Apple (AAPL) has been returning, to say the very least, a whole lot of cash to shareholders since August of 2012:
From the inception of its capital return program in August 2012 through March 2015, Apple has returned over $112 billion to shareholders, including $80 billion in share repurchases.
The company's share count is down nicely as a result of the share repurchases and, based upon the expanded program, should continue to drop.* Yet, after returning the $ 112 billion, the company still has net cash and marketable securities of nearly $ 150 billion.
The key word here being "net". Total cash and marketable securities is actually more than $ 193 billion but, after subtracting debt, the number is more like just under $ 150 billion.
Consider the fact that net cash sat at roughly $ 117 billion just before this capital return program began. So the company has still been able to increase its net cash and marketable securities after allocating the $ 112 billion.
What's more astonishing is the fact that the company's net income was $ 1.3 billion on $ 13.9 billion of sales back in 2005.
Compare that to net income of 39.5 billion on sales of $ 182.8 billion in its last full fiscal year.
Those numbers are on track to be even higher in 2015.
I think it's fair to say that's quite a decade plus.
Now, the fact is Apple remains incredibly dependent on regular product innovation. What was highly competitive not long ago requires ongoing improvements just to remain competitive. I mean, they're not exactly selling soft drinks and snacks. Whether or not Apple can maintain its advantages and competitive position over the longer haul is, at least for me, a tough question to answer. The company may still be making great products many years from now but, even if they are, that doesn't guarantee today's outstanding business economics will be persistent.
An innovative company might continue creating quality products but, due to a changing competitive and technological landscape, what were once attractive returns on capital become much less so. It need not be something catastrophic for the core economics to be hurt in a way that's meaningful for long-term investors.
Charlie Munger, at the 2015 Daily Journal (DJCO) shareholder meeting last month, was asked whether companies like Google (GOOG) and Apple have sustainable moats.
Part of his response was this:**
I am not an expert on the moats of technology companies. The reason, by and large, I don't own them is because I do not understand whether or not there are moats that will last or not.
He also added the following:
...anybody who does give you the answer is probably full of you know what.
Occasionally, certain tech stocks (incl. AAPL and GOOG) have sold at a big enough discount to my own (conservative) estimate of intrinsic value that I was willing to purchase some shares.
In other words, the price was such that there was a substantial margin of safety and not much had to go right.
Adam
Long position in AAPL and GOOG established at much lower than recent prices; no position in DJCO.
* Naturally, if the stock at some point sells for a premium to per share intrinsic value the plan to repurchase shares should be altered accordingly.
** From some excellent notes that were taken at the meeting. Well worth reading. Not a transcript.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Wednesday, April 29, 2015
Wednesday, April 22, 2015
Howard Marks on Valuations: "There's Nothing That Is Absolutely Cheap"
On CNBC earlier this month, Howard Marks had the following to say about the valuation of most assets:
"There's better and there's worse, but there's nothing that is absolutely cheap."
And later added...
"I describe most assets as being on the high side of fair."
He did also say that at least stocks are "not in the territory they were in 2000..."
Video: No compelling bargains right now, Oaktree's Marks
There are exceptions, of course, but it has become much tougher to find investments that are selling at a plain discount to value these days. The fact that they're not nearly as expensive as 15 years ago doesn't mean that finding assets with a sufficent margin of safety -- in order to buy meaningful amounts with warranted confidence -- is an easy thing to do right now.
That doesn't mean I have an opinion on where prices are going. As always, I never do. It just means, for too many stocks, the current margin of safety makes establishing new positions, as well as incremental purchases of what's already partially owned, beyond token quantities, difficult at best.
Unfortunately, the valuation environment we are in does not reveal much of use about what direction stock market prices might go over the next several years. What's somewhat expensive can easily become even more so. Trying to guess near-term market moves (near-term being anything less than five years in my view) is a terrific waste of effort and focus.
What it does mean is that today's prices offer much more risk for a whole lot less reward.
Investing well requires, among other things, an ability to estimate value and price discipline. Several years ago -- and especially during the financial crisis -- it was not difficult to find shares of good businesses selling at a discount to a conservative estimate of intrinsic value. Some of my posts about stocks during that period more or less reflected that environment. It wasn't about timing. It was about market prices versus estimated per share intrinsic value. These days it's a very different situation. Bear markets -- or, at least, the prices that often become available during and sometimes after a bear market -- are an opportunity for the long-term investor.
"You make most of your money in a bear market. You just don't realize it at the time." - Shelby Davis
So, for those with a long enough time horizon, it makes little sense to hope for a bull market.
It feels more risky (and the headlines and commentators will do plenty to reinforce the feeling) to buy during a bear market but, if the assets are sound, the risks of ownership can actually be much reduced. A bear market -- usually accompanied by some form of macro turmoil -- is when risk and reward becomes more favorable even if temporary losses are almost a given.
It's worth mentioning attempting to avoid the temporary losses creates the possibility of a different kind of mistake.
A mistake of omission.
"The most extreme mistakes in Berkshire's history have been mistakes of omission. We saw it, but didn't act on it." - Charlie Munger
Munger describes this as "buying with an eyedropper things we should be buying a lot of."
The temporary loss might have been avoided but the possibility of buying too few shares (or, worse, buying no shares at all) of something at attractive prices when the opportunity arises gets larger. Permanent capital losses should be considered unacceptable but, at least with stocks, temporary losses are almost inevitable. The gains that were missed on those things that were well understood but weren't bought matter.*
For investors, it's not about what will happen in the coming weeks, months, or even years.
The emphasis should be on decades while knowing many unexpected things will happen and there's little point in trying to predict them.
Margin of safety, to some extent, can protect against uncertainty and misjudgments. An approach dependent on an unusual talent for guessing what's going to happen in the future, even if it involves using the most sophisticated tools and brainpower available, will likely work better on paper than the real world.
It's best to develop a flexible approach and to remain open-minded.
Investing involves lots of homework and lots of waiting.
It need not -- and I'd argue should not -- involve lots of transactions.
Those who choose to actively trade stocks aren't investing, they're speculating. Now, there's nothing inherently wrong with speculating on short-term price action. Some no doubt know how to do that sort of thing well but that's inherently a very different activity.
Adam
* There's almost always individual stocks that are cheap but doesn't mean they're understood well enough by the investor to buy. Buying what's not understood -- or worse, yet, confidently buying what someone thinks is understood but actually is not -- provides a great way to burn up a whole lot of capital. Only after the fact is something truly obvious. Missing a big gainer that's not fully understood by the investor is going to happen. That's not a mistake of omission. In fact, that's why, when I own shares of a good business that's been bought at a very attractive price, my preference is to NOT sell just because the shares happen to become more fully valued. Excessive buying and selling is a recipe for trouble. There are only so many good businesses that I can understand well enough. Others may be able to figure out more but I think some kid themselves that this is possible. When business prospects remain attractive then either opportunity costs or overvaluation must become substantial for selling to be warranted.
"There's better and there's worse, but there's nothing that is absolutely cheap."
And later added...
"I describe most assets as being on the high side of fair."
He did also say that at least stocks are "not in the territory they were in 2000..."
Video: No compelling bargains right now, Oaktree's Marks
There are exceptions, of course, but it has become much tougher to find investments that are selling at a plain discount to value these days. The fact that they're not nearly as expensive as 15 years ago doesn't mean that finding assets with a sufficent margin of safety -- in order to buy meaningful amounts with warranted confidence -- is an easy thing to do right now.
That doesn't mean I have an opinion on where prices are going. As always, I never do. It just means, for too many stocks, the current margin of safety makes establishing new positions, as well as incremental purchases of what's already partially owned, beyond token quantities, difficult at best.
Unfortunately, the valuation environment we are in does not reveal much of use about what direction stock market prices might go over the next several years. What's somewhat expensive can easily become even more so. Trying to guess near-term market moves (near-term being anything less than five years in my view) is a terrific waste of effort and focus.
What it does mean is that today's prices offer much more risk for a whole lot less reward.
Investing well requires, among other things, an ability to estimate value and price discipline. Several years ago -- and especially during the financial crisis -- it was not difficult to find shares of good businesses selling at a discount to a conservative estimate of intrinsic value. Some of my posts about stocks during that period more or less reflected that environment. It wasn't about timing. It was about market prices versus estimated per share intrinsic value. These days it's a very different situation. Bear markets -- or, at least, the prices that often become available during and sometimes after a bear market -- are an opportunity for the long-term investor.
"You make most of your money in a bear market. You just don't realize it at the time." - Shelby Davis
So, for those with a long enough time horizon, it makes little sense to hope for a bull market.
It feels more risky (and the headlines and commentators will do plenty to reinforce the feeling) to buy during a bear market but, if the assets are sound, the risks of ownership can actually be much reduced. A bear market -- usually accompanied by some form of macro turmoil -- is when risk and reward becomes more favorable even if temporary losses are almost a given.
It's worth mentioning attempting to avoid the temporary losses creates the possibility of a different kind of mistake.
A mistake of omission.
"The most extreme mistakes in Berkshire's history have been mistakes of omission. We saw it, but didn't act on it." - Charlie Munger
Munger describes this as "buying with an eyedropper things we should be buying a lot of."
The temporary loss might have been avoided but the possibility of buying too few shares (or, worse, buying no shares at all) of something at attractive prices when the opportunity arises gets larger. Permanent capital losses should be considered unacceptable but, at least with stocks, temporary losses are almost inevitable. The gains that were missed on those things that were well understood but weren't bought matter.*
For investors, it's not about what will happen in the coming weeks, months, or even years.
The emphasis should be on decades while knowing many unexpected things will happen and there's little point in trying to predict them.
Margin of safety, to some extent, can protect against uncertainty and misjudgments. An approach dependent on an unusual talent for guessing what's going to happen in the future, even if it involves using the most sophisticated tools and brainpower available, will likely work better on paper than the real world.
It's best to develop a flexible approach and to remain open-minded.
Investing involves lots of homework and lots of waiting.
It need not -- and I'd argue should not -- involve lots of transactions.
