With a rough back-of-the-envelope 9/30/2012 book value around $110,500, Berkshire is now trading at 1.23x book value and is at a four year high. Four years ago the P/B stood at 1.79.Interestingly, today's P/B value is still below the median and average P/B since October 1, 2008 which is about 1.25. If 1.25x book is the "new normal", we are at fair value with each dollar invested growing at a high single digit rate. If the typical 1.5x book since the turn of the century is normal, Berkshire is a cheap and safe 80 cent dollar growing at a high single digit trend rate. If Book value grows at 9% over the next two years and we get a 1.5x valuation around 10/1/2014, that leads to a share price of $197K, or around 20% compounded from today's price. I'm not aware of too many investments with a similar risk/reward profile. The main risk I see to this two year scenario is that a fiscal cliff induced 2013 recession would probably make 9% annualized growth in book value over the next two years difficult. Despite last night's debate, I still think the odds are in favor of an Obama victory with a GOP House followed by a gridlocked lame duck session and a major fiscal tightening in 2013. But that scenario is not going to hurt Berkshire in any unique way that won't affect most other large US companies.
Still cheap at 4 year high Indeed!A pretty conservative medium term suggestion of what one might reasonably expect:Book value by mid 2015 (2.75 years hence) should be about equal to today's price,up around 25% in the 3 years since June 30 this year.At 1.5x book the price should then be around $200000, up 50% from here, or 15.6%/year compounded return based on 8.4%/year compounded book growth.The rates are more solid than the timeframe, which might be shorter orlonger depending on the particular set of years that the price crosses 1.5x.We haven't had one in a while.Jim
Hey, rational--Remember that long flat spot Q4 2006 through Q2 2007 that Berkshire traded at almost exactly $110000?What would (did) you peg fair value at at say end Q2 2007?I'm just realizing how much my views appear to have changed. Dumb anchoring, or newfound wisdom?I was convinced the the $110k was getting more and more preposterous, loadingup like an overwound spring, based on the idea that firm was worth maybe $135k+ back then, the range in which I started lightening up later in the year.But that figure represents 1.9 times the end-Q2 2007 book.In December I noted that the "expected" price based on long run historic averageprice to IV ratio would suggest one should expect to see a market price (not IV) of $131500.http://boards.fool.com/the-price-26153807.aspxThat's 1.70 times the then latest reported Q3 book.Needless to say, figures like 1.7x and 1.9x are a lot higher than the 1.5x we now holde as a distant "some day" stretch goal!Of course price/book is a pretty crude value metric, not really good enough.I'm happy discussing it these days because the choice of valuation methodology doesn't change the conclusion at times of serious undervaluation.When we get closer to IV we can be a bit more discerning about valuation models!Jim
What would (did) you peg fair value at at say end Q2 2007?I still have spreadsheets from that timeframe so I went back to check. It is somewhat humbling and/or embarrassing but it is what it is:My year-end 2006 valuation was $153K based on a float based valuation model. I pegged the value of the insurance operations at $183.5 million, the value of the non-insurance businesses at $43.5 million, and assumed that 50 percent of the deferred tax liability was part of intrinsic value. Total valuation was $236 million which worked out to $153K/A share based on 1.54 million shares outstanding. I didn't maintain valuation models based on price/book or two-column back then. I also maintained limited historical data and, in retrospect, the level/quality of analysis was quite poor. If I had done a better job, maybe I would have cross-checked the float based model with other models and historical valuation levels and had second thoughts. The float based model I used in early 2007 based on year-end 2006 data implied a very high P/B of 2.18x. Of course, by the end of 2007, Berkshire DID in fact come close to hitting my price target ... but I only sold a minimal number of shares because by then I had further increased my IV estimate based on more aggressive assumptions. I also did not want to pay capital gains taxes (maybe that is a subconscious reason that I raised my IV estimate so I wouldn't have to sell). Even without being able to foresee the financial crisis, it should have been apparent that Berkshire was fully valued in late 2007 so complaining about "hindsight bias being 20/20" won't get me off the hook! Then again, all we can do is learn from the past and try to avoid repeating those mistakes in the future. For me, that means maintaining much better data, having multiple valuation models, and promising to begin selling shares when the price begins to imply that 3-5 year forward returns are likely to fail to meet my required hurdle rate after accounting for the capital gains tax hit I will face.
