Last year, we saw a whole bunch of what Bespoke Investment Group calls 'all or nothing days'.*
So how many have there been in 2012?
There have been none according to this recent post.
Where Have The All or Nothing Days Gone?
"In the second half of 2011, 'all or nothing days' in the S&P 500 were practically an every other day occurrence. This year though, they have been non existent."
There were 70 such days last year. To put that in perspective, during the entire decade of the 1990s there was a total of 27.
It's at least worth noting how much daily market price action has changed compared to last year.
The question is whether the kind of price action we saw on a regular basis last year will return anytime soon.
What I find more than mildly interesting is how relevant the following roughly 75 year old quote by John Maynard Keynes remains today.
The quote is from Chapter 12 of The General Theory of Employment, Interest and Money:
"If I may be allowed to appropriate the term speculation for the activity of forecasting the psychology of the market, and the term enterprise for the activity of forecasting the prospective yield of assets over their whole life, it is by no means always the case that speculation predominates over enterprise. As the organisation of investment markets improves, the risk of the predominance of speculation does, however, increase. In one of the greatest investment markets in the world, namely, New York, the influence of speculation (in the above sense) is enormous. Even outside the field of finance, Americans are apt to be unduly interested in discovering what average opinion believes average opinion to be; and this national weakness finds its nemesis in the stock market."
The only difference may be that it now has gone global. A bit later in the chapter, Keynes follows the above with this:
"Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done."
The last sentence, of course, is one of his more well-known quotes.
Personally, I like when all the hyperactivity creates lower stock prices. Having said that, markets do a better job allocating capital if participants generally have a longer investing horizon and view the system as, if not necessarily safe, at least reasonably stable. Overall, it would be better if the extremely volatile and highly correlated price action of last year didn't return.
Unfortunately, I'm guessing at some point it will.
Hyperactive trading in response to the next real or perceived crisis isn't going away anytime soon.
Adam
* Any day when more than 400 stocks in the S&P 500 move in the same direction.
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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.
Thursday, March 8, 2012
Wednesday, March 7, 2012
Buffett: Three Chapters Investors Should Read - Part II
Below are some excerpts from The General Theory of Employment, Interest, and Money by John Maynard Keynes. This is a follow up to yesterday's post on the three chapters* that Warren Buffett has often said investors should read.
To keep the original post from getting too long, I provided only excerpts from chapter 8 and 20 of The Intelligent Investor.
So now here's a couple of excerpts from chapter 12 of The General Theory of Employment, Interest, and Money:
General Theory of Employment, Interest, and Money - Chapter 12
"In former times, when enterprises were mainly owned by those who undertook them or by their friends and associates, investment depended on a sufficient supply of individuals of sanguine temperament and constructive impulses who embarked on business as a way of life, not really relying on a precise calculation of prospective profit. The affair was partly a lottery, though with the ultimate result largely governed by whether the abilities and character of the managers were above or below the average. Some would fail and some would succeed. But even after the event no one would know whether the average results in terms of the sums invested had exceeded, equalled or fallen short of the prevailing rate of interest; though, if we exclude the exploitation of natural resources and monopolies, it is probable that the actual average results of investments, even during periods of progress and prosperity, have disappointed the hopes which prompted them. Business men play a mixed game of skill and chance, the average results of which to the players are not known by those who take a hand. If human nature felt no temptation to take a chance, no satisfaction (profit apart) in constructing a factory, a railway, a mine or a farm, there might not be much investment merely as a result of cold calculation.
Decisions to invest in private business of the old-fashioned type were, however, decisions largely irrevocable, not only for the community as a whole, but also for the individual. With the separation between ownership and management which prevails to-day and with the development of organised investment markets, a new factor of great importance has entered in, which sometimes facilitates investment but sometimes adds greatly to the instability of the system. In the absence of security markets, there is no object in frequently attempting to revalue an investment to which we are committed. But the Stock Exchange revalues many investments every day and the revaluations give a frequent opportunity to the individual (though not to the community as a whole) to revise his commitments. It is as though a farmer, having tapped his barometer after breakfast, could decide to remove his capital from the farming business between 10 and 11 in the morning and reconsider whether he should return to it later in the week."
The convenience and low cost of trading makes it easier than ever to own shares of a business. I mean, could it be more straightforward to gain partial ownership of a good business than via the stock market?
This convenience has huge benefits, of course, but also potentially leads to instability when taken to extremes.
Keynes understood, though it was a very different time, that this creates a dilemma.
Speculative excesses, and the instability that comes with those excesses,are inevitable when markets are extremely liquid. So it may be tempting to try and...
"...force the investor to direct his mind to the long-term prospects and to those only. But a little consideration of this expedient brings us up against a dilemma, and shows us how the liquidity of investment markets often facilitates, though it sometimes impedes, the course of new investment. For the fact that each individual investor flatters himself that his commitment is 'liquid' (though this cannot be true for all investors collectively) calms his nerves and makes him much more willing to run a risk. If individual purchases of investments were rendered illiquid, this might seriously impede new investment, so long as alternative ways in which to hold his savings are available to the individual."
It's a problem that we clearly are still struggling with to this day. Throttling speculative tendencies doesn't come without costs. Getting the right balance, not easy. I wonder if Keynes could imagine speculation would go the extremes we see today.
Obviously, what happened in 1929 obviously wasn't far from the mind of John Maynard Keynes when he wrote the above.
Adam
* Those three chapters are 8 and 20 of The Intelligent Investor (Benjamin Graham, 1949) and chapter 12 of The General Theory of Employment, Interest, and Money (John Maynard Keynes, 1936).
-Chapter 8 in Graham's The Intelligent Investor is "The Investor and Market Fluctuations."
-Chapter 20 in Graham's The Intelligent Investor is "Margin of Safety as the Central Concept of Investment." -Chapter 12 in Keynes' General Theory is "The State of Long-Term Expectation."
---
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 are never a recommendation to buy or sell anything.
To keep the original post from getting too long, I provided only excerpts from chapter 8 and 20 of The Intelligent Investor.
So now here's a couple of excerpts from chapter 12 of The General Theory of Employment, Interest, and Money:
General Theory of Employment, Interest, and Money - Chapter 12
"In former times, when enterprises were mainly owned by those who undertook them or by their friends and associates, investment depended on a sufficient supply of individuals of sanguine temperament and constructive impulses who embarked on business as a way of life, not really relying on a precise calculation of prospective profit. The affair was partly a lottery, though with the ultimate result largely governed by whether the abilities and character of the managers were above or below the average. Some would fail and some would succeed. But even after the event no one would know whether the average results in terms of the sums invested had exceeded, equalled or fallen short of the prevailing rate of interest; though, if we exclude the exploitation of natural resources and monopolies, it is probable that the actual average results of investments, even during periods of progress and prosperity, have disappointed the hopes which prompted them. Business men play a mixed game of skill and chance, the average results of which to the players are not known by those who take a hand. If human nature felt no temptation to take a chance, no satisfaction (profit apart) in constructing a factory, a railway, a mine or a farm, there might not be much investment merely as a result of cold calculation.
Decisions to invest in private business of the old-fashioned type were, however, decisions largely irrevocable, not only for the community as a whole, but also for the individual. With the separation between ownership and management which prevails to-day and with the development of organised investment markets, a new factor of great importance has entered in, which sometimes facilitates investment but sometimes adds greatly to the instability of the system. In the absence of security markets, there is no object in frequently attempting to revalue an investment to which we are committed. But the Stock Exchange revalues many investments every day and the revaluations give a frequent opportunity to the individual (though not to the community as a whole) to revise his commitments. It is as though a farmer, having tapped his barometer after breakfast, could decide to remove his capital from the farming business between 10 and 11 in the morning and reconsider whether he should return to it later in the week."
The convenience and low cost of trading makes it easier than ever to own shares of a business. I mean, could it be more straightforward to gain partial ownership of a good business than via the stock market?
This convenience has huge benefits, of course, but also potentially leads to instability when taken to extremes.
Keynes understood, though it was a very different time, that this creates a dilemma.
Speculative excesses, and the instability that comes with those excesses,are inevitable when markets are extremely liquid. So it may be tempting to try and...
"...force the investor to direct his mind to the long-term prospects and to those only. But a little consideration of this expedient brings us up against a dilemma, and shows us how the liquidity of investment markets often facilitates, though it sometimes impedes, the course of new investment. For the fact that each individual investor flatters himself that his commitment is 'liquid' (though this cannot be true for all investors collectively) calms his nerves and makes him much more willing to run a risk. If individual purchases of investments were rendered illiquid, this might seriously impede new investment, so long as alternative ways in which to hold his savings are available to the individual."