Adam
* There's almost always individual stocks that are cheap but doesn't mean they're understood well enough by the investor to buy. Buying what's not understood -- or worse, yet, confidently buying what someone thinks is understood but actually is not -- provides a great way to burn up a whole lot of capital. Only after the fact is something truly obvious. Missing a big gainer that's not fully understood by the investor is going to happen. That's not a mistake of omission. In fact, that's why, when I own shares of a good business that's been bought at a very attractive price, my preference is to NOT sell just because the shares happen to become more fully valued. Excessive buying and selling is a recipe for trouble. There are only so many good businesses that I can understand well enough. Others may be able to figure out more but I think some kid themselves that this is possible. When business prospects remain attractive then either opportunity costs or overvaluation must become substantial for selling to be warranted.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Wednesday, April 15, 2015
Berkshire's 'Big Four'
Warren Buffett, in his latest Berkshire Hathaway (BRKa) shareholder letter, wrote the following about what he calls the 'Big Four':
- American Express (AXP)
- Coca-Cola (KO)
- IBM (IBM)
- Wells Fargo (WFC)
"Berkshire increased its ownership interest last year in each of its 'Big Four' investments – American Express, Coca-Cola, IBM and Wells Fargo. We purchased additional shares of IBM (increasing our ownership to 7.8% versus 6.3% at yearend 2013). Meanwhile, stock repurchases at Coca-Cola, American Express and Wells Fargo raised our percentage ownership of each. Our equity in Coca-Cola grew from 9.1% to 9.2%, our interest in American Express increased from 14.2% to 14.8% and our ownership of Wells Fargo grew from 9.2% to 9.4%. And, if you think tenths of a percent aren't important, ponder this math: For the four companies in aggregate, each increase of one-tenth of a percent in our ownership raises Berkshire's portion of their annual earnings by $50 million."
It's worth noting that there's no attempt to bet on exceptional growth here. Some seem to think that high growth is a necessity to generate high returns. Well, consider the kind of businesses (whether through common stocks or outright purchases) Berkshire has owned over the past several decades. For the most part the returns have come from businesses that were not dependent on high growth over an extended period. Also, the returns generally have not come from businesses in industries that experience lots of change and require continuous product innovation. Instead, the emphasis has been on owning sound -- even if rather unexciting -- businesses that will be around for many decades. Ultimately, it's about increasing Berkshire's portion of what those businesses earn over time and the power of compounding effects.
So it's an emphasis on what the business can produce (in excess cash) over time. Those who, more or less, attempt to cleverly buy and sell stocks in order to profit from price action -- often with a rather not long time horizon in mind -- are engaged in a very different activity.
(This is the case whether or not the decisions are based upon business fundamentals. The fact that fundamentals are considered doesn't necessarily mean the activity isn't more speculation than investment.)
This approach works best if the business franchise remains competitive while real but manageable challenges keep the stock cheap for an extended period. A languishing stock can be a very good thing. In fact, the long-term investor in shares of a good business does not -- or, at least, should not -- logically want the share price to rise near-term or even intermediate-term.
Buffett recently said that some have a "misconception when we buy a stock we like it to go up. That's the last thing we want it to do."
For the investor who plans to be an owner for decades a rising stock price is not a good thing. What's much preferred is if the shares persistently sell at a discount to per-share intrinsic value.* When that happens -- at least for a business with sound long-term core economics -- future results improve as intrinsic value gets transferred from those who are impatient to those who are less so.**
"Our stay-put behavior reflects our view that the stock market serves as a relocation center at which money is moved from the active to the patient." - From the 1991 Berkshire Letter
A rising stock simply makes buybacks less effective and makes it tougher to accumulate more shares over time via dividend reinvestments or incremental purchases at a proper discount.***
Why Buffett Wants IBM's Shares "To Languish"
Ultimately, it's about the discounted per-share value of the excess cash that's produced as long as the business can at least maintain or, better yet, improve its competitive position.
Buffett explains in the latest letter that Berkshire's portion of the 2014 earnings from these four businesses "amounted to $4.7 billion (compared to $3.3 billion only three years ago). In the earnings we report to you, however, we include only the dividends we receive – about $1.6 billion last year. (Again, three years ago the dividends were $862 million.) But make no mistake: The $3.1 billion of these companies' earnings we don't report are every bit as valuable to us as the portion Berkshire records."
That's just one of the reasons why Berkshire's price to earnings generally isn't a terribly useful thing to consider.
Adam
Long positions in AXP, KO, WFC, BRKb established at much lower than recent prices. Long position in IBM established at slightly higher than recent prices.
* Here's how Buffett explains intrinsic value in the Berkshire Hathaway owner's manual: "Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life."
** If a dollar of value is consistently bought back for 70 cents then the other 30 cents of value doesn't just disappear, it ends up being transferred to the continuing owners. So an intelligent buyback can lead to what is effectively an intrinsic value transfer from those too focused on near-term price action to those focused on per-share intrinsic value and long-term effects.
*** From the 2011 letter: "If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise. You benefit when stocks swoon. Emotions, however, too often complicate the matter: Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day's supply.
Charlie and I don't expect to win many of you over to our way of thinking – we've observed enough human behavior to know the futility of that – but we do want you to be aware of our personal calculus."
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
- American Express (AXP)
- Coca-Cola (KO)
- IBM (IBM)
- Wells Fargo (WFC)
"Berkshire increased its ownership interest last year in each of its 'Big Four' investments – American Express, Coca-Cola, IBM and Wells Fargo. We purchased additional shares of IBM (increasing our ownership to 7.8% versus 6.3% at yearend 2013). Meanwhile, stock repurchases at Coca-Cola, American Express and Wells Fargo raised our percentage ownership of each. Our equity in Coca-Cola grew from 9.1% to 9.2%, our interest in American Express increased from 14.2% to 14.8% and our ownership of Wells Fargo grew from 9.2% to 9.4%. And, if you think tenths of a percent aren't important, ponder this math: For the four companies in aggregate, each increase of one-tenth of a percent in our ownership raises Berkshire's portion of their annual earnings by $50 million."
It's worth noting that there's no attempt to bet on exceptional growth here. Some seem to think that high growth is a necessity to generate high returns. Well, consider the kind of businesses (whether through common stocks or outright purchases) Berkshire has owned over the past several decades. For the most part the returns have come from businesses that were not dependent on high growth over an extended period. Also, the returns generally have not come from businesses in industries that experience lots of change and require continuous product innovation. Instead, the emphasis has been on owning sound -- even if rather unexciting -- businesses that will be around for many decades. Ultimately, it's about increasing Berkshire's portion of what those businesses earn over time and the power of compounding effects.
So it's an emphasis on what the business can produce (in excess cash) over time. Those who, more or less, attempt to cleverly buy and sell stocks in order to profit from price action -- often with a rather not long time horizon in mind -- are engaged in a very different activity.
(This is the case whether or not the decisions are based upon business fundamentals. The fact that fundamentals are considered doesn't necessarily mean the activity isn't more speculation than investment.)
This approach works best if the business franchise remains competitive while real but manageable challenges keep the stock cheap for an extended period. A languishing stock can be a very good thing. In fact, the long-term investor in shares of a good business does not -- or, at least, should not -- logically want the share price to rise near-term or even intermediate-term.
Buffett recently said that some have a "misconception when we buy a stock we like it to go up. That's the last thing we want it to do."
For the investor who plans to be an owner for decades a rising stock price is not a good thing. What's much preferred is if the shares persistently sell at a discount to per-share intrinsic value.* When that happens -- at least for a business with sound long-term core economics -- future results improve as intrinsic value gets transferred from those who are impatient to those who are less so.**
"Our stay-put behavior reflects our view that the stock market serves as a relocation center at which money is moved from the active to the patient." - From the 1991 Berkshire Letter
A rising stock simply makes buybacks less effective and makes it tougher to accumulate more shares over time via dividend reinvestments or incremental purchases at a proper discount.***
Why Buffett Wants IBM's Shares "To Languish"
Ultimately, it's about the discounted per-share value of the excess cash that's produced as long as the business can at least maintain or, better yet, improve its competitive position.
Buffett explains in the latest letter that Berkshire's portion of the 2014 earnings from these four businesses "amounted to $4.7 billion (compared to $3.3 billion only three years ago). In the earnings we report to you, however, we include only the dividends we receive – about $1.6 billion last year. (Again, three years ago the dividends were $862 million.) But make no mistake: The $3.1 billion of these companies' earnings we don't report are every bit as valuable to us as the portion Berkshire records."
That's just one of the reasons why Berkshire's price to earnings generally isn't a terribly useful thing to consider.
Adam
Long positions in AXP, KO, WFC, BRKb established at much lower than recent prices. Long position in IBM established at slightly higher than recent prices.
* Here's how Buffett explains intrinsic value in the Berkshire Hathaway owner's manual: "Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life."
** If a dollar of value is consistently bought back for 70 cents then the other 30 cents of value doesn't just disappear, it ends up being transferred to the continuing owners. So an intelligent buyback can lead to what is effectively an intrinsic value transfer from those too focused on near-term price action to those focused on per-share intrinsic value and long-term effects.
*** From the 2011 letter: "If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise. You benefit when stocks swoon. Emotions, however, too often complicate the matter: Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day's supply.
Charlie and I don't expect to win many of you over to our way of thinking – we've observed enough human behavior to know the futility of that – but we do want you to be aware of our personal calculus."
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Wednesday, April 8, 2015
Index Funds vs Actively Managed Funds
Some recent research by S&P Dow Jones Indices found that, among other things, the vast majority of U.S. actively managed equity funds did not beat the relevant benchmark over ten years.
Here's a quick summary of U.S. equity fund performance over a ten year period.*
- All Domestic Equity Funds: 76.54% underperformed
- All Large-Cap Funds: 82.07% underperformed
- All Mid-Cap Funds: 89.71% underperformed
- All Small-Cap Funds: 87.75% underperformed
From the report:
"It is commonly believed that active management works best in inefficient environments, such as small-cap or emerging markets. This argument is disputed by the findings of this SPIVA Scorecard. The majority of small-cap active managers have been consistently underperforming the benchmark over the full 10-year period..."
The results, with one exception, were similar for the 14 other U.S. equity fund categories included in the report.**
According to the report, "the majority of the active managers" that invest in international stocks also performed worse than their benchmarks over the same time frame.***
This should hardly be a surprising result. John "Jack" Bogle has been trying to educate others on the wisdom of low cost index funds over actively managed funds for decades.
