate force can overcome their most mass (inertia) to make them take on substantial velocity in the other direction.

Certain people in market will look at what has 'performed' well recently and jump aboard, either directly or by looking for smart managers who were on board that train where they want part of that action. That is certainly what happened with the huge interest in tech or TMT funds in the late 1990's and into 2000-2001. Now a lot of this focuses on FAANG and friends.

If applying this to value, some value investors may delay their buying decision until not only is a stock sufficiently undervalued but perhaps they'll wait until it shows some signs of beginning to be revalued upwards by the broader market, so they avoid tying up their capital in 'value traps' or having to wait a long to for the unrecognised value from being priced into the stock and for it to rise. They might even use some chartist approaches to time their entry, foregoing some of the gains, but potential reducing the time waiting in an undervalued stock.

I could see this is a particularly valid concern in the cigar-butt type positions where the stock is not expected to experience compound growth in the business fundamentals, so all the time waiting for the price to rise, you're not benefiting from the business gaining fundamental intrinsic value over time (unless they pay out a substantial dividend of course).

Conversely, if you buy a fundamentally good or great business that is able to compound over time with a good ROE and ROIC and no concern over heavy debt loads, you can be very happy watching it slowly compound for the long term even if your stock price remains resolutely stuck at a 30-50% discount to IV, especially if you are considering adding to your position. If you already have the full exposure you desire, you may prefer the kicker of seeing not only compounding IV but an upward re-rating of the stock, then you can get maybe 30-40% cagr and be able to sell later to take advantage of the next great undervalued idea you have in a year or two (or if not simply hold and enjoy the decent compounding in the fundamental IV.

Likewise, if you have a good to great business that compounds or distributes most of its free cash flow, selling at a substantial discount to IV, you should probably buy regardless of the danger signals visible in the broader market and its thinning number of outperformers or fears of trade wars or recessions. Very often such danger signs are around for many years before the actual top of the market (I think I remember some quite convincing danger signs being persuasively express by value legends in 2015-2018 at least, if not longer), and if you aren't fully invested in good compounders, you could well have a lot of your capital on the sidelines missing out on 3-6 years of good to great compounding (10%+ and possibly a lot more like 20% in a bull market) that would still see you well ahead of cash even after a 30-50% market crash eventually arrives. When that crash arrives, you may have to be willing to sell some moderately undervalued positions in good to great companies to raise the funds to buy some deeply undervalued huge bargains in previously overvalued great companies, rather than just using cash you had waiting on the sidelines, but it really doesn't take many years of good compounding while you are a little concerned about frothy markets to compensate for the eventual and inevitable downswing and leave you well ahead of cash earning next to nothing. If you accept that smart people will be calling the bear market for year before it arrives, and you have no ability to accurately estimate its time of arrival, you may be able to ignore it, so long as you can stomach severe 'losses' in market value.

Then again, if you're deep value and insist on a particularly high margin of safety, you might get better returns when you do invest but actually make investments far less often. Then, you should expect to have a lot of money on the sidelines while you patiently await the next big opportunity and should compensate by the outsized gains when you finally put it to work and your outperformance of folks like me in crashes when you're holding a lot of cash.

Inside Berkshire it's a little different. It seems to be mostly the float that's sitting in cash, waiting for a good buy with strong downside protection and reasonable to great upside. The shareholders' equity portion of investable funds is pretty much all being put to work already while the float portion of non-callable funding using other people's money is pretty much all in cash and short term T-bills/deposits. In the event of a downturn, the downside protection and the range of opportunities is likely to produce a sensible situation to invest much of the float portion into undervalued equities or whole company acquisitions, then over a few years, the operating profits of Berkshire's subsidiaries will gradually refill the pot and again float will be represented by mainly cash and equivalents as the next cycle matures.

Returning to momentum not being part of value.
Chartists tend to try to imagine psychological factor like 'resistance' and 'support' levels or slopes or perhaps statistical lines at 1 or 2 standard deviations, such as Bollinger bands or moving averages and to some extent some of these methods try to capture momentum effects too. In their pure form they ignore the fundamentals, but their are many flavours of chart-reading too and they can pick and choose.