It's a problem that we clearly are still struggling with to this day. Throttling speculative tendencies doesn't come without costs. Getting the right balance, not easy. I wonder if Keynes could imagine speculation would go the extremes we see today.
Obviously, what happened in 1929 obviously wasn't far from the mind of John Maynard Keynes when he wrote the above.
Adam
* Those three chapters are 8 and 20 of The Intelligent Investor (Benjamin Graham, 1949) and chapter 12 of The General Theory of Employment, Interest, and Money (John Maynard Keynes, 1936).
-Chapter 8 in Graham's The Intelligent Investor is "The Investor and Market Fluctuations."
-Chapter 20 in Graham's The Intelligent Investor is "Margin of Safety as the Central Concept of Investment." -Chapter 12 in Keynes' General Theory is "The State of Long-Term Expectation."
---
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 are never a recommendation to buy or sell anything.
Tuesday, March 6, 2012
Buffett: Three Chapters Investors Should Read
Over the years, Warren Buffett has been pretty clear that he thinks there are three chapters investors should read and understand.
Those three chapters are 8 and 20 of The Intelligent Investor and chapter 12 of The General Theory of Employment, Interest, and Money.
The Intelligent Investor
The General Theory of Employment, Interest, and Money
In a November 2011 interview with Business Wire CEO Cathy Baron Tamraz, Buffett said the following about the chapters:
"If you understand chapters 8 and 20 of The Intelligent Investor (Benjamin Graham, 1949) and chapter 12 of the General Theory (John Maynard Keynes, 1936), you don't need to read anything else and you can turn off your TV," Buffett said.
Some excerpts from the two chapters in The Intelligent Investor.
The Intelligent Investor - Chapter 8
"Imagine that in some private business you own a small share that cost you $1,000. One of your partners, named Mr. Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis. Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly.
If you are a prudent investor or a sensible businessman, will you let Mr. Market's daily communication determine your view of the value of a $1,000 interest in the enterprise? Only in case you agree with him, or in case you want to trade with him. You may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low. But the rest of the time you will be wiser to form your own ideas of the value of your holdings, based on full reports from the company about its operations and financial position.
The true investor is in that very position when he owns a listed common stock. He can take advantage of the daily market price or leave it alone, as dictated by his own judgment and inclination. He must take cognizance of important price movements, for otherwise his judgment will have nothing to work on. Conceivably they may give him a warning signal which he will do well to heed—this in plain English means that he is to sell his shares because the price has gone down, foreboding worse things to come. In our view such signals are misleading at least as often as they are helpful. Basically, price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies."
The Intelligent Investor - Chapter 20
"In the old legend the wise men finally boiled down the history of mortal affairs into the single phrase, 'This too will pass'. Confronted with a like challenge to distill the secret of sound investment into three words, we venture the motto, MARGIN OF SAFETY."
The above is how Graham began the chapter. Later he added...
"The margin-of-safety idea becomes much more evident when we apply it to the field of undervalued or bargain securities. We have here, by definition, a favorable difference between price on the one hand and indicated or appraised value on the other. That difference is the safety margin. It is available for absorbing the effect of miscalculations or worse than average luck. The buyer of bargain issues places particular emphasis on the ability of the investment to withstand adverse developments. For in most such cases he has no real enthusiasm about the company's prospects. True, if the prospects are definitely bad the investor will prefer to avoid the security no matter how low the price. But the field of undervalued issues is drawn from the many concerns—perhaps a majority of the total—for which the future appears neither distinctly promising nor distinctly unpromising. If these are bought on a bargain basis, even a moderate decline in the earning power need not prevent the investment from showing satisfactory results. The margin of safety will then have served its proper purpose."
If you've been following Buffett for a while these ideas are certainly familiar but the full chapters are still worth checking out.
I'll follow this post up with an excerpt from chapter 12 of The General Theory of Employment, Interest, and Money.
Adam
Related post:
Buffett: Three Chapters Investors Should Read - Part II
---
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 are never a recommendation to buy or sell anything.
Those three chapters are 8 and 20 of The Intelligent Investor and chapter 12 of The General Theory of Employment, Interest, and Money.
The Intelligent Investor
The General Theory of Employment, Interest, and Money
In a November 2011 interview with Business Wire CEO Cathy Baron Tamraz, Buffett said the following about the chapters:
"If you understand chapters 8 and 20 of The Intelligent Investor (Benjamin Graham, 1949) and chapter 12 of the General Theory (John Maynard Keynes, 1936), you don't need to read anything else and you can turn off your TV," Buffett said.
Some excerpts from the two chapters in The Intelligent Investor.
The Intelligent Investor - Chapter 8
"Imagine that in some private business you own a small share that cost you $1,000. One of your partners, named Mr. Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis. Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly.
If you are a prudent investor or a sensible businessman, will you let Mr. Market's daily communication determine your view of the value of a $1,000 interest in the enterprise? Only in case you agree with him, or in case you want to trade with him. You may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low. But the rest of the time you will be wiser to form your own ideas of the value of your holdings, based on full reports from the company about its operations and financial position.
The true investor is in that very position when he owns a listed common stock. He can take advantage of the daily market price or leave it alone, as dictated by his own judgment and inclination. He must take cognizance of important price movements, for otherwise his judgment will have nothing to work on. Conceivably they may give him a warning signal which he will do well to heed—this in plain English means that he is to sell his shares because the price has gone down, foreboding worse things to come. In our view such signals are misleading at least as often as they are helpful. Basically, price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies."
The Intelligent Investor - Chapter 20
"In the old legend the wise men finally boiled down the history of mortal affairs into the single phrase, 'This too will pass'. Confronted with a like challenge to distill the secret of sound investment into three words, we venture the motto, MARGIN OF SAFETY."
The above is how Graham began the chapter. Later he added...
"The margin-of-safety idea becomes much more evident when we apply it to the field of undervalued or bargain securities. We have here, by definition, a favorable difference between price on the one hand and indicated or appraised value on the other. That difference is the safety margin. It is available for absorbing the effect of miscalculations or worse than average luck. The buyer of bargain issues places particular emphasis on the ability of the investment to withstand adverse developments. For in most such cases he has no real enthusiasm about the company's prospects. True, if the prospects are definitely bad the investor will prefer to avoid the security no matter how low the price. But the field of undervalued issues is drawn from the many concerns—perhaps a majority of the total—for which the future appears neither distinctly promising nor distinctly unpromising. If these are bought on a bargain basis, even a moderate decline in the earning power need not prevent the investment from showing satisfactory results. The margin of safety will then have served its proper purpose."
If you've been following Buffett for a while these ideas are certainly familiar but the full chapters are still worth checking out.
I'll follow this post up with an excerpt from chapter 12 of The General Theory of Employment, Interest, and Money.
Adam
Related post:
Buffett: Three Chapters Investors Should Read - Part II
---
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 are never a recommendation to buy or sell anything.
Monday, March 5, 2012
Wells Fargo Plans Global Expansion
Unlike some of the other large U.S. banks, Wells Fargo (WFC) doesn't have much of an international presence.
Only 2% of the Wells Fargo staff is located outside the United States.
It looks like they're seeing an opportunity to change that.
This Financial Times article that was posted on CNBC's website said Wells Fargo has plans to build its international operations.
The article points out that Wells Fargo picked up a network of international offices via the Wachovia acquisition, but up to now has done much with them.
The reason seems simple enough.
Wachovia was a very large acquisition (Wells Fargo's assets were more than doubled) and was acquired during a troubling time (for Wachovia and the system as a whole) to say the least. So the focus has been on transforming Wachovia's substantial operations into the Wells Fargo way of doing business. Naturally, executing such a large integration takes priority over other things and, if nothing else, takes time.
This recent Forbes article explores some of the things that seems to separate Wells from other big banks.
The Bank That Works
The article describes how the former CEO Dick Kovacevich influenced Wells Fargo's culture and developed its approach to banking:
...Kovacevich is credited with developing the bank's obsession with cross-selling products to its customers. He viewed banking as a commodity business and preferred to compare Wells Fargo to merchants like Wal-Mart or Lowe's rather than Citigroup or Goldman Sachs.
His vision was that service and salesmanship would win the day and that the key to success would be to tear down the silos so cross-selling would flourish.
According to the article, John Stumpf, the current CEO of Wells Fargo, thinks about growing successfully in the following way:
First, earn more business from your current customers. Second, attract customers from your competitors. Or third, buy another company. If you can't do the first, what makes you think you can earn more business from your competitors' customers or from customers you buy through acquisition?
It's tough to know specifically what separates Wells Fargo from other banks. Much of it seems to come from differences in their banking culture and, maybe as a direct result, a superior ability to cross-sell though there is likely much more to it than that.
Whatever it is, they sure don't want competitors to really understand it.
