Some things of note from a recent Vanguard study that's cited here by John Bogle:
- 90% of investors in traditional index funds are long-term holders, while only 80% of investors in ETFs are long-term holders.
- Investor returns in traditional index funds lag the returns of the funds by 150 basis points.
- Investor returns in ETFs lag the returns of the funds by 250 basis points.
Active Managers Losing Ground Can Thank John Bogle
So, in both cases, investor results are subpar compared to the funds and those who are less long-term oriented end up lagging by a greater amount. It's investor behavior that's mostly behind the reduced returns. The ongoing attempts to be in or out at the right time based upon market conditions ends up, too often, just subtracting from results. In other words, some variation of buying when the world seems less uncertain (when stocks are more likely to not be cheap or even expensive) and selling when the world seems more uncertain (when stocks are usually most attractive in terms of risk and reward). That's a tough way to get satisfactory results when this pattern of behavior is repeated over a longer time horizon. Lots of additional effort; less than satisfactory returns. A more consistent approach along with ignoring most of the noise would have yielded better results. Essentially, it's Newton's Fourth Law. The world inevitably swings from what appear to be favorable investing environments to those that appear much less so.
Market participants respond to these changing environments to an extent in a calculated way (efficient market adherents certainly tend to think so), but also to a significant extent based upon psychological and other factors.*
Cognitive biases and emotions can dictate price action in the shorter run.
Being among the not so large group that, over the long haul, can produce results that exceed a broad-based market index is easier said. It seems improbable that recognition of this reality will change behavior all that much. Instead, plenty of active market participants will continue trying to be in or out of a particular fund (or stock) at or near just the right time -- in an attempt to outperform -- despite the near futility of acting in such a way.**
Reduced activity can be a big advantage with a sensible portfolio -- built with specific limits and circumstances in mind -- that's purchased steadily over time.
Fear and greed -- or, more generally, the fact that participants can be less than than cold and rational especially in large groups -- isn't going to stop having a big influence on investor behavior anytime soon.
Assets get mispriced -- anywhere from big premiums to big discounts -- but this only becomes obvious to the vast majority of participants after the fact.
It's not that no one can time things correctly. No doubt there are exceptions who can do just that sort of thing. It's that, apparently, too many are overconfident that they'll be able to do so.
(At least based on the fact that most actively managed equity funds can't match the performance of an index fund.)
Bogle describes some of the more specialized ETFs -- those that are niche products and sometimes use leverage -- as the "fruit and nutcake fringe" and says that they are "poision for investors."
He also mentions the following:
- The SPDR turns over 7,000% each year. For perspective, he considers 3% to be stretching the limits of what makes sense.
- When it comes to the experts who think they can advise someone to be in a particular sector at the right time:
"Advisers or whoever saying you should get out of healthcare and into technology or into financials. That's a way to manage money that doesn't work. Who knows what will do best? I don't even know anybody who knows anybody who does." - John Bogle
What matters naturally is what the companies themselves produce in terms of excess cash per share -- the main driver of intrinsic value -- over time. It's the compounded effect of increased earnings that are at least mostly put to reasonably good use (incl. dividends and buybacks).
Multiples will expand and contract, but a good investment result shouldn't depend on a getting a great price when it comes time to sell.***
Of course, those who get a chance to buy something unusually cheap, hang in there for a very long time, can gain a big advantage if they're able to sell years down the road at a more normalized (or better yet, premium) market valuation.
Consider that possibility a bonus. That's more good fortune than most should count on.
In the end the whole process requires discipline -- incl. an awareness of limitations and acting accordingly within those limitations -- more so than brilliance.
Adam
Related posts:
Buffett's Hedge Fund Bet
John Bogle's "Relentless Rules of Humble Arithmetic", Part II
Index Fund Investing Revisited
Charlie Munger on Complexity, Hedge Funds, and Pension Funds
Why Do So Many Investors Underperform?
When Mutual Funds Outperform Their Investors
John Bogle's "Relentless Rules of Humble Arithmetic"
Investor Overconfidence Revisited
Newton's Fourth Law
Investor Overconfidence
Chasing "Rearview-Mirror Performance"
Index Fund Investing
Investors Are Often Their Own Worst Enemies, Part II
Investors Are Often Their Own Worst Enemies
The Illusion of Skill
Buffett's Bet Against Hedge Funds, Part II
Buffett's Bet Against Hedge Funds
The Illusion of Control
Buffett, Bogle, and the "Invisible Foot" Revisited
If Buffett Were Paid Like a Hedge Fund Manager - Part II
If Buffett Were Paid Like a Hedge Fund Manager
Buffett, Bogle, and the Invisible Foot
Charlie Munger on LTCM & Overconfidence
"Nothing But Costs"
Bogle: History and the Classics
When Genius Failed...Again
* Some efficient market true believers might argue otherwise. Another factor to consider when it comes to what sets near-term prices isn't business fundamentals or psychology but the possibility that a build up of excess leverage in the system (margin) leads to forced selling when the next surprise arrives. Intrinsic values may be mostly unaffected but near-term price action certainly will be.
** Attempts at timing the market or a particular stock has usually been a recipe for poor results caused by unnecessary and costly mistakes. Now, this is very different than buying or selling based upon how price compares to intrinsic value with the emphasis being on margin of safety and long-term effects. For those comfortable valuing stocks (i.e. partial ownership of a business) this can make a whole lot of sense. Otherwise, for those not comfortable valuing stocks, that's where index funds bought periodically come into play. For participants overall the returns can be no more than market returns minus frictional costs. Of course, it's certainly possible that the most active participants will perform better in the future than the past suggests, but some skepticism seems warranted.