Here's how Mr. Bogle once explained it:
"The percentage of managers outperformed by the broad market index is, well, time-dependent. On a given day, it's likely about 55%; over a year maybe 60-65%, over a decade perhaps 75-80%, and over 50 years...well, there's no data (yet!) on that!
But the probability statistics suggest that over a 50-year period, some 98% of managers will lose to the market index."
The S&P Dow Jones Indices research does "account for the entire opportunity set—not just the survivors—thereby eliminating survivorship bias." Any comparison that doesn't account for the funds that are liquidated or combined with other funds during a particular period isn't going to paint a realistic picture.
The research shows result for shorter time frames but, at least to me, ten years is barely a long enough time horizon to make meaningful judgments. It's performance over decades that matters all risks considered.
It may not be impossible to figure out which fund will outperform going forward over the longer haul, but at least investors should carefully consider just how difficult it might be.
Of course, it's possible that active managers are will do much better going forward but, if nothing else, some skepticism seems warranted.
Think of it this way:
Where else does a simple cheap product exist that offers the non-expert a chance to keep up with the experts -- or, if this research is any indication, possibly outperform the vast majority of the experts -- over the longer haul?
The tough part for many is avoiding the temptation to be more active than they probably should be and end up making inopportune portfolio moves.
Some investors tend to underestimate how excessive confidence and other factors can adversely impact results.
Some relevant Bogle advice:
1) "...in investing, realize that you get what you don't pay for. Whatever future returns the markets are generous enough to deliver, few investors will succeed in capturing 100% of those returns, simply because of the high costs of investing—all those commissions, management fees, investment expenses, yes, even taxes—so pare them to the bone."
2) "Don't do something, just stand there. Own American business...a broadly diversified portfolio of lots of companies and industries. Buy such a portfolio, never sell, and hold it forever."
3) "Invest for the long term—decades, even a lifetime—and start as soon as you can. No one knows what stocks will do tomorrow, or even what they'll do over the next few decades, but over the long pull, the dividends and earnings growth of American business will be reflected in rising stock prices."
He also says to avoid "stupid mistakes" including things like -- though not limited to -- making impulse investments, buying based upon tips, and letting emotions rule over reason.
Jack Bogle's market advice: 'Don't do something, just stand there!'
Ultimately, the "humble arithmetic" is unavoidable.
Adam
Related posts:
John Bogle on Investor Returns
Buffett's Hedge Fund Bet
John Bogle's "Relentless Rules of Humble Arithmetic", Part II
Index Fund Investing Revisited
Charlie Munger on Complexity, Hedge Funds, and Pension Funds
Why Do So Many Investors Underperform?
When Mutual Funds Outperform Their Investors
John Bogle's "Relentless Rules of Humble Arithmetic"
Investor Overconfidence Revisited
Newton's Fourth Law
Investor Overconfidence
Chasing "Rearview-Mirror Performance"
Index Fund Investing
Investors Are Often Their Own Worst Enemies, Part II
Investors Are Often Their Own Worst Enemies
The Illusion of Skill
Buffett's Bet Against Hedge Funds, Part II
Buffett's Bet Against Hedge Funds
The Illusion of Control
Buffett, Bogle, and the "Invisible Foot" Revisited
If Buffett Were Paid Like a Hedge Fund Manager - Part II
If Buffett Were Paid Like a Hedge Fund Manager
Buffett, Bogle, and the Invisible Foot
Charlie Munger on LTCM & Overconfidence
"Nothing But Costs"
Bogle: History and the Classics
When Genius Failed...Again
* See page 4. Source: S&P Dow Jones Indices LLC, CRSP. Data as of Dec. 31, 2014. Charts and tables are provided for illustrative purposes. Past performance is no guarantee of future results.
** Large-Cap Value Funds: 58.76% of the funds underperformed their benchmark index over ten years. This may be a relatively better performance versus the other categories, but most funds in this group still could not outperform their benchmark.
*** Results on page 10.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Here's a quick summary of U.S. equity fund performance over a ten year period.*
- All Domestic Equity Funds: 76.54% underperformed
- All Large-Cap Funds: 82.07% underperformed
- All Mid-Cap Funds: 89.71% underperformed
- All Small-Cap Funds: 87.75% underperformed
From the report:
"It is commonly believed that active management works best in inefficient environments, such as small-cap or emerging markets. This argument is disputed by the findings of this SPIVA Scorecard. The majority of small-cap active managers have been consistently underperforming the benchmark over the full 10-year period..."
The results, with one exception, were similar for the 14 other U.S. equity fund categories included in the report.**
According to the report, "the majority of the active managers" that invest in international stocks also performed worse than their benchmarks over the same time frame.***
This should hardly be a surprising result. John "Jack" Bogle has been trying to educate others on the wisdom of low cost index funds over actively managed funds for decades.
Here's how Mr. Bogle once explained it:
"The percentage of managers outperformed by the broad market index is, well, time-dependent. On a given day, it's likely about 55%; over a year maybe 60-65%, over a decade perhaps 75-80%, and over 50 years...well, there's no data (yet!) on that!
But the probability statistics suggest that over a 50-year period, some 98% of managers will lose to the market index."
The S&P Dow Jones Indices research does "account for the entire opportunity set—not just the survivors—thereby eliminating survivorship bias." Any comparison that doesn't account for the funds that are liquidated or combined with other funds during a particular period isn't going to paint a realistic picture.
The research shows result for shorter time frames but, at least to me, ten years is barely a long enough time horizon to make meaningful judgments. It's performance over decades that matters all risks considered.
It may not be impossible to figure out which fund will outperform going forward over the longer haul, but at least investors should carefully consider just how difficult it might be.
Of course, it's possible that active managers are will do much better going forward but, if nothing else, some skepticism seems warranted.
Think of it this way:
Where else does a simple cheap product exist that offers the non-expert a chance to keep up with the experts -- or, if this research is any indication, possibly outperform the vast majority of the experts -- over the longer haul?
The tough part for many is avoiding the temptation to be more active than they probably should be and end up making inopportune portfolio moves.
Some investors tend to underestimate how excessive confidence and other factors can adversely impact results.
Some relevant Bogle advice:
1) "...in investing, realize that you get what you don't pay for. Whatever future returns the markets are generous enough to deliver, few investors will succeed in capturing 100% of those returns, simply because of the high costs of investing—all those commissions, management fees, investment expenses, yes, even taxes—so pare them to the bone."
2) "Don't do something, just stand there. Own American business...a broadly diversified portfolio of lots of companies and industries. Buy such a portfolio, never sell, and hold it forever."
3) "Invest for the long term—decades, even a lifetime—and start as soon as you can. No one knows what stocks will do tomorrow, or even what they'll do over the next few decades, but over the long pull, the dividends and earnings growth of American business will be reflected in rising stock prices."
He also says to avoid "stupid mistakes" including things like -- though not limited to -- making impulse investments, buying based upon tips, and letting emotions rule over reason.
Jack Bogle's market advice: 'Don't do something, just stand there!'
Ultimately, the "humble arithmetic" is unavoidable.
Adam
Related posts:
John Bogle on Investor Returns
Buffett's Hedge Fund Bet
John Bogle's "Relentless Rules of Humble Arithmetic", Part II
Index Fund Investing Revisited
Charlie Munger on Complexity, Hedge Funds, and Pension Funds
Why Do So Many Investors Underperform?
When Mutual Funds Outperform Their Investors
John Bogle's "Relentless Rules of Humble Arithmetic"
Investor Overconfidence Revisited
Newton's Fourth Law
Investor Overconfidence
Chasing "Rearview-Mirror Performance"
Index Fund Investing
Investors Are Often Their Own Worst Enemies, Part II
Investors Are Often Their Own Worst Enemies
The Illusion of Skill
Buffett's Bet Against Hedge Funds, Part II
Buffett's Bet Against Hedge Funds
The Illusion of Control
Buffett, Bogle, and the "Invisible Foot" Revisited
If Buffett Were Paid Like a Hedge Fund Manager - Part II
If Buffett Were Paid Like a Hedge Fund Manager
Buffett, Bogle, and the Invisible Foot
Charlie Munger on LTCM & Overconfidence
"Nothing But Costs"
Bogle: History and the Classics
When Genius Failed...Again
* See page 4. Source: S&P Dow Jones Indices LLC, CRSP. Data as of Dec. 31, 2014. Charts and tables are provided for illustrative purposes. Past performance is no guarantee of future results.
** Large-Cap Value Funds: 58.76% of the funds underperformed their benchmark index over ten years. This may be a relatively better performance versus the other categories, but most funds in this group still could not outperform their benchmark.
*** Results on page 10.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Wednesday, April 1, 2015
Buffett on the Kraft Heinz Deal
Berkshire Hathaway (BRKa) already owned roughly half of Heinz as a result of a deal that took the company private back in 2013. Well, now Berkshire and 3G Capital have put a deal together that will combine Kraft (KRFT) with Heinz.
Berkshire and 3G together will own 51 percent of the newly combined Kraft-Heinz under the terms of the deal.
Berkshire had already invested $ 4.25 billion in Heinz common stock and will invest another ~ $ 5.25 billion in Kraft common stock to complete the new deal.
Warren Buffett explained it the following way on CNBC:
"SO WE WILL HAVE $ 9.5 BILLION ROUGHLY IN THE COMMON STOCK. AND WE'LL OWN 320 ODD MILLION SHARES OF THE NEW COMPANY. BUT OF COURSE, THE STOCK YOU'RE LOOKING AT WILL GO EX-DIVIDEND [AT] $ 16.50 [PER SHARE] AT SOME POINT BEFORE WE RECEIVE OUR SHARES IN THE NEW COMPANY."
The $ 9.5 billion works out to Berkshire paying slightly less than $ 30 per share for Kraft-Heinz combined.
Buffett certainly views this as a VERY long-term investment:
"...THE SHORT TERM DOESN'T MAKE MUCH DIFFERENCE TO US BECAUSE WE WILL BE IN THIS STOCK FOREVER. THIS IS A BUSINESS WITH US, IT'S NOT REALLY A STOCK. AND IT'S A COMPANY THAT WE WILL OWN 26 AND A FRACTION PERCENT OF. SO IT'S WHERE THE NEW KRAFT/HEINZ COMPANY IS 10, 20, 50 YEARS FROM NOW THAT COUNTS TO BERKSHIRE HATHAWAY AND I LIKE THE BRANDS."