One interesting aspect of looking back several years of Berkshire's performance is to note how a steadily rising book value can partially alleviate the negative effect of failing to sell at periods of high valuation. Going back through 26 open positions in Berkshire from February 2000 to September 2006 reveals only one position from March 2003 has failed to beat the S&P 500 index fund (SPY) with dividends added back but not assumed reinvested. My calculation is that the cumulative dollar return from all positions is about 32 percent higher than if the identical dollar amount had been invested in SPY at the closing price on the same dates as the Berkshire investments. If I take Berkshire's reported book value at the time of each open position, the range of compounding of book value/share is from 8.6% to 10.4%. Actual gain in market value is lower due to P/B compression. It is quite a remarkable performance for such a large company ... posting high single digit/low double digit growth through a period including September 11, 2001, the housing bubble and bust, and the worst recession since the Great Depression.
These history lessons are great! Makes the current price seem all the cheaper.
God, does that sound familiar. I certainly didn't do the depth of analysis you and Mungo did, but I sure as heck made similar mistakes, and have similar regrets. I convinced myself that 150K was about fair value --which was almost certainly a little optimistic-- and then compounded that mistake by declining to sell a single share even when we briefly hit that level in Dec. '07. I agonized about it for a couple of hours on that day, but allowed several weak-minded impulses to cloud my thinking, and interfere with my decision process. 1. I'd become a little infatuated with the idea that BRK's historical record made it highly likely that the long period of undervaluation would be followed by an overswing to the high side, and I'd have a chance to sell for at least 110% of IV. (Of course, I'd failed to recognize that current price at that moment was probably fairly close to that level already. A double-blunder.) 2. I'd convinced myself that a major market-crash was likely (obviously, I was right about that), and that BRK would be uniquely positioned to take advantage of it. (I still think that was quite reasonable, too --and I'm still a little disappointed that we didn't do a better job of capitalizing in '09.) 3. I stupidly allowed myself to think that lots of other folks would see it that way too, and that BRK would be seen as a uniquely safe haven in the storm. 4. I stupidly failed to properly assess the likely indirect impact of a major market crash on BRK valuation. (Huge drop in portfolio value, credit rating dropped, option-marks crushed. Failed also to recognize how badly the economy might be damaged by a major market-crash, and what that would do to BRK's op-earnings.) 5. I really didn't know what the hell I'd do with the money, after selling my BRK stake, which was the lion's share of my portfolio. I was afraid I'd be back to earning nothing in cash for an extended period. (I should've been channeling Munger, and been happy to sit in cash, and wait for another fat pitch.) 6. Didn't want to deal with a large cap-gains bite. (I should've accepted it gladly, as the cost of reaping a huge reward.) 7. It happened so fast (the huge BRK run-up in '07), that I really wasn't quite psychologically prepared. I'd been gradually building a big position, and still wished to build it a lot further, and suddenly saw the price climb to levels at which I needed to reverse course and start selling. I was still psychologically in buying mode, when I needed to snap out of it, and deal with the realities of the moment. If I'd addressed these factors with a clearer head, and done a better job of weighing them properly... if I'd sold even half my position on that day in Dec. '07 (which seems to me now like a clear no-brainer), I'd be a whole lot richer now. Like Ravi said, it's embarrassing to think back on the dumb things I did, but all we can do is learn, and adjust. I also agree, however, with Jim's implication (at least I think he may have implied it) that all of this anguished retrospection may tend to induce some unfortunate bias in the reverse direction in the next big upswing in BRK's price. Those of us who went through these experiences, and the subsequent agonized reflection, last time, may be all too quick to sell out at 1.3 or 1.4 BV this time... which could prove to be another big mistake.
