| Posted: 03 Feb 2007 03:19 | |
|
Registered User Currently Offline |
Posts: 16 Join Date: Feb 2007 |
|
Hi There – I’m new to the forum.
So, to get my toes wet, I want to pose a light-hearted question which has been sitting uncomfortably at the back of my mind for a while and which I would appreciate anyone’s judgment on - as Graham said there is no such thing as incorrect opinion, merely a different view. I’ve been studying Buffett/Graham for about 10 years now. I follow the philosophy, I practice “Value” and have become reasonable wealthy by doing so. Never been able to make the Berkshire pilgrimage so I’ve never had the direct opportunity to pose this question and from what I can recall from the Q&A transcripts, nobody else seems to have either. A keystone of Berkshire’s investment and finance philosophy has been the 100% retention of profit for purposes of reinvestment. No enterprising investor will dispute the logic that retained earnings allocated by Warren will be generally done so far for productively than the owners themselves would be able to accomplish. But on the other hand, the correct temperament of a value investor relies on visualizing hypothetical closure of the stock market the day after the share purchase (a mental model even Warren advocates). In other words, the share price should not even be looked at post purchase. This however presents the Berkshire Hathaway paradox. Because Warren, Charlie and the rest of the owners rely on the share price ever increasing to realize an appreciating investment. It also pokes fun at value investors. Without a stock market there is no value to be gained from owning BRKA, since dividends are not paid – and rationally speaking should never be paid. Using stock standard – John Burr Williams - valuation means, no dividends means zero value. Without a stock market (and sentiment driving the price up!!) no value either. So as value investors we're not practicing what we preach. 
|
|
| Posted: 04 Feb 2007 10:05 | |
|
Registered User Currently Offline |
Posts: 5 Join Date: Jan 2007 |
|
This is Buffetfannumber1
Thank you for presenting your views on the Berkshire paradox. I am also a strong fun of Buffett and Graham and in fact they are my role models I have read pretty much 85% of their books. It’s true that their strategy discourages looking at price each day and the reason is that price can be very deceptive. For example a stock can be priced at $2 in the market but given the company’s brands, assets, competitive advantage and other precious assets disregarded because the general rationale is that in the market, is the market price is final in valuing a company. (The ticker tape tells ALL) This company could be valued at $90 in a private transaction after considering all those assets. The very reason that the value strategy hates looking at price is that price is deceptive and does not tell the entire picture, but in reality you can not value a company without establishing a price. Buffet, Charlie and myself compute intrinsic values of companies and by doing so we are trying to find a true price that is not reflected by the daily charts, if our intrinsic value price comes up to $90 per share and the market says its $2. We pick interest but it does not mean we shall buy. It must be superior company, superior management and then the superior price of $2 for company worth $90. That’s how money is made, by not following the crowd. If we purchase, we don’t pull up quotes to validate our well being, because they are meaningless in the short-term but will be meaningful 10yrs later if we at all intend to sell. But it’s better if we never sell, which makes long term prices can also be less meaningful. To simply this for you, I would says, short term prices are meaningless and long term prices are meaningful to a lesser extent. Buffettfannumber1 NH USA
|
|
| Posted: 04 Feb 2007 13:45 | |
|
Registered User Currently Offline |
Posts: 16 Join Date: Feb 2007 |
|
Hi BF#1
It’s all very well establishing the intrinsic value of the company. You may even use the owner earnings of the company to do so, thereby using a rational method of valuation. But the act of investment is based on expected return on that investment principle. Returns have to be ultimately in the form of cash flow. They cannot exist perpetually in an abstract world; this renders them intangible and of no utility – other than bragging rights. So the cash flow either has to be derived from dividends or sales of assets (just like any day-to-day business). Since we have no dividends, we have to rely on selling at the highest price to yield the highest return. A high price driven by market sentiment; the bane of value investment. Thus the contradiction!