Berkshire also still has the preferred stock investment in Heinz but most likely not for long:
"...AND THEN WE HAVE $ 8 BILLION OF PREFERRED. ALTHOUGH I'M AFRAID THAT WILL GET CALLED AS SOON AS THEY CAN CALL IT."
The $ 8 billion of preferred stock pays a 9% dividend and was a part of the Heinz deal. Those preferred shares can be called at a premium after June 7, 2016.*
Boil this down and Berkshire paid a bit less than $ 30 per share for a stock that currently trades for ~ $ 88 per share. Of course, as Buffett points out, the $ 16.50 per share special dividend that will be paid before deal is completed should be accounted for to make a meaningful comparison.
Once paid the market price will, of course, adjust downward to reflect that special distribution.
Clearly that's quite a big discount to the current market price. Yet, that the shares were bought at such a discount to what it currently trades at isn't really what matters all that much. What's truly impressive is getting control of two rather large high quality franchises at what seems like a very fair price compared to current intrinsic value -- with value that should increase at a nice clip over time -- and the ability to put quality management in place. I'm guessing, though it already seems a fine deal compared to current value, what Berkshire paid for Heinz and Kraft will look rather very good against the value that will be created over many decades.
It's what the business will be worth many decades from now that matters.
It's worth pointing out that, at least by my math, the current market price seems to represent a rather full current valuation.
Naturally if this were more of a short-term bet that gap in price paid to the current market price would be more relevant. Well, plainly this is no quick trade so such a short-term gain means little since Buffett plans to hold it "forever". In fact, if that rather high market price were to persist it simply means that potential future share repurchases won't make much sense nor do much good for continuing shareholders. Almost all Buffett's investments are longer term in nature but any business that's purchased outright it's even more so. He makes it pretty clear that this investment, even though Berkshire will only own 26 percent plus of the common stock, is more like the purchase of a business outright versus a typical stock investment.
(Though certain stocks in the Berkshire portfolio tend to be held indefinitely if not "forever" while most others, at least, are held for a very long time. Mistakes get made that require a quick adjustment and sometimes the capital is needed elsewhere because the opportunity costs are high enough. Otherwise, short-term bets aren't really in the Berkshire playbook.)
More relevant is what was paid compared to what a reasonable estimate of what the two businesses are capable of earning on a normalized basis.
Heinz was earning roughly $ 1 billion per year before the company went private. Kraft as a stand alone company should earn $ 2 billion this year if expected earnings multiplied by current shares outstanding proves at least a reasonable guide.
(Heinz net income is currently lower due to the additional debt that was taken on as well as the preferred stock. It will take some time for the added debt to be paid down, along with the preferred shares, before this all falls to the bottom line for common stockholders.)
So, for roughly $ 9.5 billion, Berkshire now owns 26 percent plus of those earnings (and, for the time being, until they're likely called, will be getting that nice dividend payment from the preferred shares).
Seems like a more than reasonable price to pay for a business that should be around for a very long time.
If any of the expected annual cost savings come to fruition that'll only improve the picture.
Adam
No position in KRFT. Long position in BRKb established at much lower than recent prices.
* See note 6, page 9 of the 2nd Quarter 2013 10-Q. Warrants were also included in that deal.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Berkshire and 3G together will own 51 percent of the newly combined Kraft-Heinz under the terms of the deal.
Berkshire had already invested $ 4.25 billion in Heinz common stock and will invest another ~ $ 5.25 billion in Kraft common stock to complete the new deal.
Warren Buffett explained it the following way on CNBC:
"SO WE WILL HAVE $ 9.5 BILLION ROUGHLY IN THE COMMON STOCK. AND WE'LL OWN 320 ODD MILLION SHARES OF THE NEW COMPANY. BUT OF COURSE, THE STOCK YOU'RE LOOKING AT WILL GO EX-DIVIDEND [AT] $ 16.50 [PER SHARE] AT SOME POINT BEFORE WE RECEIVE OUR SHARES IN THE NEW COMPANY."
The $ 9.5 billion works out to Berkshire paying slightly less than $ 30 per share for Kraft-Heinz combined.
Buffett certainly views this as a VERY long-term investment:
"...THE SHORT TERM DOESN'T MAKE MUCH DIFFERENCE TO US BECAUSE WE WILL BE IN THIS STOCK FOREVER. THIS IS A BUSINESS WITH US, IT'S NOT REALLY A STOCK. AND IT'S A COMPANY THAT WE WILL OWN 26 AND A FRACTION PERCENT OF. SO IT'S WHERE THE NEW KRAFT/HEINZ COMPANY IS 10, 20, 50 YEARS FROM NOW THAT COUNTS TO BERKSHIRE HATHAWAY AND I LIKE THE BRANDS."
Berkshire also still has the preferred stock investment in Heinz but most likely not for long:
"...AND THEN WE HAVE $ 8 BILLION OF PREFERRED. ALTHOUGH I'M AFRAID THAT WILL GET CALLED AS SOON AS THEY CAN CALL IT."
The $ 8 billion of preferred stock pays a 9% dividend and was a part of the Heinz deal. Those preferred shares can be called at a premium after June 7, 2016.*
Boil this down and Berkshire paid a bit less than $ 30 per share for a stock that currently trades for ~ $ 88 per share. Of course, as Buffett points out, the $ 16.50 per share special dividend that will be paid before deal is completed should be accounted for to make a meaningful comparison.
Once paid the market price will, of course, adjust downward to reflect that special distribution.
Clearly that's quite a big discount to the current market price. Yet, that the shares were bought at such a discount to what it currently trades at isn't really what matters all that much. What's truly impressive is getting control of two rather large high quality franchises at what seems like a very fair price compared to current intrinsic value -- with value that should increase at a nice clip over time -- and the ability to put quality management in place. I'm guessing, though it already seems a fine deal compared to current value, what Berkshire paid for Heinz and Kraft will look rather very good against the value that will be created over many decades.
It's what the business will be worth many decades from now that matters.
It's worth pointing out that, at least by my math, the current market price seems to represent a rather full current valuation.
Naturally if this were more of a short-term bet that gap in price paid to the current market price would be more relevant. Well, plainly this is no quick trade so such a short-term gain means little since Buffett plans to hold it "forever". In fact, if that rather high market price were to persist it simply means that potential future share repurchases won't make much sense nor do much good for continuing shareholders. Almost all Buffett's investments are longer term in nature but any business that's purchased outright it's even more so. He makes it pretty clear that this investment, even though Berkshire will only own 26 percent plus of the common stock, is more like the purchase of a business outright versus a typical stock investment.
(Though certain stocks in the Berkshire portfolio tend to be held indefinitely if not "forever" while most others, at least, are held for a very long time. Mistakes get made that require a quick adjustment and sometimes the capital is needed elsewhere because the opportunity costs are high enough. Otherwise, short-term bets aren't really in the Berkshire playbook.)
More relevant is what was paid compared to what a reasonable estimate of what the two businesses are capable of earning on a normalized basis.
Heinz was earning roughly $ 1 billion per year before the company went private. Kraft as a stand alone company should earn $ 2 billion this year if expected earnings multiplied by current shares outstanding proves at least a reasonable guide.
(Heinz net income is currently lower due to the additional debt that was taken on as well as the preferred stock. It will take some time for the added debt to be paid down, along with the preferred shares, before this all falls to the bottom line for common stockholders.)
So, for roughly $ 9.5 billion, Berkshire now owns 26 percent plus of those earnings (and, for the time being, until they're likely called, will be getting that nice dividend payment from the preferred shares).
Seems like a more than reasonable price to pay for a business that should be around for a very long time.
If any of the expected annual cost savings come to fruition that'll only improve the picture.
Adam
No position in KRFT. Long position in BRKb established at much lower than recent prices.
* See note 6, page 9 of the 2nd Quarter 2013 10-Q. Warrants were also included in that deal.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Wednesday, March 25, 2015
Charlie Munger on Lee Kuan Yew
Over this past weekend news came that Lee Kuan Yew had died at the age of 91.
During his three decades as Singapore's founding prime minister, GDP per capita increased dramatically. In fact, GDP per capita grew from roughly $ 500 in the mid-1960s to recently among the highest in the world.
Back in 2010 Charlie Munger said the following things about Singapore's founding father:
"My favorite political system in terms of being adapted to its particular circumstances, successfully, is Singapore. I think Singapore is the single most successful governmental system that exists in the world."
"If you will make a study of the life and the work of Lee Kuan Yew, you will find one of the most interesting and instructive political stories written in the history of mankind. This is better than Athens...and you will learn a lot that will be useful in your whole life."
"...study the life and work of Lee Kuan Yew, you're going to be flabbergasted."
Munger praises Singapore and Lee Kuan Yew
This parable written by Munger back in 2010 is another indication of the respect that he had for Yew (and some others).
In the parable, the politicians, facing a "brutal new reality...asked for advice from Benfranklin Leekwanyou Vokker, an old man who was considered so virtuous and wise that he was often called the 'Good Father.' Such consultations were rare. Politicians usually ignored the Good Father because he made no campaign contributions."
Who Munger considers "virtuous and wise" obviously isn't exactly a mystery.
Vast experience and a high IQ doesn't necessarily go hand in hand with great virtue, wisdom, and other critical talents. Still, I don't think it's all that difficult with a little effort to separate the Charlie Mungers or Lee Kuan Yews of the world from those who think they've got it all figured out but, well, really just do not.
James Grant wrote in his book Money of the Mind that "Progress is cumulative in science and engineering, but cyclical in finance."
This cyclicality doesn't just apply to finance.
Put another way, the world may continue to become more technically sophisticated, but the aspects of human nature that cause even very smart individuals to make big and costly* -- though often largely unnecessary -- mistakes don't fundamentally change all that much.
"Smart, hard-working people aren't exempted from professional disasters from overconfidence. Often, they just go aground in the more difficult voyages they choose..." - Charlie Munger speaking to the Foundation Financial Officers Group in 1998
Overconfidence is just one example among many.
Naturally, there are lots of smart people in business, finance, and politics. Unfortunately, this offers no guarantee they'll act with as much virtue and wisdom that one might like and end up doing great things for the world.