He'd [Stumpf] as soon reveal his methods as Coke would the ingredients of its syrup.
What's easier to see is that they've consistently produces higher returns with what seems less risk and complexity than peers.
Whether the international expansion makes a big difference in the near term or not, I wouldn't bet against long-term success.
It's also worth noting that Wells has been recently acquiring assets from banks that are under pressure to shrink their balance sheets.
Adam
Long position in WFC established at lower than recent market prices
---
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.
Only 2% of the Wells Fargo staff is located outside the United States.
It looks like they're seeing an opportunity to change that.
This Financial Times article that was posted on CNBC's website said Wells Fargo has plans to build its international operations.
The article points out that Wells Fargo picked up a network of international offices via the Wachovia acquisition, but up to now has done much with them.
The reason seems simple enough.
Wachovia was a very large acquisition (Wells Fargo's assets were more than doubled) and was acquired during a troubling time (for Wachovia and the system as a whole) to say the least. So the focus has been on transforming Wachovia's substantial operations into the Wells Fargo way of doing business. Naturally, executing such a large integration takes priority over other things and, if nothing else, takes time.
This recent Forbes article explores some of the things that seems to separate Wells from other big banks.
The Bank That Works
The article describes how the former CEO Dick Kovacevich influenced Wells Fargo's culture and developed its approach to banking:
...Kovacevich is credited with developing the bank's obsession with cross-selling products to its customers. He viewed banking as a commodity business and preferred to compare Wells Fargo to merchants like Wal-Mart or Lowe's rather than Citigroup or Goldman Sachs.
His vision was that service and salesmanship would win the day and that the key to success would be to tear down the silos so cross-selling would flourish.
According to the article, John Stumpf, the current CEO of Wells Fargo, thinks about growing successfully in the following way:
First, earn more business from your current customers. Second, attract customers from your competitors. Or third, buy another company. If you can't do the first, what makes you think you can earn more business from your competitors' customers or from customers you buy through acquisition?
It's tough to know specifically what separates Wells Fargo from other banks. Much of it seems to come from differences in their banking culture and, maybe as a direct result, a superior ability to cross-sell though there is likely much more to it than that.
Whatever it is, they sure don't want competitors to really understand it.
He'd [Stumpf] as soon reveal his methods as Coke would the ingredients of its syrup.
What's easier to see is that they've consistently produces higher returns with what seems less risk and complexity than peers.
Whether the international expansion makes a big difference in the near term or not, I wouldn't bet against long-term success.
It's also worth noting that Wells has been recently acquiring assets from banks that are under pressure to shrink their balance sheets.
Adam
Long position in WFC established at lower than recent market prices
---
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.
Friday, March 2, 2012
Buffett on BNSF
From Warren Buffett's latest Berkshire Hathaway (BRKa) shareholder letter:
Measured by ton-miles, rail moves 42% of America’s inter-city freight, and BNSF moves more than any other railroad – about 37% of the industry total.
Buffett added that BNSF must maintain and improve 23,000 miles of track, 13,000 plus bridges/tunnels, nearly 6,900 locomotives, and 78,600 freight cars in all economic environments.
Obviously, operating a railroad requires no small amount of capital year after year just to remain competitive. Hopefully that capital can be put to use in a way that also generates acceptable returns for shareholders.
It's more than a decent business, at least it is these days, but far from ideal.
Buffett continued later by saying...
To fulfill its societal obligation, BNSF regularly invests far more than its depreciation charge, with the excess amounting to $1.8 billion in 2011. The three other major U.S. railroads are making similar outlays. Though many people decry our country’s inadequate infrastructure spending, that criticism cannot be levied against the railroad industry. It is pouring money – funds from the private sector – into the investment projects needed to provide better and more extensive service in the future. If railroads were not making these huge expenditures, our country’s publicly-financed highway system would face even greater congestion and maintenance problems than exist today.
Massive investments of the sort that BNSF is making would be foolish if it could not earn appropriate returns on the incremental sums it commits. But I am confident it will do so because of the value it delivers. Many years ago Ben Franklin counseled, "Keep thy shop, and thy shop will keep thee."
The railroad business, at least in the U.S., is far better than it has been historically but that's not saying much. Changes in industry structure and the competitive landscape over time has made them more attractive.
In their current form, they're fine long-term investments but far from being among the best in my view.
BNSF did earn just under $ 3 billion after tax last year and that's likely to grow nicely. Profitability like that would be more attractive if it didn't require so much incremental capital each year. The inherent capital-intensiveness means BNSF is likely only capable of delivering solid but far from spectacular returns going forward.
BNSF certainly adds substantial societal value and is a solid investment but there are better businesses to own.
It would be nice if the things that add the most societal value were also the things that produced the highest returns for shareholders. Unfortunately, that's not the case.
Adam
Long position in BRKb established at lower prices
---
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.
Measured by ton-miles, rail moves 42% of America’s inter-city freight, and BNSF moves more than any other railroad – about 37% of the industry total.
Buffett added that BNSF must maintain and improve 23,000 miles of track, 13,000 plus bridges/tunnels, nearly 6,900 locomotives, and 78,600 freight cars in all economic environments.
Obviously, operating a railroad requires no small amount of capital year after year just to remain competitive. Hopefully that capital can be put to use in a way that also generates acceptable returns for shareholders.
It's more than a decent business, at least it is these days, but far from ideal.
Buffett continued later by saying...
To fulfill its societal obligation, BNSF regularly invests far more than its depreciation charge, with the excess amounting to $1.8 billion in 2011. The three other major U.S. railroads are making similar outlays. Though many people decry our country’s inadequate infrastructure spending, that criticism cannot be levied against the railroad industry. It is pouring money – funds from the private sector – into the investment projects needed to provide better and more extensive service in the future. If railroads were not making these huge expenditures, our country’s publicly-financed highway system would face even greater congestion and maintenance problems than exist today.
Massive investments of the sort that BNSF is making would be foolish if it could not earn appropriate returns on the incremental sums it commits. But I am confident it will do so because of the value it delivers. Many years ago Ben Franklin counseled, "Keep thy shop, and thy shop will keep thee."
The railroad business, at least in the U.S., is far better than it has been historically but that's not saying much. Changes in industry structure and the competitive landscape over time has made them more attractive.
In their current form, they're fine long-term investments but far from being among the best in my view.
BNSF did earn just under $ 3 billion after tax last year and that's likely to grow nicely. Profitability like that would be more attractive if it didn't require so much incremental capital each year. The inherent capital-intensiveness means BNSF is likely only capable of delivering solid but far from spectacular returns going forward.
BNSF certainly adds substantial societal value and is a solid investment but there are better businesses to own.
It would be nice if the things that add the most societal value were also the things that produced the highest returns for shareholders. Unfortunately, that's not the case.
Adam
Long position in BRKb established at lower prices
---
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.
Thursday, March 1, 2012
Six Stock Portfolio Performance
It has now been a little less than three years since I first mentioned the Six Stock Portfolio. At that time, I considered those stocks attractive long-term investments, at the then-prevailing price levels, for my own portfolio.*
At the time, I felt the share price of each represented a very nice discount to likely intrinsic value a few years out and said as much. No estimate of value can be perfect, of course, but each seemed oddly cheap back then compared to even the most conservative estimate of their intrinsic worth.
Some are still at a discount to my judgment of their value, but not by enough to warrant buying more shares. To me, the margin of safety is now insufficient.
Some are still at a discount to my judgment of their value, but not by enough to warrant buying more shares. To me, the margin of safety is now insufficient.
As a group, the six stocks have a bit more than doubled in price since they were first mentioned.
Stock |4/9/09 Price| Current Price| Total Return**
Wells Fargo (WFC) 19.61 31.29 65%
Diageo (DEO) 45.54 95.56 133%
Philip Morris (PM) 37.71 83.52 151%
Pepsi (PEP) 52.10 62.94 32%
Lowe's (LOW) 20.32 28.38 48%
AmEx (AXP) 18.83 52.89 195%
Wells Fargo (WFC) 19.61 31.29 65%
Diageo (DEO) 45.54 95.56 133%
Philip Morris (PM) 37.71 83.52 151%
Pepsi (PEP) 52.10 62.94 32%
Lowe's (LOW) 20.32 28.38 48%
AmEx (AXP) 18.83 52.89 195%
The combined return is 104 percent (including dividends) for these six stocks while the SPDR S&P 500 (SPY) (also including dividends) returned 68 percent over the same time frame.
Below is a quick summary of current trailing price to earnings ratio and dividend yield of each stock compared to the SPDR S&P 500.