Those of us who went through these experiences, and the subsequent agonized reflection, last time, may be all too quick to sell out at 1.3 or 1.4 BV this time... which could prove to be another big mistake.-------------------------------------------I will tell a worse mistake: BRK gets to 1.4x book, or $150-160k, and you tell yourself that selling will be a big mistake, so you hold on. Then, a few months later the stock market begins a new bear market, and also WEB has an unfortunate health problem like a moderate stroke, and decides to relinquish his CEO duties. Because of this the stock drops back down to $96k.Tell me how you would feel then about your decision to not sell at 1.4 x book?
Those of us who went through these experiences, and the subsequent agonized reflection, last time, may be all too quick to sell out at 1.3 or 1.4 BV this time... which could prove to be another big mistake. I agree that this is a risk. I'm not sure what the best solution really is, but my approach is to have in place a plan to sell a specified number of shares at intervals between approximately 1.35x book and 1.65x book except for a set amount of shares that I do not plan to sell at almost any valuation level (well, maybe at 2x book or higher). Your recollection regarding the speed of the late 2007 share price increase matches my own recollection and experience. It happened quickly and I did not have any prepared selling plan in place. But that's probably not the real reason I failed to sell a significant number of shares. I believe the main reason was a combination of raising my IV estimate as the share price rallied (changing to more aggressive assumptions - essentially allowing Mr. Market to influence my bullishness) and my desire to avoid paying the capital gains tax.
Great! Another person selling into the market, artificially depressing the price.:-)
Yep. My current plan is very similar to yours.
Of course, both of those things could easily happen tomorrow. So why aren't you selling today? Or, just as easily, Uncle Warren might stay at the top of his game for six more years, BV might grow at 10% till then, and price might happen to fall at a not-at-all-crazy 1.6 X Book at that particular juncture...... in which case you'll find yourself sitting at your computer one day in the winter of 2018, saying, "Goddammit!!! Why the hell did I get nervous and sell my entire BRK stake at $155K, when it's quoted today at $314K ??!! What the hell was I thinking??!!" It's not nearly as simple as you'd like to make it.
Regret avoidance is one of the psychological issues associated with investing that I find most difficult to address successfully. I have next to no issues with a stock that I buy getting cheaper even immediately after a purchase since I'm usually happy to buy more at a lower price (assuming the investment thesis remains intact). Theoretically, if a stock reaches a price target and one sells, subsequent movements in that stock should have no more of an influence on one's state of mind than the movements of any other security. But it doesn't quite work that way. Nothing is more annoying than selling something at $X, particularly after waiting a couple of years for it to work out, only to see the price pop to $X + 20% shortly after the sale. I think the solution is to have both a phased buying and phased selling plan in place ahead of time and to stick to it. For example, selling a position in 20% chunks rather than all at once starting at a modest level below IV and ending at a modest level above IV can likely yield the same net proceeds over a number of investments over many years versus selling everything exactly at IV. But it is psychologically less problematic because when one sells that initial 20% stake and the stock goes up, that's fine because 80% is still in the portfolio. Anyway, selling any Berkshire is still quite a ways off at this point but I think having that plan in place ahead of time is very important. Especially in the case of Berkshire due to its unique history and leadership.