So that means, at least for me, when someone like Lee Kuan Yew comes along some appreciation is warranted and deserved. Perfection doesn't exist in the real world but, overall, his accomplishments seem rather astounding by almost any standard.
Much can be learned.
Few would seem to possess the combination of characteristics required to achieve what he did during his lifetime.
Here's a recent article that has a short collection of Lee Kuan Yew quotes.
Adam
* The costs, of course, aren't necessarily only measured in financial terms.
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
During his three decades as Singapore's founding prime minister, GDP per capita increased dramatically. In fact, GDP per capita grew from roughly $ 500 in the mid-1960s to recently among the highest in the world.
Back in 2010 Charlie Munger said the following things about Singapore's founding father:
"My favorite political system in terms of being adapted to its particular circumstances, successfully, is Singapore. I think Singapore is the single most successful governmental system that exists in the world."
"If you will make a study of the life and the work of Lee Kuan Yew, you will find one of the most interesting and instructive political stories written in the history of mankind. This is better than Athens...and you will learn a lot that will be useful in your whole life."
"...study the life and work of Lee Kuan Yew, you're going to be flabbergasted."
Munger praises Singapore and Lee Kuan Yew
This parable written by Munger back in 2010 is another indication of the respect that he had for Yew (and some others).
In the parable, the politicians, facing a "brutal new reality...asked for advice from Benfranklin Leekwanyou Vokker, an old man who was considered so virtuous and wise that he was often called the 'Good Father.' Such consultations were rare. Politicians usually ignored the Good Father because he made no campaign contributions."
Who Munger considers "virtuous and wise" obviously isn't exactly a mystery.
Vast experience and a high IQ doesn't necessarily go hand in hand with great virtue, wisdom, and other critical talents. Still, I don't think it's all that difficult with a little effort to separate the Charlie Mungers or Lee Kuan Yews of the world from those who think they've got it all figured out but, well, really just do not.
James Grant wrote in his book Money of the Mind that "Progress is cumulative in science and engineering, but cyclical in finance."
This cyclicality doesn't just apply to finance.
Put another way, the world may continue to become more technically sophisticated, but the aspects of human nature that cause even very smart individuals to make big and costly* -- though often largely unnecessary -- mistakes don't fundamentally change all that much.
"Smart, hard-working people aren't exempted from professional disasters from overconfidence. Often, they just go aground in the more difficult voyages they choose..." - Charlie Munger speaking to the Foundation Financial Officers Group in 1998
Overconfidence is just one example among many.
Naturally, there are lots of smart people in business, finance, and politics. Unfortunately, this offers no guarantee they'll act with as much virtue and wisdom that one might like and end up doing great things for the world.
So that means, at least for me, when someone like Lee Kuan Yew comes along some appreciation is warranted and deserved. Perfection doesn't exist in the real world but, overall, his accomplishments seem rather astounding by almost any standard.
Much can be learned.
Few would seem to possess the combination of characteristics required to achieve what he did during his lifetime.
Here's a recent article that has a short collection of Lee Kuan Yew quotes.
Adam
* The costs, of course, aren't necessarily only measured in financial terms.
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Wednesday, March 18, 2015
Forecasting Folly Revisited
In the book, One Up on Wall Street, Peter Lynch wrote that many economists are "employed full-time trying to forecast recessions and interest rates, and if they could do it successfully twice in a row, they'd all be millionaires by now."
Lynch then adds:
"...as far as I know, most of them are still gainfully employed, which ought to tell us something."
Charlie Munger said the following in an interview with Susie Gharib back in 2009:
GHARIB: "When do you see the recovery coming?"
MUNGER: "We don't have any special ability to make that kind of macro economic prediction."
The good news is that successfully predicting macroeconomic outcomes isn't required for investors.
In fact, trying to do so is a distraction.
There's also the following dynamic to consider:
"Because there is no way to hold financial forecasters accountable for their incorrect predictions, they get more out of making wild ones. Wild predictions pay because the downside of being wrong is zilch, but the upside is lifelong fame."
So some in the business of making predictions are, in some ways, simply doing what's necessary for marketing purposes.
Prognosticators would argue otherwise but, given the complexity of the system they're attempting to understand, to me it seems effectively impossible to reliably make useful predictions.
Figuring out what a good business is worth and what to pay for it isn't an easy task, but at least it's not effectively an impossible task.
In 2003, Charlie Munger said the following at a speech to the University of California, Santa Babara Economics Department:
"...there's too much emphasis on macroeconomics and not enough on microeconomics. I think this is wrong. It's like trying to master medicine without knowing anatomy and chemistry. Also, the discipline of microeconomics is a lot of fun. It helps you correctly understand macroeconomics. And it's a perfect circus to do. In contrast, I don't think macroeconomics people have all that much fun. For one thing they are often wrong because of extreme complexity in the system they wish to understand."
Consider the findings of professor Philip Tetlock.
A study by professor Tetlock found that those "who earn their livings by holding forth confidently on the basis of limited information...make worse predictions about political and economic trends than they would by random chance." In fact, "the most famous and the most confident" are generally the worst at making predictions.*
According to Tetlock, the best forecasters tend to be more like foxes than hedgehogs.**
So ,while economic forecasting has certainly become more sophisticated, that doesn't mean they're becoming more useful.
"We will continue to ignore political and economic forecasts, which are an expensive distraction for many investors and businessmen." - Warren Buffett in the 1994 Berkshire (BRKa) Hathaway Shareholder Letter
Practically speaking, at least to me, it's mostly a waste of energy trying to makes guesses -- even very well informed guesses -- about what might happen in an uncertain world.
The focus should be on figuring out what's likely to do well over a longer time horizon even as the inevitably unpredictable world will bring many surprises and challenges. Will a good business be able maintain all or most of their competitive advantages for a very long time? Better yet, does the business have characteristics that make it likely those advantages will even be strengthened over time?
"If we can identify businesses similar to those we have purchased in the past, external surprises will have little effect on our long-term results." - Warren Buffett in the 1994 Berkshire Hathaway Shareholder Letter
The stock market did just fine over the past century or so despite what almost certainly be a whole host of major economic and political shocks. Stock prices, will no doubt respond to these events. That a crisis of some kind -- or maybe even several -- will undoubtedly emerge in the coming decades hardly makes it impossible to invest. The risks of attempting to time the market are not small. In fact, attempts at timing will likely do more harm than good.
"The Dow Jones Industrials advanced from 66 to 11,497 in the 20th Century, a staggering 17,320% increase that materialized despite four costly wars, a Great Depression and many recessions." - Warren Buffett in the 2012 Berkshire Hathaway shareholder letter
Keep in mind that 17,320% doesn't include a century of dividends.
Time in the market generally beats timing the market in the long run.
Stick to what can be understood then pay a price that reflects uncertainties. That there'll be challenging economic environments and upheavals is almost a given. There will never be any guarantees. Future difficulties may exceed all from the past century or so.
Being frozen by this reality is no investment strategy.
Expect market fluctuations. Forget about reliably predicting when and by how much. Ignore those who try to do so.***
John Kenneth Galbraith once said: "There are two kinds of forecasters: those who don't know, and those who don't know they don't know."
Munger and Buffett haven't needed to be brilliant forecasters to get investment results.
Adam
Long position in BRKb established at much lower than recent market prices
Other related posts:
Forecasting Folly
Henry Singleton: Why Flexibility Beats Long-Range Planning
Forecasters & Fortune Tellers
Charlie Munger: Snare and a Delusion
On Forecasting
James Grant on Economic Forecasting
* An excerpt from Susan Cain's book Quiet.
** Professor Tetlock puts it this way: "Hedgehogs are big-idea thinkers in love with grand theories" while "foxes are better at curbing their ideological enthusiasms." He goes on to say foxes tend to not over-simplify and are more aware of the limits to their arguments. As a result, they become less prone to mistakes.
*** I think this quote by Charlie Munger on macroeconomic predictions captures it well.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Lynch then adds:
"...as far as I know, most of them are still gainfully employed, which ought to tell us something."
Charlie Munger said the following in an interview with Susie Gharib back in 2009:
GHARIB: "When do you see the recovery coming?"
MUNGER: "We don't have any special ability to make that kind of macro economic prediction."
The good news is that successfully predicting macroeconomic outcomes isn't required for investors.
In fact, trying to do so is a distraction.
There's also the following dynamic to consider:
"Because there is no way to hold financial forecasters accountable for their incorrect predictions, they get more out of making wild ones. Wild predictions pay because the downside of being wrong is zilch, but the upside is lifelong fame."
So some in the business of making predictions are, in some ways, simply doing what's necessary for marketing purposes.
Figuring out what a good business is worth and what to pay for it isn't an easy task, but at least it's not effectively an impossible task.
In 2003, Charlie Munger said the following at a speech to the University of California, Santa Babara Economics Department:
"...there's too much emphasis on macroeconomics and not enough on microeconomics. I think this is wrong. It's like trying to master medicine without knowing anatomy and chemistry. Also, the discipline of microeconomics is a lot of fun. It helps you correctly understand macroeconomics. And it's a perfect circus to do. In contrast, I don't think macroeconomics people have all that much fun. For one thing they are often wrong because of extreme complexity in the system they wish to understand."
Consider the findings of professor Philip Tetlock.
A study by professor Tetlock found that those "who earn their livings by holding forth confidently on the basis of limited information...make worse predictions about political and economic trends than they would by random chance." In fact, "the most famous and the most confident" are generally the worst at making predictions.*
According to Tetlock, the best forecasters tend to be more like foxes than hedgehogs.**
So ,while economic forecasting has certainly become more sophisticated, that doesn't mean they're becoming more useful.
"We will continue to ignore political and economic forecasts, which are an expensive distraction for many investors and businessmen." - Warren Buffett in the 1994 Berkshire (BRKa) Hathaway Shareholder Letter
Practically speaking, at least to me, it's mostly a waste of energy trying to makes guesses -- even very well informed guesses -- about what might happen in an uncertain world.
The focus should be on figuring out what's likely to do well over a longer time horizon even as the inevitably unpredictable world will bring many surprises and challenges. Will a good business be able maintain all or most of their competitive advantages for a very long time? Better yet, does the business have characteristics that make it likely those advantages will even be strengthened over time?