*** Whether a basket of stocks via a fund or an individual stock, the changes to per share intrinsic value over the longer haul compared to the price paid upfront should represent a good result even market prices aren't generally selling at a high multiple of then current normalized earnings.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Wednesday, February 25, 2015
Wednesday, February 18, 2015
Berkshire Hathaway 4th Quarter 2014 13F-HR
The Berkshire Hathaway (BRKa) 4th Quarter 13F-HR was released yesterday. Below is a summary of the changes that were made to the Berkshire equity portfolio during that quarter.
(For a convenient comparison, here's a post from last quarter that summarizes Berkshire's 3rd Quarter 13F-HR.)
There was plenty of buying and selling during the quarter. Here's a quick summary of the changes:*
Added to Existing Positions
IBM (IBM): 6.49 mil. shares (incr. 9%); total stake $ 12.3 bil.
DaVita (DVA): 944k shares (2%); total stake $ 2.92 bil.
DirecTV (DTV): 1.35 mil. shares (4%); total stake $ 2.72 bil.
Deere & Co. (DE): 9.53 mil. shares (125%); total stake $ 1.51 bil.
General Motors (GM): 1.0 mil. shares (2%); total stake $ 1.43 bil.
Charter (CHTR): 1.25 mil. shares (25%); total stake $ 1.03 bil.
I've included above only those positions worth at least $ 1 billion at the end of the 4th quarter. In a portfolio this size -- roughly $ 240 billion (equities, fixed income, cash, and other investments) as of the latest available filing with roughly half made up of common stocks** -- a position that's less than $ 1 billion doesn't really move the needle much.
Other positions that were added to but worth less than $ 1 billion include: Suncor (SU), Precision Castparts (PCP), Visa (V), Viacom (VIAB), Liberty Global (LBTYA), Phillips 66 (PSX), and Mastercard (MA).
A couple of relatively small brand new positions were also added.
New Positions
Rest. Brands Int'l (QSR): 8.44 mil. shares worth $ 329 mil.***
21st Century Fox (FOXA): 4.75 mil. shares worth $ 182 mil.
It turns out that some Deere & Company shares were actually purchased during the 3rd quarter but not disclosed until yesterday.
Berkshire's 3rd Quarter 13F-HR filing had indicated some activity was being kept confidential. That filing said: "Confidential information has been omitted from the public Form 13F report and filed separately with the U.S. Securities and Exchange Commission."
We now know it was the Deere position that was omitted.
(Last quarter's 13F-HR made it appear as if Berkshire had sold its stake in Deere. In fact, they were quietly adding to the position with SEC approval.)
This separate 13F-HR/A filing reveals the specific number of shares of Deere that were bought prior to the 4th quarter. That Berkshire had initially purchased some shares of Deere in the 3rd quarter of 2012 was already known. We now know they added to the position in both 3rd and 4th quarter of last year.
Berkshire's latest 13F-HR filing did not indicate any activity was kept confidential.
Occasionally, the SEC allows Berkshire to keep certain moves in the portfolio confidential. The permission is granted by the SEC when a case can be made that the disclosure may cause buyers to drive up the price before Berkshire makes its additional purchases.
(Though some of the holdings they're responsible for have become more substantial over time.)
Top Five Holdings
After the changes, Berkshire Hathaway's portfolio of equity securities remains mostly made up of financial, consumer and, to a lesser extent, technology stocks (mostly IBM).
1. Wells Fargo (WFC) = $ 25.4 bil.
2. Coca-Cola (KO) = $ 16.9 bil.
3. American Express (AXP) = $ 14.1 bil.
4. IBM (IBM) = $ 12.3 bil.
5. Wal-Mart (WMT) = $ 5.18 bil.
At the end of the quarter, Berkshire's Wal-Mart position was only somewhat larger than the Procter & Gamble (PG) position. Well, that's going to change with Berkshire recently agreeing to acquire Duracell from P&G in exchange for Berkshire's ownership stake in the consumer goods company.
(P&G will also contribute some cash.)
As is almost always the case it's a very concentrated portfolio. The top five often represent 60-70 percent and, at times, even more of the equity portfolio. In addition, Berkshire owns equity securities listed on exchanges outside the U.S., plus fixed maturity securities, cash and cash equivalents, and other investments.
As mentioned above the portfolio value equals ~ $ 240 billion. This number includes the investment in Heinz. (The Heinz common and preferred stock are separately on the books for just under $ 12 billion with that book value likely diverge greatly from economic value over time.) The portfolio naturally excludes all the operating businesses that Berkshire owns outright with ~ 330,000 employees according to last year's letter. Numbers like these -- along with many other things of interest especially for Berkshire shareholders -- will soon be updated when the new annual report and letter is released.
Here are some examples of Berkshire's non-insurance businesses:
MidAmerican Energy, Burlington Northern Santa Fe, McLane Company, The Marmon Group, Shaw Industries, Benjamin Moore, Johns Manville, Acme Building, MiTek, Fruit of the Loom, Russell Athletic Apparel, NetJets, Nebraska Furniture Mart, See's Candies, Dairy Queen, The Pampered Chef, Business Wire, Iscar, Lubrizol, Oriental Trading Company, as well as 50% of Heinz.
(Among others.)