Stock | Trailing P/E| Dividend Yield
WFC 11.1 1.5%
DEO 19.8 2.7%
PM 17.1 3.7%
PEP 14.3 3.3%
LOW 17.1 2.0%
AXP 12.9 1.4%
The combined yield of these six is 2.4% while naturally, since the stocks as a group have doubled, the yield on the April 2009 initial investment would be close to 5%.
The yield on the SPDR S&P 500 is currently 1.9% but would be more like 3% on the initial investment if bought back in April 2009.
So the bottom line for this portfolio is returns have been 104% in a little less than 3 years while the six stocks continue to pay nearly 5% in dividends on the initial investment.
Pepsi's been the laggard and probably will continue to do so as they sort out some of their problems. I still view it as a good business for the long haul but I'll be keeping an eye on their progress in improving business performance.
Intrinsic value of the other five businesses continues to increase at a nice clip. Each business seems to be performing just fine. Unfortunately, so have the stocks.
As far as valuations go, Lowe's certainly isn't cheap but that relatively high P/E is partly the result of where we are in the housing cycle. Philip Morris and especially Diageo are, unfortunately, getting rather expensive (though both look a bit more reasonably valued based upon current year earnings).
The fact that these stocks were that inexpensive back in April of 2009 still seems amazing to me.
So, unfortunately, none are cheap enough to buy more at this point. Some might ask why not switch some of these not so cheap shares into something else that is more plainly cheap.
On rare occasions, I'll consider a switch if: valuation becomes extreme on the high side, I've lost confidence in (or significantly misjudged) the long-term prospects of the business, or I understand an equal or better quality alternative investment pretty much as well that is clearly much cheaper (I mean, it generally has to be something else that is just screaming at me). Otherwise, I'm just not that smart. Each move is just another chance to make a mistake and creates unnecessary frictional costs.
I own these because my judgment is that they have durable advantages that support attractive business economics and it was, at one time, possible to buy the shares comfortably below my conservative estimate of intrinsic value. Once I own shares of a good business at the right price (at least one that I understand), my bias is to not sell for a very long time. That means sometimes holding onto shares of a business I like even if, due to increased market prices, the stock might temporarily no longer be a bargain relative to current estimated per share intrinsic value.
(As long as my expectation is that intrinsic value will still increase over the long haul at an attractive rate.)
I don't expect many to adopt this way of thinking and apply it in their own way but it's, if nothing else, just a recognition of my own limits. Let's just see how these six perform over many years compared to the S&P 500. If I'm an idiot it will clear over time.
The blog is here to make sure of that.
(The other 15 stocks I've mentioned in my Stocks to Watch posts are also as a group up quite a bit more than the S&P 500. That's unfortunate as few of them are easy to buy right now. It would be easier to invest right now if at least some of them became a bit cheaper.)
This concentrated portfolio is meant to be an example of how attractive results can be accomplished with minimal to no trading. I'd imagine it takes a fair amount of energy to learn trading techniques and become proficient (though I don't plan to find out). My interests lie elsewhere. Instead, my energy and focus has always been on judging business quality and value, being disciplined about buying shares at a substantial discount, and minimizing frictional costs of all kinds.
Returns are driven by the economics of each business and always buying with a margin of safety, not some unusual talent for trading.
Of course, some may want or need to own more than six stocks but I generally view concentration as a good thing. At least for me, it's not possible to get a good understanding of 50-100 businesses.
Some may be able to do just that but I can't.
I suspect there are a few who are kidding themselves that they understand so many businesses well enough to risk capital.
So I think attractive results can be achieved without some unusual acuity for trading but, instead, via paying the right price for good businesses with sound economics and owning them for a very long time.
Naturally, like Pepsi, at some point each of these businesses will not perform well for a period of time (and stock performance will suffer). Yet, considering both the quality of the businesses and the price that shares could be purchased for in April 2009, I'd expect this portfolio's overall results to be just fine over the very long haul.
Of course, as noted above, if my view of future prospects were to change action might be necessary. For example, if the economic moat of one of these businesses became materially impaired (or if capital allocation decision-making by management became a serious concern), I will certainly consider switching one of these out.
It's probably obvious for those who have read some of my previous posts that I don't view it as a good thing this portfolio has doubled in value so quickly. Right now, I am comfortable with these six stocks long-term but, at current prices, neither I nor the company can buy shares at an extreme discount to value.
In the long run, as Buffett pointed out using the IBM example in the most recent Berkshire letter, that will reduce returns for long-term owners. So it makes no sense to be happy the stocks have run up this much.
It actually hurts relative and absolute long-term performance.
If these stocks do well over the long haul, it will because the six companies themselves continue to have attractive core business economics and were bought at a discount to per share value in the first place.
Finally, three years or so is still actually not long enough to make a meaningful judgment on relative performance in my view.
Adam
Long position in WFC, DEO, PM, PEP, LOW, and AXP
* 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 are never a recommendation to buy or sell anything and should never be considered specific individualized investment advice. In general, intend to be long the positions noted unless they sell significantly above intrinsic value, core business economics become materially impaired, prospects turn out to have been misjudged, or opportunity costs become high.
** Includes dividends and is based upon the closing price on April 9th, 2009 compared to February 29, 2012.
WFC 11.1 1.5%
DEO 19.8 2.7%
PM 17.1 3.7%
PEP 14.3 3.3%
LOW 17.1 2.0%
AXP 12.9 1.4%
The combined yield of these six is 2.4% while naturally, since the stocks as a group have doubled, the yield on the April 2009 initial investment would be close to 5%.
The yield on the SPDR S&P 500 is currently 1.9% but would be more like 3% on the initial investment if bought back in April 2009.
So the bottom line for this portfolio is returns have been 104% in a little less than 3 years while the six stocks continue to pay nearly 5% in dividends on the initial investment.
Pepsi's been the laggard and probably will continue to do so as they sort out some of their problems. I still view it as a good business for the long haul but I'll be keeping an eye on their progress in improving business performance.
Intrinsic value of the other five businesses continues to increase at a nice clip. Each business seems to be performing just fine. Unfortunately, so have the stocks.
As far as valuations go, Lowe's certainly isn't cheap but that relatively high P/E is partly the result of where we are in the housing cycle. Philip Morris and especially Diageo are, unfortunately, getting rather expensive (though both look a bit more reasonably valued based upon current year earnings).
The fact that these stocks were that inexpensive back in April of 2009 still seems amazing to me.
So, unfortunately, none are cheap enough to buy more at this point. Some might ask why not switch some of these not so cheap shares into something else that is more plainly cheap.
On rare occasions, I'll consider a switch if: valuation becomes extreme on the high side, I've lost confidence in (or significantly misjudged) the long-term prospects of the business, or I understand an equal or better quality alternative investment pretty much as well that is clearly much cheaper (I mean, it generally has to be something else that is just screaming at me). Otherwise, I'm just not that smart. Each move is just another chance to make a mistake and creates unnecessary frictional costs.
I own these because my judgment is that they have durable advantages that support attractive business economics and it was, at one time, possible to buy the shares comfortably below my conservative estimate of intrinsic value. Once I own shares of a good business at the right price (at least one that I understand), my bias is to not sell for a very long time. That means sometimes holding onto shares of a business I like even if, due to increased market prices, the stock might temporarily no longer be a bargain relative to current estimated per share intrinsic value.
(As long as my expectation is that intrinsic value will still increase over the long haul at an attractive rate.)
I don't expect many to adopt this way of thinking and apply it in their own way but it's, if nothing else, just a recognition of my own limits. Let's just see how these six perform over many years compared to the S&P 500. If I'm an idiot it will clear over time.
The blog is here to make sure of that.
(The other 15 stocks I've mentioned in my Stocks to Watch posts are also as a group up quite a bit more than the S&P 500. That's unfortunate as few of them are easy to buy right now. It would be easier to invest right now if at least some of them became a bit cheaper.)
This concentrated portfolio is meant to be an example of how attractive results can be accomplished with minimal to no trading. I'd imagine it takes a fair amount of energy to learn trading techniques and become proficient (though I don't plan to find out). My interests lie elsewhere. Instead, my energy and focus has always been on judging business quality and value, being disciplined about buying shares at a substantial discount, and minimizing frictional costs of all kinds.
Returns are driven by the economics of each business and always buying with a margin of safety, not some unusual talent for trading.
Of course, some may want or need to own more than six stocks but I generally view concentration as a good thing. At least for me, it's not possible to get a good understanding of 50-100 businesses.
Some may be able to do just that but I can't.
I suspect there are a few who are kidding themselves that they understand so many businesses well enough to risk capital.
So I think attractive results can be achieved without some unusual acuity for trading but, instead, via paying the right price for good businesses with sound economics and owning them for a very long time.
Naturally, like Pepsi, at some point each of these businesses will not perform well for a period of time (and stock performance will suffer). Yet, considering both the quality of the businesses and the price that shares could be purchased for in April 2009, I'd expect this portfolio's overall results to be just fine over the very long haul.
