Author Topic: Buffett's 50% per year on small sums  (Read 48671 times)

writser

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Re: Buffett's 50% per year on small sums
« Reply #130 on: July 21, 2020, 01:10:55 AM »
2) Value investors don't lack the ability or knowledge, but lack the imagination to invest in growth. They want to see everything upfront (earnings, cash flow etc) before committing up front. The market is too smart for that. Market prices in potential upside.

I think such generalities are nonsensical. Value investing is simply paying less than you get. That does NOT mean buying a terrible business at an 6x multiple automatically leads to outperformance. It also does NOT mean that buying a great business at a 200x multiple automatically leads to outperformance. Either one could be too cheap, too expensive or about fairly valued. Unfortunately you simply have to think about what you are buying, do due diligence, model the company in question, think about the actors involved, make assumptions, try to falsify those assumptions and think about why the market valuation could be wrong. That's called: work. Nobody likes it. If "imagination" was a substitute for that I'd be a billionaire but I don't think it is.

If you presume in advance that buying a balance sheet play, or a low multiple play, does not work because 'the market is too smart for that' yet you assume that you can outperform by buying growth stocks because 'the market does not have my imagination' I think you are giving the market not enough credit and you are also limiting your own options.
« Last Edit: July 21, 2020, 01:18:21 AM by writser »
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Gregmal

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Re: Buffett's 50% per year on small sums
« Reply #131 on: July 21, 2020, 06:23:51 AM »
2) Value investors don't lack the ability or knowledge, but lack the imagination to invest in growth. They want to see everything upfront (earnings, cash flow etc) before committing up front. The market is too smart for that. Market prices in potential upside.

I think such generalities are nonsensical. Value investing is simply paying less than you get. That does NOT mean buying a terrible business at an 6x multiple automatically leads to outperformance. It also does NOT mean that buying a great business at a 200x multiple automatically leads to outperformance. Either one could be too cheap, too expensive or about fairly valued. Unfortunately you simply have to think about what you are buying, do due diligence, model the company in question, think about the actors involved, make assumptions, try to falsify those assumptions and think about why the market valuation could be wrong. That's called: work. Nobody likes it. If "imagination" was a substitute for that I'd be a billionaire but I don't think it is.

If you presume in advance that buying a balance sheet play, or a low multiple play, does not work because 'the market is too smart for that' yet you assume that you can outperform by buying growth stocks because 'the market does not have my imagination' I think you are giving the market not enough credit and you are also limiting your own options.

+10

Flexibility with respect to ones mindset and ever changing data is the all important attribute. Imagination by itself can be both awfully good and awfully bad. I see plenty of people on social media "imagining" the next EV powerhouse or COVID vaccine candidate and "imagining" their calls going up 100x by Friday. Imagine that?

KJP

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Re: Buffett's 50% per year on small sums
« Reply #132 on: July 21, 2020, 07:45:40 AM »
If your first rule is to not lose capital, then you look for things in which you have high confidence in your ability to predict or project into the future.  The ability to predict is correlated with the pace of change.  So, if your first rule is not to lose capital, then you would tend to seek out very stable industries.  Stable industries, in turn, don't lend themselves to high growth, because high growth is often a byproduct of newness and can itself attract competition and unpredictability.  So if your first principles are steering you to slow growth industries, then you better have a sharp focus on current valuation according to traditional metrics.  This approach produces bad results if either you pay to much or you're wrong about the rate of change and rather than buying into a stable industry/business, you're buying into a decaying one (thus the potential danger of blindly buying anything with a single-digit multiple).  The traditional ways to address these risks are skilled qualitative assessment (Buffett) or high diversification across apparently attractive quantitative characteristics (Schloss).

So, I don't think the traditional value approach stems from a lack of imagination.  Rather, it's a predictable outcome of focusing on downside rather than upside. 
« Last Edit: July 21, 2020, 07:50:48 AM by KJP »

Munger_Disciple

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Re: Buffett's 50% per year on small sums
« Reply #133 on: July 21, 2020, 08:26:11 AM »
If your first rule is to not lose capital, then you look for things in which you have high confidence in your ability to predict or project into the future.  The ability to predict is correlated with the pace of change.  So, if your first rule is not to lose capital, then you would tend to seek out very stable industries.  Stable industries, in turn, don't lend themselves to high growth, because high growth is often a byproduct of newness and can itself attract competition and unpredictability.  So if your first principles are steering you to slow growth industries, then you better have a sharp focus on current valuation according to traditional metrics.  This approach produces bad results if either you pay to much or you're wrong about the rate of change and rather than buying into a stable industry/business, you're buying into a decaying one (thus the potential danger of blindly buying anything with a single-digit multiple).  The traditional ways to address these risks are skilled qualitative assessment (Buffett) or high diversification across apparently attractive quantitative characteristics (Schloss).