In addition, the insurance businesses (BH Reinsurance, General Re, GEICO etc.) owned by Berkshire have naturally provided plenty of "float" for their investments over time and continue to do so.
See page 111 of last year's annual report for a full list of Berkshire's businesses.
Adam
Long positions in BRKb, WFC, KO, AXP, USB, WMT, PG, DTV, COP, and PSX established at much lower than recent market prices. Also, small long position in IBM established at slightly higher than recent market prices.
* All values shown are based upon the last trading day of the 4th quarter.
** Berkshire Hathaway's holdings of ADRs are included in the 13F-HR. What is not included are the shares listed on exchanges outside the United States. The status of those shares, if a large enough position, are updated in the annual letter. So the only way any of the stocks listed on exchanges outside the U.S. will show up in the 13F-HR is if Berkshire happens to buy the ADR. Investments in things like the preferred shares (and, where applicable, related warrants) are also not included in the 13F-HR. The same is true for the Heinz common shares (i.e. not just the Heinz preferred shares).
*** This December 2014 press release further explains the investment in Restaurant Brands International.
(Formed as a result of the merger between Tim Hortons Inc. and Burger King Worldwide, Inc.)
---
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.
(For a convenient comparison, here's a post from last quarter that summarizes Berkshire's 3rd Quarter 13F-HR.)
There was plenty of buying and selling during the quarter. Here's a quick summary of the changes:*
Added to Existing Positions
IBM (IBM): 6.49 mil. shares (incr. 9%); total stake $ 12.3 bil.
DaVita (DVA): 944k shares (2%); total stake $ 2.92 bil.
DirecTV (DTV): 1.35 mil. shares (4%); total stake $ 2.72 bil.
Deere & Co. (DE): 9.53 mil. shares (125%); total stake $ 1.51 bil.
General Motors (GM): 1.0 mil. shares (2%); total stake $ 1.43 bil.
Charter (CHTR): 1.25 mil. shares (25%); total stake $ 1.03 bil.
I've included above only those positions worth at least $ 1 billion at the end of the 4th quarter. In a portfolio this size -- roughly $ 240 billion (equities, fixed income, cash, and other investments) as of the latest available filing with roughly half made up of common stocks** -- a position that's less than $ 1 billion doesn't really move the needle much.
Other positions that were added to but worth less than $ 1 billion include: Suncor (SU), Precision Castparts (PCP), Visa (V), Viacom (VIAB), Liberty Global (LBTYA), Phillips 66 (PSX), and Mastercard (MA).
A couple of relatively small brand new positions were also added.
New Positions
Rest. Brands Int'l (QSR): 8.44 mil. shares worth $ 329 mil.***
21st Century Fox (FOXA): 4.75 mil. shares worth $ 182 mil.
Berkshire's 3rd Quarter 13F-HR filing had indicated some activity was being kept confidential. That filing said: "Confidential information has been omitted from the public Form 13F report and filed separately with the U.S. Securities and Exchange Commission."
We now know it was the Deere position that was omitted.
(Last quarter's 13F-HR made it appear as if Berkshire had sold its stake in Deere. In fact, they were quietly adding to the position with SEC approval.)
This separate 13F-HR/A filing reveals the specific number of shares of Deere that were bought prior to the 4th quarter. That Berkshire had initially purchased some shares of Deere in the 3rd quarter of 2012 was already known. We now know they added to the position in both 3rd and 4th quarter of last year.
Berkshire's latest 13F-HR filing did not indicate any activity was kept confidential.
Occasionally, the SEC allows Berkshire to keep certain moves in the portfolio confidential. The permission is granted by the SEC when a case can be made that the disclosure may cause buyers to drive up the price before Berkshire makes its additional purchases.
Reduced Positions
Positions that were reduced somewhat but not sold outright include Bank of New York Mellon (BK), National Oilwell Varco (NOV), and Liberty Media (LMCA) with each being worth less than $ 1 billion.
Sold Positions
Exxon Mobil (XOM): 41.1 mil. shares worth $ 3.80 bil.
Express Scripts (ESRX): 449k shares worth $ 38.1 mil.
ConocoPhillips (COP): 472k shares worth $ 32.6 mil.
Todd Combs and Ted Weschler are responsible for an increasingly large number of the moves in the Berkshire equity portfolio. These days, any changes involving smaller positions will generally be the work of the two portfolio managers.Positions that were reduced somewhat but not sold outright include Bank of New York Mellon (BK), National Oilwell Varco (NOV), and Liberty Media (LMCA) with each being worth less than $ 1 billion.
Sold Positions
Exxon Mobil (XOM): 41.1 mil. shares worth $ 3.80 bil.
Express Scripts (ESRX): 449k shares worth $ 38.1 mil.
ConocoPhillips (COP): 472k shares worth $ 32.6 mil.
(Though some of the holdings they're responsible for have become more substantial over time.)
Top Five Holdings
After the changes, Berkshire Hathaway's portfolio of equity securities remains mostly made up of financial, consumer and, to a lesser extent, technology stocks (mostly IBM).
1. Wells Fargo (WFC) = $ 25.4 bil.
2. Coca-Cola (KO) = $ 16.9 bil.
3. American Express (AXP) = $ 14.1 bil.
4. IBM (IBM) = $ 12.3 bil.
5. Wal-Mart (WMT) = $ 5.18 bil.
At the end of the quarter, Berkshire's Wal-Mart position was only somewhat larger than the Procter & Gamble (PG) position. Well, that's going to change with Berkshire recently agreeing to acquire Duracell from P&G in exchange for Berkshire's ownership stake in the consumer goods company.