Of course, as noted above, if my view of future prospects were to change action might be necessary. For example, if the economic moat of one of these businesses became materially impaired (or if capital allocation decision-making by management became a serious concern), I will certainly consider switching one of these out.
It's probably obvious for those who have read some of my previous posts that I don't view it as a good thing this portfolio has doubled in value so quickly. Right now, I am comfortable with these six stocks long-term but, at current prices, neither I nor the company can buy shares at an extreme discount to value.
In the long run, as Buffett pointed out using the IBM example in the most recent Berkshire letter, that will reduce returns for long-term owners. So it makes no sense to be happy the stocks have run up this much.
It actually hurts relative and absolute long-term performance.
If these stocks do well over the long haul, it will because the six companies themselves continue to have attractive core business economics and were bought at a discount to per share value in the first place.
Finally, three years or so is still actually not long enough to make a meaningful judgment on relative performance in my view.
Adam
Long position in WFC, DEO, PM, PEP, LOW, and AXP
* 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 are never a recommendation to buy or sell anything and should never be considered specific individualized investment advice. In general, intend to be long the positions noted unless they sell significantly above intrinsic value, core business economics become materially impaired, prospects turn out to have been misjudged, or opportunity costs become high.
** Includes dividends and is based upon the closing price on April 9th, 2009 compared to February 29, 2012.
Wednesday, February 29, 2012
Jeremy Grantham's 4Q 2011 Letter
From the latest quarterly letter by Jeremy Grantham:
Grantham's 4Q 2011 Letter
"To be at all effective investing as an individual, it is utterly imperative that you know your limitations as well as your strengths and weaknesses. If you can be patient and ignore the crowd, you will likely win. But to imagine you can, and to then adopt a flawed approach that allows you to be seduced or intimidated by the crowd into jumping in late or getting out early is to guarantee a pure disaster. You must know your pain and patience thresholds accurately and not play over your head. If you cannot resist temptation, you absolutely MUST NOT manage your own money. There are no Investors Anonymous meetings to attend."
Later he adds...
"On the other hand, if you have patience, a decent pain threshold, an ability to withstand herd mentality, perhaps one credit of college level math, and a reputation for common sense, then go for it. In my opinion, you hold enough cards and will beat most professionals (which is sadly, but realistically, a relatively modest hurdle) and may even do very well indeed."
Understanding more than a little bit about business certainly helps. Otherwise, investing well requires an even temperament, discipline, patience, and awareness of one's limits more so than sheer brainpower.
If it was mostly about brains, Isaac Newton and John Meriwether (founder of Long-Term Capital Management) would have had more investing success.
Isaac Newton, The Investor
Clearly investing success isn't primarily about having superior intellect. Smart people are not at all immune from doing very dumb things when it comes to putting capital at risk.
"A lot of people with high IQs are terrible investors because they've got terrible temperaments." - Charlie Munger in Kiplinger's
Long-Term Capital Management (LTCM)* back in 1998, the first of many more recent debacles, serves as a good modern example among many:
"...the hedge fund known as 'Long-Term Capital Management' recently collapsed, through overconfidence in its highly leveraged methods, despite I.Q's of its principals that must have averaged 160. Smart, hard-working people aren't exempted from professional disasters from overconfidence. Often, they just go aground in the more difficult voyages they choose, relying on their self-appraisals that they have superior talents and methods." - Charlie Munger in a speech to the Foundation Financial Officers Group
In both of these spectacular investing failures**, Isaac Newton's and John Meriwether's LTCM, there was no shortage of IQ. Yet, obviously, some of the other necessary characteristics of investing success weren't there.
"A money manager with an IQ of 160 and thinks it's 180 will kill you...Going with a money manager with an IQ of 130 who thinks its 125 could serve you well." - Charlie Munger in San Francisco Business Times
The aspects of human nature that leads to costly misjudgments hasn't changed since Newton was wiped out a little less than 300 years ago.
It certainly doesn't hurt to have some awareness of what causes even relatively smart and informed investors to go off the rails.
Adam
Related posts:
Munger on LTCM and Overconfidence
When Genius Failed...Again
* Actually, not so long-term. Could a more perfectly wrong name have been chosen? It lasted all of four years before it needed to be bailed out to prevent a more widespread financial markets collapse. So the poor judgment of one highly leveraged fund had created serious monetary and systemic implications.
** These two failures are very different, of course. Newton's folly hurt only himself. Merriwether lost money for others while threatening the stability of the global financial system. In fact, as these two articles point out, Merriwether has lost money for investors more than once:
- John Meriwether, the Wile E. Coyote of Hedge Funds
- Meriwether: Fool Me Once, Shame On You. Fool Me Twice, Shame on Me
---
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.
Grantham's 4Q 2011 Letter
"To be at all effective investing as an individual, it is utterly imperative that you know your limitations as well as your strengths and weaknesses. If you can be patient and ignore the crowd, you will likely win. But to imagine you can, and to then adopt a flawed approach that allows you to be seduced or intimidated by the crowd into jumping in late or getting out early is to guarantee a pure disaster. You must know your pain and patience thresholds accurately and not play over your head. If you cannot resist temptation, you absolutely MUST NOT manage your own money. There are no Investors Anonymous meetings to attend."
Later he adds...
"On the other hand, if you have patience, a decent pain threshold, an ability to withstand herd mentality, perhaps one credit of college level math, and a reputation for common sense, then go for it. In my opinion, you hold enough cards and will beat most professionals (which is sadly, but realistically, a relatively modest hurdle) and may even do very well indeed."
Understanding more than a little bit about business certainly helps. Otherwise, investing well requires an even temperament, discipline, patience, and awareness of one's limits more so than sheer brainpower.
If it was mostly about brains, Isaac Newton and John Meriwether (founder of Long-Term Capital Management) would have had more investing success.
Isaac Newton, The Investor
Clearly investing success isn't primarily about having superior intellect. Smart people are not at all immune from doing very dumb things when it comes to putting capital at risk.
"A lot of people with high IQs are terrible investors because they've got terrible temperaments." - Charlie Munger in Kiplinger's
Long-Term Capital Management (LTCM)* back in 1998, the first of many more recent debacles, serves as a good modern example among many:
"...the hedge fund known as 'Long-Term Capital Management' recently collapsed, through overconfidence in its highly leveraged methods, despite I.Q's of its principals that must have averaged 160. Smart, hard-working people aren't exempted from professional disasters from overconfidence. Often, they just go aground in the more difficult voyages they choose, relying on their self-appraisals that they have superior talents and methods." - Charlie Munger in a speech to the Foundation Financial Officers Group
In both of these spectacular investing failures**, Isaac Newton's and John Meriwether's LTCM, there was no shortage of IQ. Yet, obviously, some of the other necessary characteristics of investing success weren't there.
"A money manager with an IQ of 160 and thinks it's 180 will kill you...Going with a money manager with an IQ of 130 who thinks its 125 could serve you well." - Charlie Munger in San Francisco Business Times
The aspects of human nature that leads to costly misjudgments hasn't changed since Newton was wiped out a little less than 300 years ago.
It certainly doesn't hurt to have some awareness of what causes even relatively smart and informed investors to go off the rails.
Adam
Related posts:
Munger on LTCM and Overconfidence
When Genius Failed...Again
* Actually, not so long-term. Could a more perfectly wrong name have been chosen? It lasted all of four years before it needed to be bailed out to prevent a more widespread financial markets collapse. So the poor judgment of one highly leveraged fund had created serious monetary and systemic implications.
** These two failures are very different, of course. Newton's folly hurt only himself. Merriwether lost money for others while threatening the stability of the global financial system. In fact, as these two articles point out, Merriwether has lost money for investors more than once:
- John Meriwether, the Wile E. Coyote of Hedge Funds
- Meriwether: Fool Me Once, Shame On You. Fool Me Twice, Shame on Me
---
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.
Monday, February 27, 2012
Why Buffett Wants IBM's Shares "To Languish"
In this previous post back in 2009 and later in some others, I've covered why it makes little sense for a long-term investor to hope a stock will perform well just after it has been purchased.
In fact, unless someone is primarily involved in trading near-term stock price action (all too many market participants these days), those with a long horizon should hope the shares they buy underperform in the days, weeks, and even years that follow while the business itself does well.*
Warren Buffett wrote some excellent material on this subject in the 2011 Berkshire Hathaway (BRKa) shareholder letter that was released over this past weekend.
It's the best explanation I've read yet.
Now, it's understandable that an investor will feel pretty unlucky for having bought shares at a price higher than what becomes available soon after. Yet, while that stock price drop after purchase may seem annoying, it obviously allows the long-term investor to accumulate more shares. The key is that the shares are bought at a discount to per share intrinsic value in the first place.