Your recollection regarding the speed of the late 2007 share price increase matches my own recollection and experience. It happened quickly and I did not have any prepared selling plan in place. But that's probably not the real reason I failed to sell a significant number of shares. I believe the main reason was a combination of raising my IV estimate as the share price rallied (changing to more aggressive assumptions - essentially allowing Mr. Market to influence my bullishness) and my desire to avoid paying the capital gains tax.I was a seller in late 2007. However, I did not sell out because (a) I thought a financial crisis was near and (b) I thought WEB would put the big cash and bond holdings to work. I (far from alone) had been telling myself that WEB had been building cash for a major market downturn opportunity, and would invest heavily when it happened. This would set the stage for another big surge in stock price.But it didn't happen as far as long lasting investments were concerned. WEB did put money to work, but only where he felt safe that the money would be returned - really via government intervention as he himself stated (TBTF). The rights to buy the stocks in the future at a set price were a nice kicker, but haven't turned out that well. The later investment in BAC has good potential and is hopefully an exception. But most of the money has been returned, as would be expected in a low interest rate environment.I've discussed this investment mode with friends to try to judge why? Our guess is that WEB felt pressure from regulators about the big downturn in the value of equities - maybe compounded by the equity puts he had written. In other words, he was concerned about further downgrading of Berkshire's financial rating. He was prepared for hits in the insurance contracts, but not for major hits to his capital. So he was conservative - as maybe Munger has alluded. His Pearl Harbor analogy was not just relating to the market - he was also truly surprised, and cautious.I think this failure to invest heavily in equities has had an ongoing impact on Berkshire's price versus break-up value since that time. If one refers back to Jim's plot of price versus a 1.5 book line, most of the deviation has come since the financial crisis. Have people realized that $20 billion of cash and $30+ billion in bonds are locked into no/low return investments for several years? Have they adjusted their expectations accordingly?We're finally seeing some forward movement by Berkshire. In a post a while back I recall Jim wondering how people might react to the next price runup: http://boards.fool.com/thinking-ahead-30065587.aspxHe wondered if people might think: "Berkshire is all well and good but next time the price is halfway decent it's time to allocate capital elsewhere".I'm guessing that this can be a factor if P/B rises much more. It's at least worth thinking about. One's time frame also enters into the decisions - depending if one is in the accumulation/hold or dispersal stage of life. There are a lot of aging early shareholders out there.
I hear often that WEB could have done better post the crash 0f 08 and 09. Without even mentioning the many "smaller" investments that turned out well, BNI alone made living through the crash worth it, imho.
"Have people realized that $20 billion of cash and $30+ billion in bonds are locked into no/low return investments for several years? Have they adjusted their expectations accordingly?"I know about the minimum amount of cash Brk wants on hand (makes sense to me) but are you sure he can't exit the bonds if he wants? I thought those were short term treasuries which could be dumped at any time.
3. I stupidly allowed myself to think that lots of other folks would see it that way too, and that BRK would be seen as a uniquely safe haven in the storm.It's always instructive to remember that during the oil crisis of 73 and 74, when oil and gold went up, oil companies and gold miners crashed along with the rest of the market.Most of what stock prices do in the short and medium term is a result of shifts in risk aversion, and in the end, a stock is a stock is a risky thing, and as such is sold when there is a turn to extreme risk aversion.
<<Those of us who went through these experiences, and the subsequent agonized reflection, last time, may be all too quick to sell out at 1.3 or 1.4 BV this time... which could prove to be another big mistake. >>I agree that this is a risk. I'm not sure what the best solution really is...Maybe the best solution is to think about the business and not the stock price?I very much doubt that I will sell any shares until I need the money for living expenses.
Maybe the best solution is to think about the business and not the stock price?Of course that is the proper way to look at things, but nearly all investors have psychological biases related to stock prices (anchoring, waiting to "break even", depression when a stock price falls immediately after buying, euphoria when a stock price rises rapidly, etc). Obviously not everyone suffers from all of these biases. But most people are affected to one degree or another. I very much doubt that I will sell any shares until I need the money for living expenses. Then that would ignore any price to value considerations between now and then. In my opinion, a security should be sold if the after-tax proceeds from a sale can be reinvested in another opportunity that has a high probability of achieving better long term returns adjusted for differences in business risk. A security should also be sold if prospective returns appear to be very low going forward even if a replacement security cannot be immediately found. In such a situation, cash is a residual that Buffett views as a call option on every asset class:http://www.theglobeandmail.com/globe-investor/investment-ide...