(P&G will also contribute some cash.)
As is almost always the case it's a very concentrated portfolio. The top five often represent 60-70 percent and, at times, even more of the equity portfolio. In addition, Berkshire owns equity securities listed on exchanges outside the U.S., plus fixed maturity securities, cash and cash equivalents, and other investments.
Here are some examples of Berkshire's non-insurance businesses:
MidAmerican Energy, Burlington Northern Santa Fe, McLane Company, The Marmon Group, Shaw Industries, Benjamin Moore, Johns Manville, Acme Building, MiTek, Fruit of the Loom, Russell Athletic Apparel, NetJets, Nebraska Furniture Mart, See's Candies, Dairy Queen, The Pampered Chef, Business Wire, Iscar, Lubrizol, Oriental Trading Company, as well as 50% of Heinz.
(Among others.)
In addition, the insurance businesses (BH Reinsurance, General Re, GEICO etc.) owned by Berkshire have naturally provided plenty of "float" for their investments over time and continue to do so.
See page 111 of last year's annual report for a full list of Berkshire's businesses.
Adam
Long positions in BRKb, WFC, KO, AXP, USB, WMT, PG, DTV, COP, and PSX established at much lower than recent market prices. Also, small long position in IBM established at slightly higher than recent market prices.
* All values shown are based upon the last trading day of the 4th quarter.
** Berkshire Hathaway's holdings of ADRs are included in the 13F-HR. What is not included are the shares listed on exchanges outside the United States. The status of those shares, if a large enough position, are updated in the annual letter. So the only way any of the stocks listed on exchanges outside the U.S. will show up in the 13F-HR is if Berkshire happens to buy the ADR. Investments in things like the preferred shares (and, where applicable, related warrants) are also not included in the 13F-HR. The same is true for the Heinz common shares (i.e. not just the Heinz preferred shares).
*** This December 2014 press release further explains the investment in Restaurant Brands International.
(Formed as a result of the merger between Tim Hortons Inc. and Burger King Worldwide, Inc.)
---
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, February 13, 2015
Apple: Market Share vs Profit Share
Those who think it's such a wonderful idea to aggressively pursue market share might want to consider Apple's (AAPL) share of the worldwide smartphone market.
As things currently stand, Apple's share was 15% last year and nearly 20% in the fourth quarter.
More than solid, of course, but that measure doesn't do much to reveal the true economic picture.
According to Canaccord Genuity, roughly 93% of fourth quarter smartphone profits went to Apple while Samsung (005930.KS) captured 9% of the profits. The fact that the profits of Apple and Samsung are greater than 100% means the remaining competitors combined are actually losing money. The rest collectively aren't just eating crumbs, many competitors are essentially at or near the business equivalent of starvation.
Basically, Apple feasts while, other than maybe Samsung, the rest don't even have enough leftovers to share.
Apple had something like 87% of smartphone profits roughly a year ago. So, while the new iPhones certainly contributed a bunch to the fourth quarter performance, Apple was getting more than their fair share of profits well before the new products were launched.
Now, as I've said on prior occasions, I'm generally no fan of technology stocks unless the margin of safety becomes very large.
Yet it's still hard to not admire what Apple has been doing. Describing Apple as exceptional is not only stating the obvious, it's actually a huge understatement.
Here's the tough part: Is that level of profitability is sustainable over the longer haul? For me, that still seems not an easy thing to gauge at all.
The fact that so much of Apple's profit comes from the iPhone is another important consideration.
In other words, a company's accomplishments can be extremely impressive -- as it certainly is with Apple -- but that doesn't necessarily mean estimating per share intrinsic value is easy. Figuring out Apple's value within a narrow enough range is, to me, challenging at best and warrants a significant margin of safety.*
(When I've purchased the stock in the past, my judgment was that the market price at the time offered a great deal of protection against permanent capital loss. Still, it's no favorite -- and likely never will be -- for the longer haul.)
Apple is currently a valuable business but, as far as I'm concerned, the range of outcomes is still rather too wide.
Others naturally might feel more comfortable with judging Apple's future prospects. It won't surprise me if Apple's continues to do very well. It's just that my favorite businesses have more understandable long-term prospects -- and usually that means less dependence on creating/updating brilliant products on a regular basis -- within a comparably narrow range.
How well would one of Apple's products from seven years ago compete against current alternatives?
How well would some trusted brand of soda from seven years ago compete against current alternatives?
Businesses that need to produce one hit after another run the risk of eventually hitting a wall. It's not that the business necessarily fails altogether; it's that remaining competitive long-term necessitates material changes to core business economics (i.e. increased investment and operating costs, reduced pricing power) with serious consequences for owners.
The net result being a range of outcomes -- after a number of product cycles and maybe a technological shift or two -- that's often too wide with the worst case scenario being unacceptable.
Apple, it seems more than fair to say, has earned and deserves huge respect. It's an extraordinary enterprise with, at least at the present time, astonishing economics. What they've created over the years has had an enormous favorable impact on the world. It's just important to remember this guarantees absolutely nothing about future results for a long-term shareholder.
Societal impact and rewards to investors need not necessarily be positively correlated. Over the past decade or so the correlation has clearly been, to say the least, rather very positive for Apple.
This may continue to be the case going forward but is far from a given.
It's understandable that some will pursue the transformational businesses with the potential for spectacular returns. Yet the chance for costly mistakes is usually high. Compounding at attractive (even if less than spectacular) rates of return for a very long time is, for investors, not easy but all-important.