In looking at Berkshire I have an element of appreciating some of these factors actually. There is a fundamental providing a moving support level or soft floor, and that's the stated buyback threshold of 120% of Book Value per share, which gets updated every quarter. Perhaps the upper part of Berkshire's trading range is in the 160% to 170% of BV area nowadays, rather than maybe 200% as it was maybe 20 years ago.
I imagine that soft floor support level will be breached in the event of a serious market crash because there will be great value opportunities in many places that will look more attractive than Berkshire to a lot of smart value investors, at least for a few months, but in normal market conditions, ever since Berkshire introduced first the 110% of BV threshold then the 120% of BV threshold for their buyback authorisation, I cannot recall either level being breached (if BV is defined as the last published BV), or being only slightly breach on rare occasions (if BV is defined as the live Book Value or the yet-to-be-published book value of a quarter just ended).

To me that gives enough downside protection and long-term compounding that I can meet my goals yet still take advantage of great opportunities that might come up once every few years by selling some BRK.B. If the market really crashes, I'm sure my Berkshire will be well down from its peak and quite undervalued in the market, but I may still preserve enough market value to find worthwhile trades among stocks that are more deeply beaten down that it would be beneficial for me to sell BRK.B at the bottom of the market.

But there are many ways to adapt value investing to your style and your goals, opportunity set and circle of competence, so your mileage may vary, and I certainly don't profess to be anything like a great investor.

CorpRaider

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Re: berkshire - cheap?
« Reply #235 on: July 12, 2018, 05:06:41 AM »
"indexing effects (in my thinely informed opinion) can be best understood if you imagine only two active investors exist and all others just index: every time those two agree in an above market purchase, all others will follow and bid the stock up  while dumping all other stocks to normalize the weighting. This two pronged move will feed on itself until the two investors act again.

Applied to the real market: companies in favour to active investors (be it because of momentum or real increase in value) will be bid up by indexing and the remaining will be sold down. Only active investors can stop this trends and will do so only after the first have risen further and the second have fallen further down." 


I may be misunderstanding you, but I think the index investors in your example would do nothing and the stock that was increased in price/market cap by the transaction between the active investors would have a higher relative weight simply because of the price as established by the active participants.
« Last Edit: July 12, 2018, 05:08:34 AM by CorpRaider »

longinvestor

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Re: berkshire - cheap?
« Reply #236 on: July 12, 2018, 05:07:16 AM »
Here’s a summary of recent posts;
1. Cheery consensus in full force. Around 6 or so now famous names.
2. No, value has not died permanently. Whew, my waiting induced boredom is not coma! Thank goodness for message boards where comatose hang together in the afterlife 😉

In the excellent link in Cigarbutt’s post above to the Integrating Investor, the Li Lu quote provided “You either get value investing at the outset or you never will”. Hmmm...whither me?
« Last Edit: July 12, 2018, 05:24:41 AM by longinvestor »

Dynamic

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Re: berkshire - cheap?
« Reply #237 on: July 12, 2018, 05:08:28 AM »
indexing effects (in my thinely informed opinion) can be best understood if you imagine only two active investors exist and all others just index: every time those two agree in an above market purchase, all others will follow and bid the stock up  while dumping all other stocks to normalize the weighting. This two pronged move will feed on itself until the two investors act again.

Applied to the real market: companies in favour to active investors (be it because of momentum or real increase in value) will be bid up by indexing and the remaining will be sold down. Only active investors can stop this trends and will do so only after the first have risen further and the second have fallen further down.

I know where you're coming from and there's certainly some merit in this model.

A lot of this was discussed in the thread about the Semper Augustus Letter, so you might find that interesting, even if I'm not sure we agreed or came up with a convincing conclusion.

There the point was made that the proportion of declared index funds is about 13% of all activity or maybe 25% of all funds in the market (from a skim read - perhaps need to check the sources). So even if many managed funds are closet-indexing a substantial part of their money, it still represents probably no more than 50% of the market cap, and if indexers trade much less frequently, it also represents much less than 50% of the traded volume in a given period.

If there are no deposits or withdrawals from index funds, they do not impact the market for the buying and selling of underlying stocks at all, except on the re-weighting of the index or at any other times when the algorithms start to adjust the weightings of their stock holdings (e.g. they may choose to select only a sample of the smaller-weighted index components to reduce costs while maintaining reasonably small tracking error, or to allow larger deviations between the index fund's weighting and the official index weighting among those smaller positions where it matters less overall).