That is the #1 reason that I don't trade often - TAXES! You take a haircut right away on your return, and then you must hope to find something that can generate a better return right after that haircut.One of the things that is best about Berkshire, is that it is truly one of those businesses people think of first as a buy and hold forever - 70+ businesses in fact. And you don't have to worry about taxes on dividends because we have a management in place that doesn't piss away shareholder value. For all I care they can keep 100 Billion in cash waiting for that elephant. I trust the management can do better with it (and the share price will show that in due time). I just don't need dividend income. I have a job. Berkshire is my investment.I was very proud to be a shareholder when Buffett told Charlie Rose in an interview I believe earlier this year, or maybe it was last year, that Berkshire is built to last forever after he asked about if he thought Berkshire would be OK after he passed. Forever "should" last long enough for anyone, shouldn't it?
I also agree, however, with Jim's implication (at least I think he may have implied it) that all of this anguished retrospection may tend to induce some unfortunate bias in the reverse direction in the next big upswing in BRK's price.Those of us who went through these experiences, and the subsequent agonized reflection, last time, may be all too quick to sell out at 1.3 or 1.4 BV this time... which could prove to be another big mistake. Gosh, I don't even have to say this stuff any more!That's pretty much what I was thinking.Plus the notion that maybe we were right last time and 1.5x is cheap and 1.7x is fair.I will tell a worse mistake: BRK gets to 1.4x book, or $150-160k, and you tell yourself that selling will be a big mistake, so you hold on. Then, a few months later the stock market begins a new bear market...Tell me how you would feel then about your decision to not sell at 1.4 x book? I'd be clearheaded and happy.It's not sensible to sell something at a price demonstrably below what it's worth if you don't have a pressing need for the money.Plus, if you are in a situation that you might have a pressingneed for the money you shouldn't have it in this or any other stock.One's entire equity portfolio should be sized based on the assumptionthat the market might drop 90% and stay there for 5 years.A couple of statistical quirks that might be worth keeping in mind as people are reading this great thread.Warning to pure value investors: price effects ahead.- Though it may have no predictive power whatsoever, historicallywhen Berkshire gets into a rally it keeps going pretty steadily then stops abruptly.Historically it has not paid to sell during such a rally, but ratherto wait for a pullback of at least 3% as a sign that the rally is over.This is a particularly interesting notion if there is a rally into overvalued territory.- If there are are people out there who are tired of waiting and start selling too early at 1.3x or 1.4x, due to an interesting thing called the "disposition effect" this will actually increase the momentum of the rally.Though perhaps somewhat jagged and unpredictable, the momentum of the rise in a stock will tend to be longer and stronger.This isn't just mystical chartism, it falls out of the math when you look at people who are anchoring on their entry prices and sell too rapidly when they move from a loss into a profit position.The strength of this effect can be estimated using something called the Capital Gains Overhead Regressor (CGOR), which basically is an estimate of the weighted average entry price of the people likely to be trading the stock this year. In short, the stock price is repelled by this price level, and it will be fairly low for Berkshire for a long time.You can set up a 100% simulated universe of traders and stocks and prices,some modest fraction of whom will tend to sell promptly soon after they move into a profit position,and this is sufficient to create momentum very similar to what is observed.Jim
One's entire equity portfolio should be sized based on the assumptionthat the market might drop 90% and stay there for 5 years.Under that assumption the size of my equity portfolio should be zero. I and my wife are both retired, and while we do have other income, the difference between a financially worry free retirement and a more budgeted retirement rests in our investments. The implications of an economic environment where equity prices would fall by 90% and remain there for five years are of such dire consequences that I would see cash – even considering its inevitable losses in purchasing power – as being the only reasonable choice. I am willing to risk Buffett’s 50% warning, but not your 90%.