Well, it's tough to be confident the time frame will be a very long time with any business that depends extensively on ingenious innovations being delivered on a regular basis.**
The power of long-term compounding effects can inadvertently become lost in the chase for the next big thing.
The market eventually weighs business success or failure reasonably well even if sometimes the recognition is delayed.
That delayed recognition can, at times, be a very good thing for the long-term owner.
Adam
Long position in AAPL established at much lower than recent market prices
Related posts:
Mr. Market
Buffett on Autos, Airplanes, and Airlines
Warren Buffett on "The Key to Investing"
Technology Stocks
* As always, I have no opinion about how Apple's stock (or any stock) might perform in the near-term or even intermediate-term. In fact, I never have a view on such things. Those who attempt to profit from price action are engaged in an entirely different game (whether or not fundamentals are used in their decision-making). My emphasis is on how price compares to value (based upon the excess cash a business is expected to produce over time), the likelihood that the value will increase at least at a satisfactory clip, and long-term effects. Business prospects are sometimes mispriced -- even for an extended period -- but eventually should be confirmed by, and reflected in, market prices.
** Some quality businesses can maintain substantial competitive advantages over the longer haul without lots of innovation. Still, even the best businesses will face real challenges from time to time.
---
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.
As things currently stand, Apple's share was 15% last year and nearly 20% in the fourth quarter.
More than solid, of course, but that measure doesn't do much to reveal the true economic picture.
According to Canaccord Genuity, roughly 93% of fourth quarter smartphone profits went to Apple while Samsung (005930.KS) captured 9% of the profits. The fact that the profits of Apple and Samsung are greater than 100% means the remaining competitors combined are actually losing money. The rest collectively aren't just eating crumbs, many competitors are essentially at or near the business equivalent of starvation.
Basically, Apple feasts while, other than maybe Samsung, the rest don't even have enough leftovers to share.
Apple had something like 87% of smartphone profits roughly a year ago. So, while the new iPhones certainly contributed a bunch to the fourth quarter performance, Apple was getting more than their fair share of profits well before the new products were launched.
Now, as I've said on prior occasions, I'm generally no fan of technology stocks unless the margin of safety becomes very large.
Yet it's still hard to not admire what Apple has been doing. Describing Apple as exceptional is not only stating the obvious, it's actually a huge understatement.
Here's the tough part: Is that level of profitability is sustainable over the longer haul? For me, that still seems not an easy thing to gauge at all.
The fact that so much of Apple's profit comes from the iPhone is another important consideration.
In other words, a company's accomplishments can be extremely impressive -- as it certainly is with Apple -- but that doesn't necessarily mean estimating per share intrinsic value is easy. Figuring out Apple's value within a narrow enough range is, to me, challenging at best and warrants a significant margin of safety.*
(When I've purchased the stock in the past, my judgment was that the market price at the time offered a great deal of protection against permanent capital loss. Still, it's no favorite -- and likely never will be -- for the longer haul.)
Apple is currently a valuable business but, as far as I'm concerned, the range of outcomes is still rather too wide.
Others naturally might feel more comfortable with judging Apple's future prospects. It won't surprise me if Apple's continues to do very well. It's just that my favorite businesses have more understandable long-term prospects -- and usually that means less dependence on creating/updating brilliant products on a regular basis -- within a comparably narrow range.
How well would one of Apple's products from seven years ago compete against current alternatives?
How well would some trusted brand of soda from seven years ago compete against current alternatives?
Businesses that need to produce one hit after another run the risk of eventually hitting a wall. It's not that the business necessarily fails altogether; it's that remaining competitive long-term necessitates material changes to core business economics (i.e. increased investment and operating costs, reduced pricing power) with serious consequences for owners.
The net result being a range of outcomes -- after a number of product cycles and maybe a technological shift or two -- that's often too wide with the worst case scenario being unacceptable.
Apple, it seems more than fair to say, has earned and deserves huge respect. It's an extraordinary enterprise with, at least at the present time, astonishing economics. What they've created over the years has had an enormous favorable impact on the world. It's just important to remember this guarantees absolutely nothing about future results for a long-term shareholder.
Societal impact and rewards to investors need not necessarily be positively correlated. Over the past decade or so the correlation has clearly been, to say the least, rather very positive for Apple.
This may continue to be the case going forward but is far from a given.
It's understandable that some will pursue the transformational businesses with the potential for spectacular returns. Yet the chance for costly mistakes is usually high. Compounding at attractive (even if less than spectacular) rates of return for a very long time is, for investors, not easy but all-important.
Well, it's tough to be confident the time frame will be a very long time with any business that depends extensively on ingenious innovations being delivered on a regular basis.**
The power of long-term compounding effects can inadvertently become lost in the chase for the next big thing.
The market eventually weighs business success or failure reasonably well even if sometimes the recognition is delayed.
That delayed recognition can, at times, be a very good thing for the long-term owner.
Adam
Long position in AAPL established at much lower than recent market prices
Related posts:
Mr. Market
Buffett on Autos, Airplanes, and Airlines
Warren Buffett on "The Key to Investing"
Technology Stocks
* As always, I have no opinion about how Apple's stock (or any stock) might perform in the near-term or even intermediate-term. In fact, I never have a view on such things. Those who attempt to profit from price action are engaged in an entirely different game (whether or not fundamentals are used in their decision-making). My emphasis is on how price compares to value (based upon the excess cash a business is expected to produce over time), the likelihood that the value will increase at least at a satisfactory clip, and long-term effects. Business prospects are sometimes mispriced -- even for an extended period -- but eventually should be confirmed by, and reflected in, market prices.