"If we can identify businesses similar to those we have purchased in the past, external surprises will have little effect on our long-term results." - Warren Buffett in the 1994 Berkshire Hathaway Shareholder Letter
The stock market did just fine over the past century or so despite what almost certainly be a whole host of major economic and political shocks. Stock prices, will no doubt respond to these events. That a crisis of some kind -- or maybe even several -- will undoubtedly emerge in the coming decades hardly makes it impossible to invest. The risks of attempting to time the market are not small. In fact, attempts at timing will likely do more harm than good.
"The Dow Jones Industrials advanced from 66 to 11,497 in the 20th Century, a staggering 17,320% increase that materialized despite four costly wars, a Great Depression and many recessions." - Warren Buffett in the 2012 Berkshire Hathaway shareholder letter
Keep in mind that 17,320% doesn't include a century of dividends.
Time in the market generally beats timing the market in the long run.
Stick to what can be understood then pay a price that reflects uncertainties. That there'll be challenging economic environments and upheavals is almost a given. There will never be any guarantees. Future difficulties may exceed all from the past century or so.
Being frozen by this reality is no investment strategy.
Expect market fluctuations. Forget about reliably predicting when and by how much. Ignore those who try to do so.***
John Kenneth Galbraith once said: "There are two kinds of forecasters: those who don't know, and those who don't know they don't know."
Munger and Buffett haven't needed to be brilliant forecasters to get investment results.
Adam
Long position in BRKb established at much lower than recent market prices
Other related posts:
Forecasting Folly
Henry Singleton: Why Flexibility Beats Long-Range Planning
Forecasters & Fortune Tellers
Charlie Munger: Snare and a Delusion
On Forecasting
James Grant on Economic Forecasting
* An excerpt from Susan Cain's book Quiet.
** Professor Tetlock puts it this way: "Hedgehogs are big-idea thinkers in love with grand theories" while "foxes are better at curbing their ideological enthusiasms." He goes on to say foxes tend to not over-simplify and are more aware of the limits to their arguments. As a result, they become less prone to mistakes.
*** I think this quote by Charlie Munger on macroeconomic predictions captures it well.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Wednesday, March 11, 2015
Investment Sins
"The fault, dear Brutus, is not in our stars, but in ourselves." - William Shakespeare in Julius Caesar
Warren Buffett, in his latest Berkshire Hathaway (BRKa) letter to shareholders*, explained the consequences of volatility being viewed, mistakenly, as a meaningful indication of risk.
In fact, he writes that such a view can "ironically" cause the investor to "end up doing some very risky things."
Buffett then adds to remember "the pundits who six years ago bemoaned fall stock prices and advised investing in 'safe' Treasury bills or bank certificates of deposit. People who heeded this sermon are now earning a pittance on sums they had previously expected would finance a pleasant retirement."
Since then the S&P 500 has roughly tripled. The extreme volatility that occurred during that time was more opportunity than risk.
So, unfortunately, due to the "fear of meaningless price volatility, these investors could have assured themselves of a good income for life by simply buying a very low-cost index fund whose dividends would trend upward over the years and whose principal would grow as well (with many ups and downs, to be sure).
Investors, of course, can, by their own behavior, make stock ownership highly risky. And many do. Active trading, attempts to 'time' market movements, inadequate diversification, the payment of high and unnecessary fees to managers and advisors, and the use of borrowed money can destroy the decent returns that a life-long owner of equities would otherwise enjoy."
Charlie Munger once pointed out that some of this comes down to temperament:
"A lot of people with high IQs are terrible investors because they've got terrible temperaments."
In the letter Buffett goes on to say:
"Anything can happen anytime in markets. And no advisor, economist, or TV commentator – and definitely not Charlie nor I – can tell you when chaos will occur. Market forecasters will fill your ear but will never fill your wallet.
The commission of the investment sins listed above is not limited to 'the little guy.' Huge institutional investors, viewed as a group, have long underperformed the unsophisticated index-fund investor who simply sits tight for decades. A major reason has been fees: Many institutions pay substantial sums to consultants who, in turn, recommend high-fee managers. And that is a fool's game."
Some investment pros are naturally very capable but Buffett points out it's tough to know, at least in the near-term, "whether a great record is due to luck or talent."
He also says that professional advisors mostly "are far better at generating high fees than they are at generating high returns. In truth, their core competence is salesmanship. Rather than listen to their siren songs, investors – large and small – should instead read Jack Bogle's The Little Book of Common Sense Investing."
Buffett then refers to the Shakespeare quote included at the beginning of this post.
Those who trade frequently, try to be clever about market timing, diversify insufficiently (with the right amount being necessarily unique for each investor), incur lots of frictional costs, and use leverage to purchase equities shouldn't be surprised if they end up with a rather not so great outcome.
The ability to recognize where one's own behavior and limitations might get in the way of satisfactory (or better) returns can be a big advantage.
I'd add that choosing to make a specific investment based upon what someone else thinks is asking for trouble.
As Buffett says: "Anything can happen anytime..."
Well, if prices decline, it will be tough to hang in there (assuming hanging in there makes sense longer term) when an investment isn't truly well understood. Intrinsic worth, within a narrow range, has to be clear to the investor well before the market storm clouds arrive.
When price action goes south, who can maintain a justifiably positive view about something if it's been purchased based upon what someone else thinks? Real conviction in an investment comes from doing the necessary work then reaching one's own (hopefully sensible) conclusions. Listening to others is a recipe for inopportune selling.
Most investments -- even the one's that are very sound -- inevitably require that lots of warranted conviction will be needed from time to time.
Adam
Long position in BRKb established at much lower prices
Related posts:
Stocks and Risk
Munger on Focus Investing
Buffett on Risk and Reward
* The excerpts from the letter included in this post can be found on pages 18 and 19.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Warren Buffett, in his latest Berkshire Hathaway (BRKa) letter to shareholders*, explained the consequences of volatility being viewed, mistakenly, as a meaningful indication of risk.
In fact, he writes that such a view can "ironically" cause the investor to "end up doing some very risky things."
Buffett then adds to remember "the pundits who six years ago bemoaned fall stock prices and advised investing in 'safe' Treasury bills or bank certificates of deposit. People who heeded this sermon are now earning a pittance on sums they had previously expected would finance a pleasant retirement."
Since then the S&P 500 has roughly tripled. The extreme volatility that occurred during that time was more opportunity than risk.
So, unfortunately, due to the "fear of meaningless price volatility, these investors could have assured themselves of a good income for life by simply buying a very low-cost index fund whose dividends would trend upward over the years and whose principal would grow as well (with many ups and downs, to be sure).
Investors, of course, can, by their own behavior, make stock ownership highly risky. And many do. Active trading, attempts to 'time' market movements, inadequate diversification, the payment of high and unnecessary fees to managers and advisors, and the use of borrowed money can destroy the decent returns that a life-long owner of equities would otherwise enjoy."
Charlie Munger once pointed out that some of this comes down to temperament:
"A lot of people with high IQs are terrible investors because they've got terrible temperaments."
In the letter Buffett goes on to say:
"Anything can happen anytime in markets. And no advisor, economist, or TV commentator – and definitely not Charlie nor I – can tell you when chaos will occur. Market forecasters will fill your ear but will never fill your wallet.
The commission of the investment sins listed above is not limited to 'the little guy.' Huge institutional investors, viewed as a group, have long underperformed the unsophisticated index-fund investor who simply sits tight for decades. A major reason has been fees: Many institutions pay substantial sums to consultants who, in turn, recommend high-fee managers. And that is a fool's game."
Some investment pros are naturally very capable but Buffett points out it's tough to know, at least in the near-term, "whether a great record is due to luck or talent."
He also says that professional advisors mostly "are far better at generating high fees than they are at generating high returns. In truth, their core competence is salesmanship. Rather than listen to their siren songs, investors – large and small – should instead read Jack Bogle's The Little Book of Common Sense Investing."
Buffett then refers to the Shakespeare quote included at the beginning of this post.
Those who trade frequently, try to be clever about market timing, diversify insufficiently (with the right amount being necessarily unique for each investor), incur lots of frictional costs, and use leverage to purchase equities shouldn't be surprised if they end up with a rather not so great outcome.
The ability to recognize where one's own behavior and limitations might get in the way of satisfactory (or better) returns can be a big advantage.
I'd add that choosing to make a specific investment based upon what someone else thinks is asking for trouble.
As Buffett says: "Anything can happen anytime..."
Well, if prices decline, it will be tough to hang in there (assuming hanging in there makes sense longer term) when an investment isn't truly well understood. Intrinsic worth, within a narrow range, has to be clear to the investor well before the market storm clouds arrive.
When price action goes south, who can maintain a justifiably positive view about something if it's been purchased based upon what someone else thinks? Real conviction in an investment comes from doing the necessary work then reaching one's own (hopefully sensible) conclusions. Listening to others is a recipe for inopportune selling.
Most investments -- even the one's that are very sound -- inevitably require that lots of warranted conviction will be needed from time to time.
Adam
Long position in BRKb established at much lower prices
Related posts:
Stocks and Risk
Munger on Focus Investing
Buffett on Risk and Reward
* The excerpts from the letter included in this post can be found on pages 18 and 19.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Wednesday, March 4, 2015
Stocks and Risk
From Warren Buffett's most recent Berkshire Hathaway (BRKa) shareholder letter:*
"The unconventional, but inescapable, conclusion to be drawn from the past fifty years is that it has been far safer to invest in a diversified collection of American businesses than to invest in securities – Treasuries, for example – whose values have been tied to American currency. That was also true in the preceding half-century, a period including the Great Depression and two world wars. Investors should heed this history. To one degree or another it is almost certain to be repeated during the next century.
Stock prices will always be far more volatile than cash-equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments – far riskier investments – than widely-diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions. That lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray.
It is true, of course, that owning equities for a day or a week or a year is far riskier (in both nominal and purchasing-power terms) than leaving funds in cash equivalents. That is relevant to certain investors – say, investment banks – whose viability can be threatened by declines in asset prices and which might be forced to sell securities during depressed markets. Additionally, any party that might have meaningful near-term needs for funds should keep appropriate sums in Treasuries or insured bank deposits.