|
|
| Posted: 04 Feb 2007 22:20 | |
|
Registered User Currently Offline |
Posts: 40 Join Date: Dec 2006 |
|
Scarborough : Interesting Paradox...I had never given it any thought until I read your Post . One must admit though the Paradox has worked well for BRK holders . WEB realized something years ago ....remember the old saying " it takes money to make money ? " He understood this better than most , his first big venture being a partnership . And he understood the potential of using OPM or other people's money . Further , he understood far better than anyone else the enormous value of float , using the float from Blue Chip to buy See's Candies in 1972 and then later
The Buffalo News in 1977 and on and on with Wesco and others . His is a truly fascinating story and I am quite enamored with all the aspects of the rise of BRK and Buffett . Thanks for your Post , I found it quite interesting . Best Regards , TBB43
|
|
| Posted: 12 Feb 2007 14:14 | |
|
Registered User Currently Offline |
Posts: 4 Join Date: Feb 2007 |
|
Hi
Interesting paradox, but actually you do not need a stock market you need a buyer
|
|
| Posted: 13 Feb 2007 23:50 | |
|
Registered User Currently Offline |
Posts: 4 Join Date: Feb 2007 |
|
Scarborough,
Interesting thoughts, though I believe flawed, for lack of a better term. Many, if not most companies in their typically early years of rapid growth retain all of their earnings to support that growth. A family member of mine for example is president and majority owner of a small company that most recently netted about $2m in 2006. The company is over 10 years old and has never paid out any earnings to its owners because of its continuous growth. Because the company hasn't ever paid out a penny, does that mean it is of no value? Surely not. I also have to disagree with the logic of, "Without a stock market there is no value to be gained from owning BRKA, since dividends are not paid." For anything of any "worth" (for which one could obviously debate the meaning of), providing there is a buyer, there is value. In other words, as we all have heard, everything is worth what someone else will pay for it. The thoughts you present are interest though. Do some research on all the different types of security analysis techniques and its amazing the different ways or figures academics have proposed using to determine "value". I believe many investment firms, one of which I know is Legg Mason, employ their own custom methods of determining so called "value". Academics just so happened to come up with some handy discount models that makes "valuing" a mathematical exercise. Appraising property is no different. In most cases, real estate doesn't pay out any "coupons", though as we have seen as of late especially, it surely can be a "valuable" investment. My biggest argument against your proposition is the assumption that an investment is the discounted value of all its expected cash flows. My issue being, what are cash flows? In your view, these cash flows have to be realized by the investor. Maybe you're right, but this is only theory, not principle. Obviously others, including Buffett, would disagree with that assumption. On the other side of this argument, is one that Buffett has proposed, his so called "look through earnings". Though I'll leave this for another day. But taking Berkshire's look-through earnings into account, the company is probably selling at a P/E of less than 5. I enjoy the discussion and the thoughts. Keep em coming. Its sometimes hard to find anyone else who wants to debate anything other than celebrity current events. Thanks, Tbare
|
|
| Posted: 14 Feb 2007 03:15 | |
|
Registered User Currently Offline |
Posts: 16 Join Date: Feb 2007 |
|
Tbare, your opposition is very much appreciated
Utilizing your example of your family member's business; the situation is not entirely unlike that of Berkshire. By each year end the business as thrown off surplus cash, the return on deployed assets (or even equity for that matter) is well above that of assets/securities of similar risk profiles outside the business and hence demands that extra cash remain vested within the realm of that business. Thus compounding growth is achieved. But for your relative to behave precisely as Warren Buffett has, no threshold would be achieved where the cash, surplus to the operations' requirements, could no longer be deployed profitably within the business i.e. the growth could conceivably continue infinitum. In the mean time and assuming your kinsman has paid himself a market related salary all along; whether the business is a noble, entrepreneurial start-up or a multinational conglomerate, his lifestyle hasn't changed one iota. He uses the same brand of single ply toilet paper, eats meat loaf on Sunday evenings, clips coupons for washing detergent and uses his same '67 Ford pick-up; because he has never paid himself a "dividend" (or even withdrawn money from petty cash) and has never sold off a piece of his business. So the question remains what utility does he derive from owning the business in the first place? Apart from the personal satisfaction of being your own boss, it has to undoubtedly be the "promise" of either 1) eventually paying himself a portion of the year end profits or 2) finding an able and willing buyer to purchase a share or the whole of the business. Either way he has cash flow in the bank from running a good business. I believe, I also made the error of not predefining "cash flow" sufficiently. To plagiarize: "the intrinsic value a security may be derived from discounting the expected, future cash flows which may be taken out over the LIFETIME of the business - without affecting the growth or alternatively the viability of the enterprise. Owner or look through earnings would be these cash flows before realization. This is just like valuing a bond or fixed income security. But in this case, Berkshire as a “zero bond” of sorts relies on the entire investment cash flow being discounted from the day of sale. This brings us the true dogma of value investing. The crux of the matter (and my view an issue still unresolved) is that the value of an asset or a security should not depend on whether a market or eventual buyer even exists; because in times of panic invariably when you need them most, buyers won’t exist. This doctrine is essential to eventual elimination of fear and doubt, and fostering rational determination of the intrinsic value of the business. Scarborough
|
|
| Posted: 14 Feb 2007 13:13 | |
|
Registered User Currently Offline |
Posts: 4 Join Date: Feb 2007 |
|
Hi Scarborough,
Exactly, So where is the paradox? As you said the value of an asset or a security should not depend on a market or eventual buyer, that is to say there is an intrinsic value of the business (estimated with whichever method you choose); an even without a stock mkt. or buyer the price (actually the value) of the business will change (hopefully will appreciate). the market just gives you a number which may or may not be equal to the intrinsic value. and by the way there is allways goig to be a buyer (even in the worst panic) it is all a matter of price .(regardless of value)
|
|
RSS 2.0 Atom 1.0