If there are net withdrawals from index funds (and others too) for a certain period, that will produce selling pressure on all the stocks they contain over that period on average proportional to the rate of withdrawal and how that compares to traded market volumes.

Conversely, if there are net deposits, which is probably more normal, especially with reinvesting dividends, that will produce buying pressure on all the stocks contained.

Nonetheless, for market-cap weighted indexes, as far as I can see, essentially, 1 million units of the index, say, represents x% of each company's outstanding share count, regardless of their weighting in the index. As long as they remain in the index and the index has the same number of constituent companies, their weighting is adjusted according a fixed percentage of the number of shares outstanding (except for rare occasions when it's adjusted for free float, which would include Berkshire Hathaway and a few other stocks where insiders are not expected to buy or sell stock and contribute to the trading market or where there are substantial numbers of restricted shares and so on).

So if Apple buys back and retires 2% of its outstanding stock, its weighting will decrease to (0.98 x its previous weighting) so that 1 million units of the index still represents x% of the stock outstanding. The buyback program actually eventually causes the index funds to sell stock (or to buy less stock than the inflow would otherwise make them buy) once the index weighting is readjusted.

If there is net inflow into index funds it certainly does provide some buying volume to all component stocks regardless of the underlying price whether the stock is ludicrously expensive or ludicrously cheap or somewhere in the middle. So it may cause a net upward push to the market prices of all index components over time until everyone decides to head for the exits in a panic! But it seems logical that it's a small proportion of traded volume that doesn't care about the price at all. It seems the stock turnover and thus trading volume generated by managed funds and institutions and for many individual investors is far, far higher than for index funds, so they should still have an outsized influence on price-setting.

Nonetheless many fund managers do experience pressure to include the popular names to attract assets under management, so may be pressured to buy even when they're already rather fully priced, possibly at the expense of fund performance, even if their past performance came about by buying those names only when they were much more undervalued. And many individual investors of a similar mind but who don't choose to invest in funds are attracted to the familiar names they read about a lot too and want a piece of that action (especially if it has risen recently - 'momentum' again), without necessarily having any grounding in the difference between price and value.

But the passivity and moderate market volume caused by indexing and the static weighting (in terms of proportion of market cap and thus proportion of shares) - unless I'm entirely wrong here - should be relatively minor impacts, shouldn't they?

Perhaps the counter-argument is that indexing is a more insidious and powerful form of volume, because it is all in one direction (net inflow-and-reinvestment or net outflow of funds causing only either continual buying pressure or continual selling pressure respectively on all stocks in the index) while other market participants who are actively trading are acting on opinions about the correct current and future pricing of the securities under various strategies, and largely offset each other's bullish or bearish opinions, but nonetheless the balance is skewed by the one-directional pressure from indexers.

rolling

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Re: berkshire - cheap?
« Reply #238 on: July 12, 2018, 05:24:55 AM »
"indexing effects (in my thinely informed opinion) can be best understood if you imagine only two active investors exist and all others just index: every time those two agree in an above market purchase, all others will follow and bid the stock up  while dumping all other stocks to normalize the weighting. This two pronged move will feed on itself until the two investors act again.

Applied to the real market: companies in favour to active investors (be it because of momentum or real increase in value) will be bid up by indexing and the remaining will be sold down. Only active investors can stop this trends and will do so only after the first have risen further and the second have fallen further down." 


I may be misunderstanding you, but I think the index investors in your example would do nothing and the stock that was increased in price/market cap by the transaction between the active investors would have a higher relative weight simply because of the price as established by the active participants.
Let us do the math:
Stock 1 equals 50% of the 100 point index. Stock 1 doubles and is now 66,6% of the 150 point index. Index funds get the same boost in price.

It seems to me you are right    :o sorry to all
My usual portfolio: Highly concentrated (up to 3 or 4 positions) in smallcaps and microcaps.

Dynamic

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Re: berkshire - cheap?
« Reply #239 on: July 12, 2018, 06:41:52 AM »
Don't worry, @rolling, I think it's been a good discussion to have and I value your contribution, and how indexing may or may not affect market prices is an important question to consider if people are pontificating about calling the top of the market based on such effects or thinning of gains to just a few popular names.