** Some quality businesses can maintain substantial competitive advantages over the longer haul without lots of innovation. Still, even the best businesses will face real challenges from time to time.
---
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, February 6, 2015
Buffett's Hedge Fund Bet
Warren Buffett made a bet quite a while back with Protege Partners, LLC. He bet that, over ten years, an S&P 500 index fund* would outperform a basket of hedge funds chosen by Protege.
The bet started in 2008 and goes through 2017.
Well, Buffett is well ahead seven years into the bet.
More specifically,it turns out that, seven years in to a ten year bet, so far Buffett is up 63.5% while Protege Partners is up an estimated 19.6 % (this is an estimate because some of the funds returns are yet to be finalized).
Here's an excerpt of Buffett's argument: "A number of smart people are involved in running hedge funds. But to a great extent their efforts are self-neutralizing, and their IQ will not overcome the costs they impose on investors."
And an excerpt of Protege's argument: "There is a wide gap between the returns of the best hedge funds and the average ones. This differential affords sophisticated institutional investors, among them funds of funds, an opportunity to pick strategies and managers that these investors think will outperform the averages."
So Buffett is betting on a more passive approach while Protege is advocating a more active approach. A charity of the winner's choosing will get $ 1 million once the bet has been complete. It turns out that Buffett and Protege initially put $ 320,000 each into a zero-coupon bond with the idea that its value would be roughly $ 1 million when it came time to donate the money. Well, both sides agreed -- after the zero-coupon bond did rather better than expected due to the substantial drop in interest rates -- to sell the zero-coupon bond in 2012 and put the money into Berkshire Hathaway's (BRKb) Class B common stock.
(Buffett has apparently promised to pay the full amount if the stock ends up being worth less than $ 1 million at the end of the bet.)
In fact, Berkshire's stock has rallied quite a bit since they made that switch. The value currently sits at $ 1.68 million. So the initial investment by both Buffett and Protege seems rather likely to be worth much more than $ 1 million once this bet is settled.
Buffett wrote the following in the 2013 Berkshire letter:
"...the 'know-nothing' investor who both diversifies and keeps his costs minimal is virtually certain to get satisfactory results. Indeed, the unsophisticated investor who is realistic about his shortcomings is likely to obtain better long-term results than the knowledgeable professional who is blind to even a single weakness.
If 'investors' frenetically bought and sold farmland to each other, neither the yields nor prices of their crops would be increased. The only consequence of such behavior would be decreases in the overall earnings realized by the farm-owning population because of the substantial costs it would incur as it sought advice and switched properties."
Consistent with this thinking, he has instructed a more passive investment approach for his wife's future benefit:
"My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard's.)"
Buffett has previously made a similar point. He thinks that many investors would end up better off if they simply bought index funds on a periodic basis. John Bogle and others seem to think along the same lines.
The emphasis being on increases to intrinsic value and long-term effects instead of cleverly timing price movements. It's generally foolish to try and time the market (or, for that matter, an individual stock) though obviously that doesn't stop many from trying to do so.
Attempts at clever timing tend to subtract from results.
Act accordingly.
Stocks, in general, seem not at all cheap these days. That doesn't make it time to sell. To me, it means lowering expectations and learning how to deal with the inevitable but unpredictable price moves. Substantial price moves may be inevitable, but it's nearly impossible to know when and by how much. Stocks (and funds) will drop dramatically from time to time. What's expensive goes on to become even more expensive. So assume that predicting near-term price moves is nearly futile.
Better to expend energy elsewhere.
Those who can't handle the fluctuations -- sometimes driven more by psychology than fundamentals -- likely won't do all that well in stocks or funds. Too often, they end up buying and selling at inopportune times.
So trying to time price action is not a solution; it likely creates more problems than it solves. Now, for those inclined/able to judge price versus value and in a position to act decisively, the next big decline should be viewed as an opportunity. Pay sensible prices and simply expect, ignore, or even benefit from the price action. The price paid is in an investor's control; most everything else is not. If a good business is bought cheap and intrinsic value increases at a satisfactory rate, those fluctuations should over time increasingly look meaningless once the weighing machine asserts its influence. What about those who don't feel comfortable judging business economics and whether a particular enterprise has real durable advantages? Well, as Buffett has pointed out, they can do just fine as long as they recognize their own limits.
"By periodically investing in an index fund..... the know-nothing investor can actually out-perform most investment professionals. Paradoxically, when 'dumb' money acknowledges its limitations, it ceases to be dumb."
Excessive buying and selling, even if thoughtful and well-intentioned, will too often just create unnecessary frictional costs (taxes, commissions, etc.) with little benefit otherwise.** The same goes for the fees that are typically charged by hedge funds. Those costs are incurred by investors -- transferring wealth in the process -- whether there's lots of trading activity by the fund or not.
Of course, it's not as if there aren't a large number of investors who are capable of doing very well owning individual stocks. Many, in fact, do very well.
Buffett once wrote that those who are "able to understand business economics and to find five to ten sensibly-priced companies that possess important long-term competitive advantages," can do just fine.
It's just that too many also have an unwarranted confidence in their own capabilities especially once all the frictional costs are taken into account. Lots of incremental effort with no incremental benefit (or, in enough cases to at least be of interest, returns that are made worse by all the activity).