For the great majority of investors, however, who can – and should – invest with a multi-decade horizon, quotational declines are unimportant. Their focus should remain fixed on attaining significant gains in purchasing power over their investing lifetime. For them, a diversified equity portfolio, bought over time, will prove far less risky than dollar-based securities."
This isn't simply a minor disagreement with modern finance theory. It's a major one. Modern theory considers the idea that stocks return more than other assets because they are more risky as some kind of fundamental truism.
Warren Buffett is saying that the exact opposite, in some circumstances, can be true in the long run. Consider this the next time someone says more risk must be taken to achieve greater returns and assumes there's always a positive correlation.
More risk = more rewards?
Not exactly.
The whole idea sounds reasonable enough but, well, it's flawed at best.
In fact, the real world provides us something a far more challenging when it comes time to understand risk and its relationship with investment returns.
Howard Marks offered this take in a memo last year:
Howard Marks on Risk
"We hear it all the time: 'Riskier investments produce higher returns' and 'If you want to make more money, take more risk.'
Both of these formulations are terrible. In brief, if riskier investments could be counted on to produce higher returns, they wouldn't be riskier."
A chart on page 6 of the memo by Marks presents risk and return the traditional way (with risk and return positively correlated). A second chart on the same page explains the relationship between risk and reward in a way that, to me, much more closely represents the world as it is. As far as I'm concerned it's a much more useful and correct depiction of risk and return.
How often do investors, whether it's explicit or not, assume incremental risk is required to generate incremental returns?
This assumption is a rather costly one for too many market participants. Near-term volatility -- as measured by beta -- just isn't very likely to reveal much about the long-term risks and potential returns of an investment (despite what finance theory suggests).** It'd be nice if understanding long-term investment risk came down to a single number. Unfortunately, making judgments about risk is necessarily imprecise and tough to quantify.
Those who choose to invest based upon some torched version of reality aren't likely to produce satisfactory investment outcomes.
Contending with all the illusions, biases, and fallacies -- among other things -- already makes investing well tough enough to do consistently well. So, wherever possible, it's essential to eliminate any distraction that might be caused by plainly flawed models.
Cash for near-term needs is essential. Funds needed in the next few years (and maybe even somewhat longer) should never be in stocks. Yet cash also has the lowest possible volatility -- so theory says it shouldn't be risky -- but the long-term risk ends up being not at all small.
A diversified basket of stocks bought with funds needed in the near-term and even intermediate-term is, of course, much riskier than cash.
Sometimes risk and reward must correlate in a positive manner.
It just need not necessarily be the case with a long enough time horizon.
Owning a portfolio of fine businesses long-term -- the only appropriate time horizon for equities -- allows risk to become much reduced.
Fortunately, many convenient low cost ways exist to obtain partial ownership of a diversified basket of businesses.
Whether mutual funds (incl. ETFs) or individual stocks is the right way to go naturally depends on the investor.
Adam
Long position in BRKb established at much lower than recent market prices
Related posts:
-Quality Stocks & the Risk-Return Tradeoff
-Howard Marks on Risk
-Grantham on Efficient Markets, Bubbles, and Ignoble Prizes
-Efficient Markets - Part II
-Risk and Reward Revisited
-Efficient Markets
-Modern Portfolio Theory, Efficient Markets, and the Flat Earth Revisited
-Buffett on Risk and Reward
-Buffett: Why Stocks Beat Bonds
-Beta, Risk, & the Inconvenient Real World Special Case
-Howard Marks: The Two Main Risks in the Investment World
-Black-Scholes and the Flat Earth Society
-Buffett: Indebted to Academics
-Friends & Romans
-Superinvestors: Galileo vs The Flat Earth
-Max Planck: Resistance of the Human Mind
* See page 18.
** According to the capital asset pricing model (CAPM), for example, highly volatile stocks should produce higher returns than the less volatile stocks to compensate investors for the additional risk. CAPM is a one factor model. In this model beta is the measure of volatility and is supposed to (somehow) represent risk. Well, the estimation of risk is necessarily qualitative and can't be captured by a single factor like beta. The Fama and French three factor model adds two additional factors. Others might find this stuff useful. I find none of it to be. Pure distraction.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
"The unconventional, but inescapable, conclusion to be drawn from the past fifty years is that it has been far safer to invest in a diversified collection of American businesses than to invest in securities – Treasuries, for example – whose values have been tied to American currency. That was also true in the preceding half-century, a period including the Great Depression and two world wars. Investors should heed this history. To one degree or another it is almost certain to be repeated during the next century.
Stock prices will always be far more volatile than cash-equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments – far riskier investments – than widely-diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions. That lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray.
It is true, of course, that owning equities for a day or a week or a year is far riskier (in both nominal and purchasing-power terms) than leaving funds in cash equivalents. That is relevant to certain investors – say, investment banks – whose viability can be threatened by declines in asset prices and which might be forced to sell securities during depressed markets. Additionally, any party that might have meaningful near-term needs for funds should keep appropriate sums in Treasuries or insured bank deposits.
For the great majority of investors, however, who can – and should – invest with a multi-decade horizon, quotational declines are unimportant. Their focus should remain fixed on attaining significant gains in purchasing power over their investing lifetime. For them, a diversified equity portfolio, bought over time, will prove far less risky than dollar-based securities."
This isn't simply a minor disagreement with modern finance theory. It's a major one. Modern theory considers the idea that stocks return more than other assets because they are more risky as some kind of fundamental truism.
Warren Buffett is saying that the exact opposite, in some circumstances, can be true in the long run. Consider this the next time someone says more risk must be taken to achieve greater returns and assumes there's always a positive correlation.
More risk = more rewards?
Not exactly.
The whole idea sounds reasonable enough but, well, it's flawed at best.
Howard Marks offered this take in a memo last year:
Howard Marks on Risk
"We hear it all the time: 'Riskier investments produce higher returns' and 'If you want to make more money, take more risk.'
Both of these formulations are terrible. In brief, if riskier investments could be counted on to produce higher returns, they wouldn't be riskier."
A chart on page 6 of the memo by Marks presents risk and return the traditional way (with risk and return positively correlated). A second chart on the same page explains the relationship between risk and reward in a way that, to me, much more closely represents the world as it is. As far as I'm concerned it's a much more useful and correct depiction of risk and return.
How often do investors, whether it's explicit or not, assume incremental risk is required to generate incremental returns?
This assumption is a rather costly one for too many market participants. Near-term volatility -- as measured by beta -- just isn't very likely to reveal much about the long-term risks and potential returns of an investment (despite what finance theory suggests).** It'd be nice if understanding long-term investment risk came down to a single number. Unfortunately, making judgments about risk is necessarily imprecise and tough to quantify.
Those who choose to invest based upon some torched version of reality aren't likely to produce satisfactory investment outcomes.
Contending with all the illusions, biases, and fallacies -- among other things -- already makes investing well tough enough to do consistently well. So, wherever possible, it's essential to eliminate any distraction that might be caused by plainly flawed models.
Cash for near-term needs is essential. Funds needed in the next few years (and maybe even somewhat longer) should never be in stocks. Yet cash also has the lowest possible volatility -- so theory says it shouldn't be risky -- but the long-term risk ends up being not at all small.
A diversified basket of stocks bought with funds needed in the near-term and even intermediate-term is, of course, much riskier than cash.
Sometimes risk and reward must correlate in a positive manner.
It just need not necessarily be the case with a long enough time horizon.
Owning a portfolio of fine businesses long-term -- the only appropriate time horizon for equities -- allows risk to become much reduced.
Fortunately, many convenient low cost ways exist to obtain partial ownership of a diversified basket of businesses.
Whether mutual funds (incl. ETFs) or individual stocks is the right way to go naturally depends on the investor.
Adam
Long position in BRKb established at much lower than recent market prices
Related posts:
-Quality Stocks & the Risk-Return Tradeoff
-Howard Marks on Risk
-Grantham on Efficient Markets, Bubbles, and Ignoble Prizes
-Efficient Markets - Part II
-Risk and Reward Revisited
-Efficient Markets
-Modern Portfolio Theory, Efficient Markets, and the Flat Earth Revisited
-Buffett on Risk and Reward
-Buffett: Why Stocks Beat Bonds
-Beta, Risk, & the Inconvenient Real World Special Case
-Howard Marks: The Two Main Risks in the Investment World
-Black-Scholes and the Flat Earth Society
-Buffett: Indebted to Academics
-Friends & Romans
-Superinvestors: Galileo vs The Flat Earth
-Max Planck: Resistance of the Human Mind
* See page 18.
** According to the capital asset pricing model (CAPM), for example, highly volatile stocks should produce higher returns than the less volatile stocks to compensate investors for the additional risk. CAPM is a one factor model. In this model beta is the measure of volatility and is supposed to (somehow) represent risk. Well, the estimation of risk is necessarily qualitative and can't be captured by a single factor like beta. The Fama and French three factor model adds two additional factors. Others might find this stuff useful. I find none of it to be. Pure distraction.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Wednesday, February 25, 2015
John Bogle on Investor Returns
Some things of note from a recent Vanguard study that's cited here by John Bogle:
- 90% of investors in traditional index funds are long-term holders, while only 80% of investors in ETFs are long-term holders.
- Investor returns in traditional index funds lag the returns of the funds by 150 basis points.
- Investor returns in ETFs lag the returns of the funds by 250 basis points.
Active Managers Losing Ground Can Thank John Bogle
So, in both cases, investor results are subpar compared to the funds and those who are less long-term oriented end up lagging by a greater amount. It's investor behavior that's mostly behind the reduced returns. The ongoing attempts to be in or out at the right time based upon market conditions ends up, too often, just subtracting from results. In other words, some variation of buying when the world seems less uncertain (when stocks are more likely to not be cheap or even expensive) and selling when the world seems more uncertain (when stocks are usually most attractive in terms of risk and reward). That's a tough way to get satisfactory results when this pattern of behavior is repeated over a longer time horizon. Lots of additional effort; less than satisfactory returns. A more consistent approach along with ignoring most of the noise would have yielded better results. Essentially, it's Newton's Fourth Law. The world inevitably swings from what appear to be favorable investing environments to those that appear much less so.