So, I don't think the traditional value approach stems from a lack of imagination.  Rather, it's a predictable outcome of focusing on downside rather than upside. 

+1

Excellent post KJP. Bill Ruane who founded Sequoia Fund once said (when asked about the secret to their success) they were really closet bears. That says it all!

cherzeca

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Re: Buffett's 50% per year on small sums
« Reply #134 on: July 21, 2020, 11:31:40 AM »
you are not going to get 50% PA returns as a value investor unless you can "imagine" a catalyst. that is not to say that value investing's focusing on the downside doesn't make sense, but you have to be able to not only understand value but also understand how that value can accelerate...hence some focus must be made on the upside catalyst probabilities.  I actually think value investing with a special situation/catalyst focus lets you buy cheaper opportunities for value acceleration (since not everyone will see the catalyst) than growth investing where paying up for the upside is built into the buy price

wabuffo

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Re: Buffett's 50% per year on small sums
« Reply #135 on: July 21, 2020, 11:55:50 AM »
I continue to maintain that anyone with a proven 50% CAGR track record over 5+ years can only get there with the use of leverage/margin.  If its real estate, then there are mortgages/borrowed money involved.  If its equities, then there is option usage (which is also another form of leverage).   

Even Buffett during his BPL days would often use borrowed funds up to 25% of portfolio assets (usually on the workout portion of the portfolio).  Greenblatt talks about using WFC LEAPS during his salad days of the early 90s.

I think "god-mode" on a long-only equity portfolio with no margin/leverage probably maxes out in the high 25-29% range over 5 years in average markets (ie, +15-20% better than the equity benchmarks). 

wabuffo
« Last Edit: July 21, 2020, 12:01:25 PM by wabuffo »

Gregmal

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Re: Buffett's 50% per year on small sums
« Reply #136 on: July 21, 2020, 12:01:52 PM »
I continue to maintain that anyone with a proven 50% CAGR track record over 5+ years can only get there with the use of leverage/margin.  If its real estate, then there are mortgages/borrowed money involved.  If its equities, then there is option usage (which is also another form of leverage).   

Even Buffett during his BPL days would often use borrowed funds up to 25% of portfolio assets (usually on the workout portion of the portfolio).  Greenblatt talks about using WFC LEAPS during his salad days of the early 90s.

I think "god-mode" on a long-only equity portfolio with no margin/leverage probably maxes out in the high 25-29% range over 5 years in average markets.

wabuffo

And usually follows some sort of major "reset" type event.

scorpioncapital

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Re: Buffett's 50% per year on small sums
« Reply #137 on: July 21, 2020, 05:42:01 PM »
Not sure I understand. If a stock you own (or a REIT) uses 2x leverage, then do you mean that if I buy it without leverage I might get 50% due to the look-thru leverage of the stock/reit? By this standard virtually every stock out there except some cash rich tech stocks are using at least 2:1 leverage. Anyway these days every stock seems to be using alot of look-thru leverage.

wabuffo

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Re: Buffett's 50% per year on small sums
« Reply #138 on: July 21, 2020, 06:20:25 PM »
If a stock you own (or a REIT) uses 2x leverage, then do you mean that if I buy it without leverage I might get 50% due to the look-thru leverage of the stock/reit?

SC - I think you might be misinterpreting what I said.  I'm not talking about the underlying capital structure of a business whose stock you buy.  I'm talking about using borrowed money to buy the stock. 

WFC might be levered 10-to-1 on its balance sheet but buying WFC common stock is not employing borrowed money, IMO.   Buying a WFC 2022 LEAP call is employing borrowed money because that is what a call option is.  Its buying the underlying WFC common on margin plus a put option.

Hope that helps,

wabuffo
« Last Edit: July 21, 2020, 06:29:53 PM by wabuffo »

scorpioncapital

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Re: Buffett's 50% per year on small sums
« Reply #139 on: July 22, 2020, 04:10:09 AM »
I think I understand. I agree that for very large or even medium cap stocks you need some leverage for outrageous returns. Although very small stocks can very easily do 50% without any leverage, but it may be one time and require multiple 'punchcard moves'.