As a result, the vast proportion of market participants -- and it's not just the amateurs -- can't match the performance of a minimal effort required low-cost index fund that's bought periodically, almost never traded, and held for the long-term.
The emphasis is on how the business (or businesses) increase intrinsically in value instead of trading the price movements or, as Buffett calls it, attempting "to dance in and out".
Long-term investors in individual common stocks need not have some special talent for trading; they need to understand how price compares to value; they need to have the patience to wait until the price-value comparison is hugely in their favor and stick to owning what they truly understand.
Sounds simple enough.
In many ways it actually is.
It's just not all that easy.
That's because the simplicity is deceptive.
Lots of discipline and hard work is still very much required.
Important qualitative and quantitative elements must be carefully considered.
Psychological factors that can impact results must be understood then managed or, at the very least, the damage that various biases can do needs to be contained.
They aren't just someone else's problem.
Also, temperament come into play.
Common stocks can make sense for those who feel comfortable judging and valuing individual businesses; index funds make more sense for those who do not.
Some will overestimate their own ability to pick stocks consistently well; they'll end up doing a bunch of work that adds nothing to returns and might even subtract. With individual stocks, it's far more likely that big and costly mistakes -- including substantial permanent capital loss -- will be made.
With index funds, psychological biases and temperamental factors still matter; discipline is still required.
Otherwise, index funds should require a whole lot less work and far fewer difficult judgments compared to stocks.
Adam
Long position in BRKb established at much lower than recent market prices
Related posts:
The Curse of Liquidity
John Bogle's "Relentless Rules of Humble Arithmetic", Part II
Index Fund Investing Revisited
Charlie Munger on Complexity, Hedge Funds, and Pension Funds
Why Do So Many Investors Underperform?
When Mutual Funds Outperform Their Investors
Buffett on "Asset Gathering" vs "Asset Managing"
John Bogle's "Relentless Rules of Humble Arithmetic"
Investor Overconfidence Revisited
Newton's Fourth Law
Investor Overconfidence
Chasing "Rearview-Mirror Performance"
Index Fund Investing
Investors Are Often Their Own Worst Enemies, Part II
Investors Are Often Their Own Worst Enemies
The Illusion of Skill
Buffett's Bet Against Hedge Funds, Part II
Buffett's Bet Against Hedge Funds
The Illusion of Control
Buffett, Bogle, and the "Invisible Foot" Revisited
If Buffett Were Paid Like a Hedge Fund Manager - Part II
If Buffett Were Paid Like a Hedge Fund Manager
Buffett, Bogle, and the Invisible Foot
Charlie Munger on LTCM & Overconfidence
"Nothing But Costs"
Bogle: History and the Classics
Recent Study on Investor Returns
When Genius Failed...Again
Best Performing Mutual Funds - 20 Years
* Vanguard 500 Index Fund Admiral Shares (VFIAX).
** Excessive activity can also lead to mistakes. Each move is an opportunity to improve results; it's also an opportunity to make things worse. It's easy to put too much emphasis on the former while giving too little consideration for the latter.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
The bet started in 2008 and goes through 2017.
Well, Buffett is well ahead seven years into the bet.
More specifically,it turns out that, seven years in to a ten year bet, so far Buffett is up 63.5% while Protege Partners is up an estimated 19.6 % (this is an estimate because some of the funds returns are yet to be finalized).
Here's an excerpt of Buffett's argument: "A number of smart people are involved in running hedge funds. But to a great extent their efforts are self-neutralizing, and their IQ will not overcome the costs they impose on investors."
And an excerpt of Protege's argument: "There is a wide gap between the returns of the best hedge funds and the average ones. This differential affords sophisticated institutional investors, among them funds of funds, an opportunity to pick strategies and managers that these investors think will outperform the averages."
So Buffett is betting on a more passive approach while Protege is advocating a more active approach. A charity of the winner's choosing will get $ 1 million once the bet has been complete. It turns out that Buffett and Protege initially put $ 320,000 each into a zero-coupon bond with the idea that its value would be roughly $ 1 million when it came time to donate the money. Well, both sides agreed -- after the zero-coupon bond did rather better than expected due to the substantial drop in interest rates -- to sell the zero-coupon bond in 2012 and put the money into Berkshire Hathaway's (BRKb) Class B common stock.
(Buffett has apparently promised to pay the full amount if the stock ends up being worth less than $ 1 million at the end of the bet.)
In fact, Berkshire's stock has rallied quite a bit since they made that switch. The value currently sits at $ 1.68 million. So the initial investment by both Buffett and Protege seems rather likely to be worth much more than $ 1 million once this bet is settled.
Buffett wrote the following in the 2013 Berkshire letter:
"...the 'know-nothing' investor who both diversifies and keeps his costs minimal is virtually certain to get satisfactory results. Indeed, the unsophisticated investor who is realistic about his shortcomings is likely to obtain better long-term results than the knowledgeable professional who is blind to even a single weakness.
If 'investors' frenetically bought and sold farmland to each other, neither the yields nor prices of their crops would be increased. The only consequence of such behavior would be decreases in the overall earnings realized by the farm-owning population because of the substantial costs it would incur as it sought advice and switched properties."
Consistent with this thinking, he has instructed a more passive investment approach for his wife's future benefit:
"My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard's.)"
Buffett has previously made a similar point. He thinks that many investors would end up better off if they simply bought index funds on a periodic basis. John Bogle and others seem to think along the same lines.