Market participants respond to these changing environments to an extent in a calculated way (efficient market adherents certainly tend to think so), but also to a significant extent based upon psychological and other factors.*
Cognitive biases and emotions can dictate price action in the shorter run.
Being among the not so large group that, over the long haul, can produce results that exceed a broad-based market index is easier said. It seems improbable that recognition of this reality will change behavior all that much. Instead, plenty of active market participants will continue trying to be in or out of a particular fund (or stock) at or near just the right time -- in an attempt to outperform -- despite the near futility of acting in such a way.**
Reduced activity can be a big advantage with a sensible portfolio -- built with specific limits and circumstances in mind -- that's purchased steadily over time.
Fear and greed -- or, more generally, the fact that participants can be less than than cold and rational especially in large groups -- isn't going to stop having a big influence on investor behavior anytime soon.
Assets get mispriced -- anywhere from big premiums to big discounts -- but this only becomes obvious to the vast majority of participants after the fact.
It's not that no one can time things correctly. No doubt there are exceptions who can do just that sort of thing. It's that, apparently, too many are overconfident that they'll be able to do so.
(At least based on the fact that most actively managed equity funds can't match the performance of an index fund.)
Bogle describes some of the more specialized ETFs -- those that are niche products and sometimes use leverage -- as the "fruit and nutcake fringe" and says that they are "poision for investors."
He also mentions the following:
- The SPDR turns over 7,000% each year. For perspective, he considers 3% to be stretching the limits of what makes sense.
- When it comes to the experts who think they can advise someone to be in a particular sector at the right time:
"Advisers or whoever saying you should get out of healthcare and into technology or into financials. That's a way to manage money that doesn't work. Who knows what will do best? I don't even know anybody who knows anybody who does." - John Bogle
What matters naturally is what the companies themselves produce in terms of excess cash per share -- the main driver of intrinsic value -- over time. It's the compounded effect of increased earnings that are at least mostly put to reasonably good use (incl. dividends and buybacks).
Multiples will expand and contract, but a good investment result shouldn't depend on a getting a great price when it comes time to sell.***
Of course, those who get a chance to buy something unusually cheap, hang in there for a very long time, can gain a big advantage if they're able to sell years down the road at a more normalized (or better yet, premium) market valuation.
Consider that possibility a bonus. That's more good fortune than most should count on.
In the end the whole process requires discipline -- incl. an awareness of limitations and acting accordingly within those limitations -- more so than brilliance.
Adam
Related posts:
Buffett's Hedge Fund Bet
John Bogle's "Relentless Rules of Humble Arithmetic", Part II
Index Fund Investing Revisited
Charlie Munger on Complexity, Hedge Funds, and Pension Funds
Why Do So Many Investors Underperform?
When Mutual Funds Outperform Their Investors
John Bogle's "Relentless Rules of Humble Arithmetic"
Investor Overconfidence Revisited
Newton's Fourth Law
Investor Overconfidence
Chasing "Rearview-Mirror Performance"
Index Fund Investing
Investors Are Often Their Own Worst Enemies, Part II
Investors Are Often Their Own Worst Enemies
The Illusion of Skill
Buffett's Bet Against Hedge Funds, Part II
Buffett's Bet Against Hedge Funds
The Illusion of Control
Buffett, Bogle, and the "Invisible Foot" Revisited
If Buffett Were Paid Like a Hedge Fund Manager - Part II
If Buffett Were Paid Like a Hedge Fund Manager
Buffett, Bogle, and the Invisible Foot
Charlie Munger on LTCM & Overconfidence
"Nothing But Costs"
Bogle: History and the Classics
When Genius Failed...Again
* Some efficient market true believers might argue otherwise. Another factor to consider when it comes to what sets near-term prices isn't business fundamentals or psychology but the possibility that a build up of excess leverage in the system (margin) leads to forced selling when the next surprise arrives. Intrinsic values may be mostly unaffected but near-term price action certainly will be.
** Attempts at timing the market or a particular stock has usually been a recipe for poor results caused by unnecessary and costly mistakes. Now, this is very different than buying or selling based upon how price compares to intrinsic value with the emphasis being on margin of safety and long-term effects. For those comfortable valuing stocks (i.e. partial ownership of a business) this can make a whole lot of sense. Otherwise, for those not comfortable valuing stocks, that's where index funds bought periodically come into play. For participants overall the returns can be no more than market returns minus frictional costs. Of course, it's certainly possible that the most active participants will perform better in the future than the past suggests, but some skepticism seems warranted.
*** Whether a basket of stocks via a fund or an individual stock, the changes to per share intrinsic value over the longer haul compared to the price paid upfront should represent a good result even market prices aren't generally selling at a high multiple of then current normalized earnings.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
- 90% of investors in traditional index funds are long-term holders, while only 80% of investors in ETFs are long-term holders.
- Investor returns in traditional index funds lag the returns of the funds by 150 basis points.
- Investor returns in ETFs lag the returns of the funds by 250 basis points.
Active Managers Losing Ground Can Thank John Bogle
So, in both cases, investor results are subpar compared to the funds and those who are less long-term oriented end up lagging by a greater amount. It's investor behavior that's mostly behind the reduced returns. The ongoing attempts to be in or out at the right time based upon market conditions ends up, too often, just subtracting from results. In other words, some variation of buying when the world seems less uncertain (when stocks are more likely to not be cheap or even expensive) and selling when the world seems more uncertain (when stocks are usually most attractive in terms of risk and reward). That's a tough way to get satisfactory results when this pattern of behavior is repeated over a longer time horizon. Lots of additional effort; less than satisfactory returns. A more consistent approach along with ignoring most of the noise would have yielded better results. Essentially, it's Newton's Fourth Law. The world inevitably swings from what appear to be favorable investing environments to those that appear much less so.
Market participants respond to these changing environments to an extent in a calculated way (efficient market adherents certainly tend to think so), but also to a significant extent based upon psychological and other factors.*
Cognitive biases and emotions can dictate price action in the shorter run.
Being among the not so large group that, over the long haul, can produce results that exceed a broad-based market index is easier said. It seems improbable that recognition of this reality will change behavior all that much. Instead, plenty of active market participants will continue trying to be in or out of a particular fund (or stock) at or near just the right time -- in an attempt to outperform -- despite the near futility of acting in such a way.**
Reduced activity can be a big advantage with a sensible portfolio -- built with specific limits and circumstances in mind -- that's purchased steadily over time.
Fear and greed -- or, more generally, the fact that participants can be less than than cold and rational especially in large groups -- isn't going to stop having a big influence on investor behavior anytime soon.
Assets get mispriced -- anywhere from big premiums to big discounts -- but this only becomes obvious to the vast majority of participants after the fact.
It's not that no one can time things correctly. No doubt there are exceptions who can do just that sort of thing. It's that, apparently, too many are overconfident that they'll be able to do so.
(At least based on the fact that most actively managed equity funds can't match the performance of an index fund.)
Bogle describes some of the more specialized ETFs -- those that are niche products and sometimes use leverage -- as the "fruit and nutcake fringe" and says that they are "poision for investors."
He also mentions the following:
- The SPDR turns over 7,000% each year. For perspective, he considers 3% to be stretching the limits of what makes sense.
- When it comes to the experts who think they can advise someone to be in a particular sector at the right time:
"Advisers or whoever saying you should get out of healthcare and into technology or into financials. That's a way to manage money that doesn't work. Who knows what will do best? I don't even know anybody who knows anybody who does." - John Bogle
What matters naturally is what the companies themselves produce in terms of excess cash per share -- the main driver of intrinsic value -- over time. It's the compounded effect of increased earnings that are at least mostly put to reasonably good use (incl. dividends and buybacks).
Multiples will expand and contract, but a good investment result shouldn't depend on a getting a great price when it comes time to sell.***
Of course, those who get a chance to buy something unusually cheap, hang in there for a very long time, can gain a big advantage if they're able to sell years down the road at a more normalized (or better yet, premium) market valuation.
Consider that possibility a bonus. That's more good fortune than most should count on.
In the end the whole process requires discipline -- incl. an awareness of limitations and acting accordingly within those limitations -- more so than brilliance.
Adam
Related posts:
Buffett's Hedge Fund Bet
John Bogle's "Relentless Rules of Humble Arithmetic", Part II
Index Fund Investing Revisited
Charlie Munger on Complexity, Hedge Funds, and Pension Funds
Why Do So Many Investors Underperform?
When Mutual Funds Outperform Their Investors
John Bogle's "Relentless Rules of Humble Arithmetic"
Investor Overconfidence Revisited
Newton's Fourth Law
Investor Overconfidence
Chasing "Rearview-Mirror Performance"
Index Fund Investing
Investors Are Often Their Own Worst Enemies, Part II
Investors Are Often Their Own Worst Enemies
The Illusion of Skill
Buffett's Bet Against Hedge Funds, Part II
Buffett's Bet Against Hedge Funds
The Illusion of Control
Buffett, Bogle, and the "Invisible Foot" Revisited
If Buffett Were Paid Like a Hedge Fund Manager - Part II
If Buffett Were Paid Like a Hedge Fund Manager
Buffett, Bogle, and the Invisible Foot
Charlie Munger on LTCM & Overconfidence
"Nothing But Costs"
Bogle: History and the Classics
When Genius Failed...Again
* Some efficient market true believers might argue otherwise. Another factor to consider when it comes to what sets near-term prices isn't business fundamentals or psychology but the possibility that a build up of excess leverage in the system (margin) leads to forced selling when the next surprise arrives. Intrinsic values may be mostly unaffected but near-term price action certainly will be.
** Attempts at timing the market or a particular stock has usually been a recipe for poor results caused by unnecessary and costly mistakes. Now, this is very different than buying or selling based upon how price compares to intrinsic value with the emphasis being on margin of safety and long-term effects. For those comfortable valuing stocks (i.e. partial ownership of a business) this can make a whole lot of sense. Otherwise, for those not comfortable valuing stocks, that's where index funds bought periodically come into play. For participants overall the returns can be no more than market returns minus frictional costs. Of course, it's certainly possible that the most active participants will perform better in the future than the past suggests, but some skepticism seems warranted.
*** Whether a basket of stocks via a fund or an individual stock, the changes to per share intrinsic value over the longer haul compared to the price paid upfront should represent a good result even market prices aren't generally selling at a high multiple of then current normalized earnings.
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