A market drop of 90% should take at least five years I would imagine. I honestly do not accept that, but I do have my money invested. The only way possible for that to happen would be a catastrophe on our planet or massive deflation. Charlie Munger has stated that an investor should have the temperament to see holdings go down by 50% three times every hundred years.
an investor should have the temperament to see holdings go down by 50% three times every hundred years.And I would add, the longevityG H U
I would see cash – even considering its inevitable losses in purchasing power – as being the only reasonable choice.As a dividend freak, and a much maligned one on this board, I would look at many more factors than 90%. If dividends go down only 20% I would keep the stocks and buy more so I could live comfortably on the imcome. So long as my dividemd income is alright, I don't want speculation about IV or BV and above all, no recs please. I would only begin to question my judgment if this board bestowed recs.G H U
a security should be sold if the after-tax proceeds from a sale can be reinvested in another opportunity that has a high probability of achieving better long term returns this theory is workable for an investor who is a life assurance company that has sold nothing but whole life policies to people under 30. If you are a normal consumer person who has hunger, likes to bestow jewelry on his female companion and has other needs that are not discussed by Ben Graham, you should not look to your executor for posthumous enrichment.<b<G H U
I am willing to risk Buffett’s 50% warning, but not your 90%. Your optimism seems misplaced, as I think a 50% drop is about the minimum I'd expect in real terms from valuations as high as today.(the market would then be cheaper than usual, but that's true half the time).But in any case, even assuming that a 50% drop is the worst you shouldreasonably expect, it probably doesn't change the investment strategy.If you are relying on getting a good price for your equities in theshort term (less than a market cycle), you have too many equities.It's likely that prices 50% lower than today's represent prices at which you would not want to sell. That's what cash is for.And no, IMO dividends don't count. They can be cut at will by management for any or no reason at any time, and across the broad US market they have dropped by a lot with alarming regularity.Since 1930 they've dropped by 25-30% six times, by 40-50% three times, and over half once.Charlie Munger has stated that an investor should have the temperament to see holdings go down by 50% three times every hundred years. I'm surprised he'd have said such a thing. It happens a lot more often than that!Not counting the many overlapping intervals, the real S&P droppedmore than 50% five times just since 1930 including more than 60% twice.Clearly a big drop is more of a risk when valuations are high as today:given that the US market has in the past dropped far enough to give a trend earnings yield over 13% on six separate occasions since the late 1800s, one should pencil a quite reasonable chance of a drop of the S&P to around the 520 level in today's dollars.The trend earnings yield surpassed 16% twice, which would be S&P ~420 now.That's a drop of over 70% from here to a valuation level still higher than what has been seen twice.The plunge frequency per century isn't all that important, of course, since onealways has to be prepared for a big multi-year drop starting immediately.Jim
A market drop of 90% should take at least five years I would imagine.On September 3, 1929, the Dow Jones Industrial Average closed at 381.17.Two years, ten months, and five days later it closed at 41.22, down 339.95 points or 89.18%.jkm929
On September 3, 1929, the Dow Jones Industrial Average closed at 381.17.Two years, ten months, and five days later it closed at 41.22, down 339.95 points or 89.18%.Exactly. More recently, Iceland dropped about that much in a year because they let their banks fail:http://www.tradingeconomics.com/iceland/stock-marketThe only reason we didn't get an 75+% drop in 2008 was due to intervention. So anyone who is one hundred percent long equities and "comfortable with a 50% drop" is implicitly relying on a government bailout.
So anyone who is one hundred percent long equities and "comfortable with a 50% drop" is implicitly relying on a government bailout. To be fair, one could be well aware that a big drop is possible but stillbe long equities because your time frame is meaningfully long.Even really bad bear markets do eventually end.And of course bonds make no sense given the negative expected real return.But 100% long equities? You'd want to have a very secure job or pension.Jim
http://newsandinsight.thomsonreuters.com/Securities/Insight/...Lend and relend and relend and relend...Here's something that could lead to your 75-90% drop in a year.-Rob
Here's something that could lead to your 75-90% drop in a year.http://newsandinsight.thomsonreuters.com/Securities/Insight/... Here's another number to ponder as the euro crisis rumbles on.2010 US-based banks total assets to US GDP: 0.8x2010 Euro-area based banks total assets to US GDP: 3.5xIn short, I wouldn't lose sleep over what US firms are doing in Europe,I'd lose sleep over what the European banks are doing.By the way, that's a bizarrely good article with oddly insightful comments on it as well (read them in reverse order though).Makes you despair for the future of the uselessness of the internet.Now I'll have to go watch a video of Maru to recover.Jim
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