The emphasis being on increases to intrinsic value and long-term effects instead of cleverly timing price movements. It's generally foolish to try and time the market (or, for that matter, an individual stock) though obviously that doesn't stop many from trying to do so.
Attempts at clever timing tend to subtract from results.
Act accordingly.
Stocks, in general, seem not at all cheap these days. That doesn't make it time to sell. To me, it means lowering expectations and learning how to deal with the inevitable but unpredictable price moves. Substantial price moves may be inevitable, but it's nearly impossible to know when and by how much. Stocks (and funds) will drop dramatically from time to time. What's expensive goes on to become even more expensive. So assume that predicting near-term price moves is nearly futile.
Better to expend energy elsewhere.
Those who can't handle the fluctuations -- sometimes driven more by psychology than fundamentals -- likely won't do all that well in stocks or funds. Too often, they end up buying and selling at inopportune times.
So trying to time price action is not a solution; it likely creates more problems than it solves. Now, for those inclined/able to judge price versus value and in a position to act decisively, the next big decline should be viewed as an opportunity. Pay sensible prices and simply expect, ignore, or even benefit from the price action. The price paid is in an investor's control; most everything else is not. If a good business is bought cheap and intrinsic value increases at a satisfactory rate, those fluctuations should over time increasingly look meaningless once the weighing machine asserts its influence. What about those who don't feel comfortable judging business economics and whether a particular enterprise has real durable advantages? Well, as Buffett has pointed out, they can do just fine as long as they recognize their own limits.
"By periodically investing in an index fund..... the know-nothing investor can actually out-perform most investment professionals. Paradoxically, when 'dumb' money acknowledges its limitations, it ceases to be dumb."
Excessive buying and selling, even if thoughtful and well-intentioned, will too often just create unnecessary frictional costs (taxes, commissions, etc.) with little benefit otherwise.** The same goes for the fees that are typically charged by hedge funds. Those costs are incurred by investors -- transferring wealth in the process -- whether there's lots of trading activity by the fund or not.
Of course, it's not as if there aren't a large number of investors who are capable of doing very well owning individual stocks. Many, in fact, do very well.
Buffett once wrote that those who are "able to understand business economics and to find five to ten sensibly-priced companies that possess important long-term competitive advantages," can do just fine.
It's just that too many also have an unwarranted confidence in their own capabilities especially once all the frictional costs are taken into account. Lots of incremental effort with no incremental benefit (or, in enough cases to at least be of interest, returns that are made worse by all the activity).
As a result, the vast proportion of market participants -- and it's not just the amateurs -- can't match the performance of a minimal effort required low-cost index fund that's bought periodically, almost never traded, and held for the long-term.
The emphasis is on how the business (or businesses) increase intrinsically in value instead of trading the price movements or, as Buffett calls it, attempting "to dance in and out".
Long-term investors in individual common stocks need not have some special talent for trading; they need to understand how price compares to value; they need to have the patience to wait until the price-value comparison is hugely in their favor and stick to owning what they truly understand.
Sounds simple enough.
In many ways it actually is.
It's just not all that easy.
That's because the simplicity is deceptive.
Lots of discipline and hard work is still very much required.
Important qualitative and quantitative elements must be carefully considered.
Psychological factors that can impact results must be understood then managed or, at the very least, the damage that various biases can do needs to be contained.
They aren't just someone else's problem.
Also, temperament come into play.
Common stocks can make sense for those who feel comfortable judging and valuing individual businesses; index funds make more sense for those who do not.
Some will overestimate their own ability to pick stocks consistently well; they'll end up doing a bunch of work that adds nothing to returns and might even subtract. With individual stocks, it's far more likely that big and costly mistakes -- including substantial permanent capital loss -- will be made.
With index funds, psychological biases and temperamental factors still matter; discipline is still required.
Otherwise, index funds should require a whole lot less work and far fewer difficult judgments compared to stocks.
Adam
Long position in BRKb established at much lower than recent market prices
Related posts:
The Curse of Liquidity
John Bogle's "Relentless Rules of Humble Arithmetic", Part II
Index Fund Investing Revisited
Charlie Munger on Complexity, Hedge Funds, and Pension Funds
Why Do So Many Investors Underperform?
When Mutual Funds Outperform Their Investors
Buffett on "Asset Gathering" vs "Asset Managing"
John Bogle's "Relentless Rules of Humble Arithmetic"
Investor Overconfidence Revisited
Newton's Fourth Law
Investor Overconfidence
Chasing "Rearview-Mirror Performance"
Index Fund Investing
Investors Are Often Their Own Worst Enemies, Part II
Investors Are Often Their Own Worst Enemies
The Illusion of Skill
Buffett's Bet Against Hedge Funds, Part II
Buffett's Bet Against Hedge Funds
The Illusion of Control
Buffett, Bogle, and the "Invisible Foot" Revisited
If Buffett Were Paid Like a Hedge Fund Manager - Part II
If Buffett Were Paid Like a Hedge Fund Manager
Buffett, Bogle, and the Invisible Foot
Charlie Munger on LTCM & Overconfidence
"Nothing But Costs"
Bogle: History and the Classics
Recent Study on Investor Returns
When Genius Failed...Again
Best Performing Mutual Funds - 20 Years
* Vanguard 500 Index Fund Admiral Shares (VFIAX).
** Excessive activity can also lead to mistakes. Each move is an opportunity to improve results; it's also an opportunity to make things worse. It's easy to put too much emphasis on the former while giving too little consideration for the latter.
---
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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