If shares are actually purchased at a discount, there should be no complaints if they temporarily sell at an even greater discount. In other words, a discount can be a very good thing -- even if it lasts for many years -- for long-term owners provided that business value was judged reasonably well in the first place.
The lower price naturally also benefits long-term owners if free cash flow (in combination with cash on the balance sheet and, in some cases, debt issuance) is persistent and used intelligently to buy back cheap shares over time.
If done in a smart way the compounded benefits for continuing long-term shareholders is not at all small.
This generally only works if the buybacks are done comfortably below (ideally, well below) a conservative estimate of intrinsic value -- too often with buybacks this is not the case -- and the investor has a long time horizon.
A price that offers an appropriate margin of safety protects the investor from the unforeseen and, maybe, the unforeseeable -- what cannot necessarily be known beforehand -- as well as the inevitable mistakes.
This applies whether the investor is accumulating shares or the company is repurchasing stock.
Uncertainty is a given. The price paid should reflect this reality.
Overconfidence in future outcomes can destroy returns.
Of course, the business itself must have a strong balance sheet and plenty of free cash flow that's at least sustainable and, ideally, increasing somewhat over time; it must also have enough financial flexibility to carry out the buyback without damaging the moat, adversely affecting operations, and making other important investments.**
Here's how Buffett explained it in the letter:
"When Berkshire buys stock in a company that is repurchasing shares, we hope for two events: First, we have the normal hope that earnings of the business will increase at a good clip for a long time to come; and second, we also hope that the stock underperforms in the market for a long time as well. A corollary to this second point: 'Talking our book' about a stock we own – were that to be effective – would actually be harmful to Berkshire, not helpful as commentators customarily assume."
Buffett continues by focusing in on IBM's financial management (some might call it "financial engineering"):
"Indeed, I can think of no major company that has had better financial management, a skill that has materially increased the gains enjoyed by IBM shareholders. The company has used debt wisely, made value-adding acquisitions almost exclusively for cash and aggressively repurchased its own stock."
He later added...
"Naturally, what happens to the company's earnings over the next five years is of enormous importance to us. Beyond that, the company will likely spend $50 billion or so in those years to repurchase shares. Our quiz for the day: What should a long-term shareholder, such as Berkshire, cheer for during that period?
I won't keep you in suspense. We should wish for IBM's stock price to languish throughout the five years."
Buffett then walks through some of the math:
"If IBM's stock price averages, say, $200 during the period, the company will acquire 250 million shares for its $50 billion. There would consequently be 910 million shares outstanding, and we would own about 7% of the company. If the stock conversely sells for an average of $300 during the five-year period, IBM will acquire only 167 million shares. That would leave about 990 million shares outstanding after five years, of which we would own 6.5%.
If IBM were to earn, say, $20 billion in the fifth year, our share of those earnings would be a full $100 million greater under the 'disappointing' scenario..."
He concludes by saying:
"The logic is simple: 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."
Many buyers of stock like to see it go up after purchase but the high price actually does reduce long-term returns. I understand that seeing a stock sell below the price paid, especially if it is for an extended period, is difficult for most investors to tolerate. Quite a few end up bailing out before the compounded benefits of shares bought at cheap prices has really had an impact.
Loss aversion is a powerful force but it's possible to develop a more rational response. The long-term investor should hope the stock performs poorly in the near-term and, in fact, for even much longer.
(It's not at all hard to see why this way of thinking might not be particularly popular. That is especially true in an environment where the focus is on profiting from near-term price action instead of long run investment outcomes. What's popular is often very different from what's sensible.)
If shares of a good business are bought consistently below intrinsic value it has powerful long-term effects (especially in terms of risk-reward). This can work whether it is the individual investor -- through additional share purchases or dividend reinvestments -- or the company itself that is doing the buying.
(Other than the tax considerations, share repurchases and dividend reinvestments -- implemented when shares are selling at reasonable or, better yet, cheap valuation levels -- similarly benefit long-term owners; the former reduces overall share count, while the latter increases the number of shares owned. Repurchases, depending on the type of account, are generally more tax efficient.)
One of the keys, again, is a truly long-term investing horizon.
Here's another important thing to consider: the business itself can (and likely will) experience difficulties from time to time. Even the best of them usually do.
(Some might, as a result, be tempted to jump in and out at just the right time. That's usually a better idea in theory than in reality.)
Despite the inevitable business challenges, what really matters is whether the core business economics remain mostly intact once most of the problems are solved. Well, whether IBM's competitive position in the longer run will remain strong seems, at the very least, not the easiest thing to figure out. That's just the nature of technology businesses. To me, at a minimum, this means a larger margin of safety is required.
I'd add that businesses with the most exciting growth will often get their fair share of attention (along with a premium market price). Well, while it's crucial that returns on capital are both durable and attractive, growth actually need not be all that impressive if the price is right.
So growth can be a fine thing, of course, it's just not inevitably a wonderful thing. The price that's paid and whether a business will still be producing attractive returns on capital in 20-30 years (or longer) is what's all-important.***
The fact is, while growth can be an important contributor to long-term returns, it need not be.
I write this because some seem to assume (and behave as if) all growth is good growth.
It's just not.
Buffett's thinking on share repurchases begins at the bottom of page 6 of the letter.
Well worth reading.
As is the rest of the letter.
Adam
Long position in BRKb established at lower than recent prices. No position in IBM at this time.
Related posts:
Buffett on IBM: Berkshire Buys "Big Blue"
Buffett: When it's Advisable for a Company to Repurchase Shares
The Best Use of Corporate Cash
Technology Stocks
Buffett on Stock Buybacks - Part II
Buffett on Stock Buybacks
Buy a Stock...Hope the Price Drops?
* Naturally, in the longer run, an investor will wants the stock price to at least roughly track the increases to per share intrinsic value.
** The business must have plentiful funds available for operational liquidity needs while not underinvesting in crucial assets that widen the economic moat and provide competitive advantages. So, in general, a long-term investor logically should not want shares of a sound business to go up in the near-term or even longer. What's an exception to this? Here's one scenario to consider. Unfortunately, at least for some businesses, there's the very real risk that a buyout offer comes in at a premium to market value but a discount to intrinsic value. If enough short-term oriented owners are okay with the gain (and, of course, enough board members) that will have occurred compared to the recent price action, the deal may be approved. Also, if too few have conviction about longer run prospects, the deal may get approved. When a large proportion of owners of shares are in it for the short-term or, at least, primarily to profit from price action, the chance of this happening increases. Well, those that became owners because of the plain discount to intrinsic value and the company's long run prospects will likely get hurt in this scenario. It's worth mentioning that, considering its market capitalization, IBM is not exactly a likely candidate but it can and does happen to public companies of lesser size. So picking co-owners wisely matters (as much as that is possible). Some public companies certainly have more long-term oriented owners than others.
*** What a business will look like many years from now is, in most cases, not at all easy to figure out. Neither is whether the expected exciting growth will be sustained and the high return variety (in order to justify what is often a premium price).
---
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 are never a recommendation to buy or sell anything.
In fact, unless someone is primarily involved in trading near-term stock price action (all too many market participants these days), those with a long horizon should hope the shares they buy underperform in the days, weeks, and even years that follow while the business itself does well.*
Warren Buffett wrote some excellent material on this subject in the 2011 Berkshire Hathaway (BRKa) shareholder letter that was released over this past weekend.
It's the best explanation I've read yet.
Now, it's understandable that an investor will feel pretty unlucky for having bought shares at a price higher than what becomes available soon after. Yet, while that stock price drop after purchase may seem annoying, it obviously allows the long-term investor to accumulate more shares. The key is that the shares are bought at a discount to per share intrinsic value in the first place.
If shares are actually purchased at a discount, there should be no complaints if they temporarily sell at an even greater discount. In other words, a discount can be a very good thing -- even if it lasts for many years -- for long-term owners provided that business value was judged reasonably well in the first place.
The lower price naturally also benefits long-term owners if free cash flow (in combination with cash on the balance sheet and, in some cases, debt issuance) is persistent and used intelligently to buy back cheap shares over time.
If done in a smart way the compounded benefits for continuing long-term shareholders is not at all small.
This generally only works if the buybacks are done comfortably below (ideally, well below) a conservative estimate of intrinsic value -- too often with buybacks this is not the case -- and the investor has a long time horizon.
A price that offers an appropriate margin of safety protects the investor from the unforeseen and, maybe, the unforeseeable -- what cannot necessarily be known beforehand -- as well as the inevitable mistakes.
This applies whether the investor is accumulating shares or the company is repurchasing stock.
Uncertainty is a given. The price paid should reflect this reality.
Overconfidence in future outcomes can destroy returns.
Of course, the business itself must have a strong balance sheet and plenty of free cash flow that's at least sustainable and, ideally, increasing somewhat over time; it must also have enough financial flexibility to carry out the buyback without damaging the moat, adversely affecting operations, and making other important investments.**
Here's how Buffett explained it in the letter:
"When Berkshire buys stock in a company that is repurchasing shares, we hope for two events: First, we have the normal hope that earnings of the business will increase at a good clip for a long time to come; and second, we also hope that the stock underperforms in the market for a long time as well. A corollary to this second point: 'Talking our book' about a stock we own – were that to be effective – would actually be harmful to Berkshire, not helpful as commentators customarily assume."
Buffett continues by focusing in on IBM's financial management (some might call it "financial engineering"):
"Indeed, I can think of no major company that has had better financial management, a skill that has materially increased the gains enjoyed by IBM shareholders. The company has used debt wisely, made value-adding acquisitions almost exclusively for cash and aggressively repurchased its own stock."
He later added...
"Naturally, what happens to the company's earnings over the next five years is of enormous importance to us. Beyond that, the company will likely spend $50 billion or so in those years to repurchase shares. Our quiz for the day: What should a long-term shareholder, such as Berkshire, cheer for during that period?
I won't keep you in suspense. We should wish for IBM's stock price to languish throughout the five years."
Buffett then walks through some of the math:
"If IBM's stock price averages, say, $200 during the period, the company will acquire 250 million shares for its $50 billion. There would consequently be 910 million shares outstanding, and we would own about 7% of the company. If the stock conversely sells for an average of $300 during the five-year period, IBM will acquire only 167 million shares. That would leave about 990 million shares outstanding after five years, of which we would own 6.5%.
If IBM were to earn, say, $20 billion in the fifth year, our share of those earnings would be a full $100 million greater under the 'disappointing' scenario..."
He concludes by saying:
"The logic is simple: 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."
Many buyers of stock like to see it go up after purchase but the high price actually does reduce long-term returns. I understand that seeing a stock sell below the price paid, especially if it is for an extended period, is difficult for most investors to tolerate. Quite a few end up bailing out before the compounded benefits of shares bought at cheap prices has really had an impact.
Loss aversion is a powerful force but it's possible to develop a more rational response. The long-term investor should hope the stock performs poorly in the near-term and, in fact, for even much longer.
(It's not at all hard to see why this way of thinking might not be particularly popular. That is especially true in an environment where the focus is on profiting from near-term price action instead of long run investment outcomes. What's popular is often very different from what's sensible.)
If shares of a good business are bought consistently below intrinsic value it has powerful long-term effects (especially in terms of risk-reward). This can work whether it is the individual investor -- through additional share purchases or dividend reinvestments -- or the company itself that is doing the buying.
(Other than the tax considerations, share repurchases and dividend reinvestments -- implemented when shares are selling at reasonable or, better yet, cheap valuation levels -- similarly benefit long-term owners; the former reduces overall share count, while the latter increases the number of shares owned. Repurchases, depending on the type of account, are generally more tax efficient.)
One of the keys, again, is a truly long-term investing horizon.
Here's another important thing to consider: the business itself can (and likely will) experience difficulties from time to time. Even the best of them usually do.
(Some might, as a result, be tempted to jump in and out at just the right time. That's usually a better idea in theory than in reality.)
Despite the inevitable business challenges, what really matters is whether the core business economics remain mostly intact once most of the problems are solved. Well, whether IBM's competitive position in the longer run will remain strong seems, at the very least, not the easiest thing to figure out. That's just the nature of technology businesses. To me, at a minimum, this means a larger margin of safety is required.
I'd add that businesses with the most exciting growth will often get their fair share of attention (along with a premium market price). Well, while it's crucial that returns on capital are both durable and attractive, growth actually need not be all that impressive if the price is right.
So growth can be a fine thing, of course, it's just not inevitably a wonderful thing. The price that's paid and whether a business will still be producing attractive returns on capital in 20-30 years (or longer) is what's all-important.***
The fact is, while growth can be an important contributor to long-term returns, it need not be.
I write this because some seem to assume (and behave as if) all growth is good growth.
It's just not.
Buffett's thinking on share repurchases begins at the bottom of page 6 of the letter.
Well worth reading.
As is the rest of the letter.
Adam
Long position in BRKb established at lower than recent prices. No position in IBM at this time.
Related posts:
Buffett on IBM: Berkshire Buys "Big Blue"
Buffett: When it's Advisable for a Company to Repurchase Shares
The Best Use of Corporate Cash
Technology Stocks
Buffett on Stock Buybacks - Part II
Buffett on Stock Buybacks
Buy a Stock...Hope the Price Drops?
* Naturally, in the longer run, an investor will wants the stock price to at least roughly track the increases to per share intrinsic value.
** The business must have plentiful funds available for operational liquidity needs while not underinvesting in crucial assets that widen the economic moat and provide competitive advantages. So, in general, a long-term investor logically should not want shares of a sound business to go up in the near-term or even longer. What's an exception to this? Here's one scenario to consider. Unfortunately, at least for some businesses, there's the very real risk that a buyout offer comes in at a premium to market value but a discount to intrinsic value. If enough short-term oriented owners are okay with the gain (and, of course, enough board members) that will have occurred compared to the recent price action, the deal may be approved. Also, if too few have conviction about longer run prospects, the deal may get approved. When a large proportion of owners of shares are in it for the short-term or, at least, primarily to profit from price action, the chance of this happening increases. Well, those that became owners because of the plain discount to intrinsic value and the company's long run prospects will likely get hurt in this scenario. It's worth mentioning that, considering its market capitalization, IBM is not exactly a likely candidate but it can and does happen to public companies of lesser size. So picking co-owners wisely matters (as much as that is possible). Some public companies certainly have more long-term oriented owners than others.
*** What a business will look like many years from now is, in most cases, not at all easy to figure out. Neither is whether the expected exciting growth will be sustained and the high return variety (in order to justify what is often a premium price).
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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 are never a recommendation to buy or sell anything.
Friday, February 24, 2012
Buffett on Stock Valuations
On quite a few occasions in recent years, Warren Buffett has made it clear that he is having no trouble finding attractively priced stocks.
With that in mind, consider what he was saying about equity prices during the early 2000s.
What follows is just a few samples (among many) of what he was saying back then about stock valuations.
Here's what Buffett wrote in the 2001 Berkshire Hathaway shareholder letter:
Charlie and I believe that American business will do fine over time but think that today's equity prices presage only moderate returns for investors. The market outperformed business for a very long period, and that phenomenon had to end. A market that no more than parallels business progress, however, is likely to leave many investors disappointed, particularly those relatively new to the game.
He added the following in the 2002 letter:
Despite three years of falling prices, which have significantly improved the attractiveness of common stocks, we still find very few that even mildly interest us. That dismal fact is testimony to the insanity of valuations reached during The Great Bubble. Unfortunately, the hangover may prove to be proportional to the binge.
The aversion to equities that Charlie and I exhibit today is far from congenital. We love owning common stocks – if they can be purchased at attractive prices. In my 61 years of investing, 50 or so years have offered that kind of opportunity. There will be years like that again. Unless, however, we see a very high probability of at least 10% pre-tax returns (which translate to 6½-7% after corporate tax), we will sit on the sidelines. With short-term money returning less than 1% after-tax, sitting it out is no fun. But occasionally successful investing requires inactivity.
And in the 2003 letter...
We are neither enthusiastic nor negative about the portfolio we hold. We own pieces of excellent businesses – all of which had good gains in intrinsic value last year – but their current prices reflect their excellence. The unpleasant corollary to this conclusion is that I made a big mistake in not selling several of our larger holdings during The Great Bubble. If these stocks are fully priced now, you may wonder what I was thinking four years ago when their intrinsic value was lower and their prices far higher. So do I.
Quite a contrast to Buffett's bullishness in recent years when it comes to equities. As far as returns go the decade or so that followed the above comments was, of course, a very tough one.
Here's just one example of his favorable view of stock valuations. Buffett said the following back in 2010:
It's quite clear that stocks are cheaper than bonds. I can't imagine anybody having bonds in their portfolio when they can own equities, a diversified group of equities. But people do because they, the lack of confidence. But that's what makes for the attractive prices. If they had their confidence back, they wouldn't be selling at these prices. And believe me, it will come back over time.
Long periods of inactivity is a required part of the investing process. So patience is necessary but, these days, it's not difficult to find shares of quality businesses selling at prices that provide a decent or better margin of safety.
Who knows how stock prices will fluctuate in the next week, month, or even a few years but at least now it's much easier to buy shares of businesses below intrinsic value.
For investors in common stocks, the probability of above average long-term returns seems substantially better now than it was in the early 2000s.
When quality finally sells at a comfortable discount to value my preference is to buy meaningful amounts. I do that with an understanding that it's essentially impossible to gauge the near term stock price movements. In other words, I know the stock may get even cheaper but attempting to time things perfectly leads to errors of omission.
Better to focus on price versus value and ignore the market noise.
Adam
Long position in BRKb established at lower prices
---
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.
With that in mind, consider what he was saying about equity prices during the early 2000s.
What follows is just a few samples (among many) of what he was saying back then about stock valuations.
Here's what Buffett wrote in the 2001 Berkshire Hathaway shareholder letter:
Charlie and I believe that American business will do fine over time but think that today's equity prices presage only moderate returns for investors. The market outperformed business for a very long period, and that phenomenon had to end. A market that no more than parallels business progress, however, is likely to leave many investors disappointed, particularly those relatively new to the game.
He added the following in the 2002 letter:
Despite three years of falling prices, which have significantly improved the attractiveness of common stocks, we still find very few that even mildly interest us. That dismal fact is testimony to the insanity of valuations reached during The Great Bubble. Unfortunately, the hangover may prove to be proportional to the binge.
The aversion to equities that Charlie and I exhibit today is far from congenital. We love owning common stocks – if they can be purchased at attractive prices. In my 61 years of investing, 50 or so years have offered that kind of opportunity. There will be years like that again. Unless, however, we see a very high probability of at least 10% pre-tax returns (which translate to 6½-7% after corporate tax), we will sit on the sidelines. With short-term money returning less than 1% after-tax, sitting it out is no fun. But occasionally successful investing requires inactivity.
And in the 2003 letter...
We are neither enthusiastic nor negative about the portfolio we hold. We own pieces of excellent businesses – all of which had good gains in intrinsic value last year – but their current prices reflect their excellence. The unpleasant corollary to this conclusion is that I made a big mistake in not selling several of our larger holdings during The Great Bubble. If these stocks are fully priced now, you may wonder what I was thinking four years ago when their intrinsic value was lower and their prices far higher. So do I.
Quite a contrast to Buffett's bullishness in recent years when it comes to equities. As far as returns go the decade or so that followed the above comments was, of course, a very tough one.
Here's just one example of his favorable view of stock valuations. Buffett said the following back in 2010:
It's quite clear that stocks are cheaper than bonds. I can't imagine anybody having bonds in their portfolio when they can own equities, a diversified group of equities. But people do because they, the lack of confidence. But that's what makes for the attractive prices. If they had their confidence back, they wouldn't be selling at these prices. And believe me, it will come back over time.
Long periods of inactivity is a required part of the investing process. So patience is necessary but, these days, it's not difficult to find shares of quality businesses selling at prices that provide a decent or better margin of safety.
Who knows how stock prices will fluctuate in the next week, month, or even a few years but at least now it's much easier to buy shares of businesses below intrinsic value.
For investors in common stocks, the probability of above average long-term returns seems substantially better now than it was in the early 2000s.
When quality finally sells at a comfortable discount to value my preference is to buy meaningful amounts. I do that with an understanding that it's essentially impossible to gauge the near term stock price movements. In other words, I know the stock may get even cheaper but attempting to time things perfectly leads to errors of omission.
Better to focus on price versus value and ignore the market noise.
Adam
Long position in BRKb established at lower prices
---
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.
Thursday, February 23, 2012
SEC May Ticket High Speed Traders
Apparently, the Securities and Exchange Commission (SEC) may start charging fees to curb high frequency trading. In this Wall Street Journal article, Mary Schapiro said the following:
...a large portion of equities trading has little to do with "the fundamentals of the company that's being traded." She said it had more to do with "the minuscule aberrational price move" that computer-assisted traders with direct connections to the exchange can "jump on" in fractions of a second.
In addition to forcing traders to pay for cancelled trades (it turns out cancelled trades make up something like 95 to 98% of orders by high-frequency traders), the SEC may impose a requirement on high-speed participants to maintain competitive buy and sell orders throughout most of the trading day.
According to this article, Schapiro's concerns were sparked by the "flash crash" back in May of 2010.
That article points out that the SEC's mission is to "maintain fair, orderly and efficient markets" and to "facilitate capital formation." It seems to me that most high-frequency trading activity adds little value to the capital formation process and, if anything, might be one of the reasons we've seen record volatility.
In it's current form, whether high-frequency trading somehow helps "maintain fair, orderly and efficient markets" seems at least debatable.
The article points out the crash is a challenge to the SEC's stated mission.
...to "maintain fair, orderly and efficient markets" and to "facilitate capital formation." If investors are afraid of a market crash, in other words, they won't provide the capital that public companies need to expand their businesses.
According to Schapiro, the SEC has implemented some fixes since the flash crash including:
-Circuit breakers for stocks that have large moves in a short period of time.
-A ban on stub quotes (offering to buy/sell far from what most investors are willing to pay...a contributor the the flash crash).
Some questions come to mind:
Will the fees on cancelled trades be substantial enough to actually change high-speed trading behavior?
Will the requirement to maintain competitive buy and sell orders for a certain percentage of the trading day change behavior?
In what time frame will the changes be implemented?
Are other solutions being considering to curb the influence of high frequency trading?
Just a guess but those involved in high frequency trading will likely not think these fees and other changes under consideration are such great ideas since, of course, they'll have adverse effects on "liquidity".
Well, I think we can stand for a bit less liquidity and a bit more actual investing. Charlie Munger said it best. He doesn't see much benefit to the massive amount of trading between computers that goes on. He also doesn't seem to think the energy expended and talent utilized writing algorithms (that ultimately the rest of us pay for) provides much social contribution.
"...why should we want to encourage our brightest minds to do what amounts to code-breaking and electronic trading? No I think the whole system is stark-raving mad. Why should we want 25% of our graduating engineers going into finance?" - Charlie Munger
Munger: Cut Banking Sector 80%
The economics of high frequency trading will have to be fundamentally changed for this to work in the long run.
It's not like this is static.
In other words, adjustments by high-speed traders will naturally be made to try and thrive under whatever the new rules end up being.
Adam
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.
...a large portion of equities trading has little to do with "the fundamentals of the company that's being traded." She said it had more to do with "the minuscule aberrational price move" that computer-assisted traders with direct connections to the exchange can "jump on" in fractions of a second.
In addition to forcing traders to pay for cancelled trades (it turns out cancelled trades make up something like 95 to 98% of orders by high-frequency traders), the SEC may impose a requirement on high-speed participants to maintain competitive buy and sell orders throughout most of the trading day.
According to this article, Schapiro's concerns were sparked by the "flash crash" back in May of 2010.
That article points out that the SEC's mission is to "maintain fair, orderly and efficient markets" and to "facilitate capital formation." It seems to me that most high-frequency trading activity adds little value to the capital formation process and, if anything, might be one of the reasons we've seen record volatility.
In it's current form, whether high-frequency trading somehow helps "maintain fair, orderly and efficient markets" seems at least debatable.
The article points out the crash is a challenge to the SEC's stated mission.
...to "maintain fair, orderly and efficient markets" and to "facilitate capital formation." If investors are afraid of a market crash, in other words, they won't provide the capital that public companies need to expand their businesses.
According to Schapiro, the SEC has implemented some fixes since the flash crash including:
-Circuit breakers for stocks that have large moves in a short period of time.
-A ban on stub quotes (offering to buy/sell far from what most investors are willing to pay...a contributor the the flash crash).
Some questions come to mind:
Will the fees on cancelled trades be substantial enough to actually change high-speed trading behavior?
Will the requirement to maintain competitive buy and sell orders for a certain percentage of the trading day change behavior?
In what time frame will the changes be implemented?
Are other solutions being considering to curb the influence of high frequency trading?
Just a guess but those involved in high frequency trading will likely not think these fees and other changes under consideration are such great ideas since, of course, they'll have adverse effects on "liquidity".
Well, I think we can stand for a bit less liquidity and a bit more actual investing. Charlie Munger said it best. He doesn't see much benefit to the massive amount of trading between computers that goes on. He also doesn't seem to think the energy expended and talent utilized writing algorithms (that ultimately the rest of us pay for) provides much social contribution.
"...why should we want to encourage our brightest minds to do what amounts to code-breaking and electronic trading? No I think the whole system is stark-raving mad. Why should we want 25% of our graduating engineers going into finance?" - Charlie Munger
Munger: Cut Banking Sector 80%
The economics of high frequency trading will have to be fundamentally changed for this to work in the long run.
It's not like this is static.
In other words, adjustments by high-speed traders will naturally be made to try and thrive under whatever the new rules end up being.
Adam
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.
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