Intel has never paid a dividend. Microsoft didn’t until fairly recently. I think you would have done reasonably well investing in them early on.
An interesting concept is that of 'sunspots ’
“A sunspot equilibrium is an economic equilibrium where the market outcome or allocation of resources depends on an extrinsic random variable, or “sunspots” that matters only because people think it matters.”
Basically, if enough people think that the stock price of a company will go up based on an event (*any *event, even irrelevant to the company), then, when that event happens, the stock price will indeed go up. This is true even if the investors are rational agents (and not just irrational humans)
It so happens that, at this point in time, people have agreed that the stock price is tied to the performance of the company. This is “justified” by the fact that you have “ownership” of the company.
In fact, this onwership, as you and others have mentioned is meaningless in most cases (i.e. it gives you no power to do anything with the company’s assets).
Nevertheless, since, at present, everyone believes that the stock price is tied to the performance of the company, it actually behaves as if it were indeed tied to it.
I think the problem (or at least one problem) with the stock market is that it is a positive feedback loop. If people believe the price will go up because of some event, people will start buying the stock, which pushes the price up. If people believe the price will go down because of some event, people will start selling the stock, which pushes the price down.
So, we have a self-fullfilling prophecy.
Any system with a positive feedback loop is unstable.
Finally, to address the issue of ever-increasing stock prices, isn’t it the case that, even if the market itself will stay on forever (which is doubtful), each individual company will eventually go out of business. Maybe not now, maybe not next year, but at some point, there will be no Microsoft. The people buying the stock on its way down (which may last for years) will be the losers in what has been referred to as “the greater fool game”.
As an aside, regarding Warren Buffet, yes, he does use fundamentals when making decisions, but from what I know, he also goes in and has a huge influence on what the company whose stock he just bought does. So, that does not compare with any “small guy” buying stock based on fundamentals. Therefore, it isn’t clear that he can be used as an example of how good or profitable fundamental investing can be.
Just because you don’t have complete control of the assets doesn’t mean ownership of them is meaningless. It may be less valuable than ownership of something you directly control, but it’s certainly not valueless. That’s like saying people shouldn’t be interested in politics because they’re not politicians.
On the Berkshire Hathaway issue, I’d just like to point out that “never” is an awfully long time. The people running it today are going to get old and die. The assets will still be there, just as valuable as they were the day before. As long as the company owns assets that are valuable, ownership of the company will have value. Even if the ‘payoff’ is 100 years away, there has to be some string of ownership leading up to that point, and there’s no reason to expect all the profit to go only to the final owner.
No, it isn’t
I’m not sure if you were responding to my comment with the above, but what I was saying is that in 100 years time, Berkshire may not have assets of value. As far as I know it owns other companies, like Geico. In 100 years, companies like Geico might be gone, or their profitability, and thus their value, greatly diminished.
So the people who will buy Berkshire stock in the last, say, 10 or more years of its existence as a stock will be the losers in this game.
Now, Berkshire may last much longer than other companies in the market, so the effects may be hard to see. With other “normal” companies like Kodak and Sun Microsystems, the life and death cycle of the company is much shorter, so the losers in the stock market game can be seen in our lifetime.
One vote doesn’t mean a lot either. If enough stockholders want to do something with a company’s assets, they will. Companies have been sold against the wishes of management based on stockholder votes. Now, it is true that those with lots of money and lots of shares have more voice than shlubs like us.
You forget that if there is a perception of underlying value in the company and stock, if it goes down far enough more and more people will see it as a bargain, buy, and stabilize the price. That’s the negative feedback.
Let me reply to the following point in a little more detail:
It’s not that you don’t have complete control. You have essentially NO control of the assets. If you own Google stock, there is nothing from the companies assets that you can use or control.
No, it isn’t. Large percentages of stock of a company are owned by some big players, who may each have 10-30% of a company. Saying that your 100 stocks of Google give you control is meaningless. The votes that your 100 stocks give you are useless compared to the votes from the big boys.
This is not similar to the political arena. It would be similar if Bill Gates had 6 billion votes and you and I had 1 vote each.
That’s a good point. However, the negative feedback is very weak to non-existent for companies that have very little in the way of assets and their valuation is based mostly on the expectation of future earnings.
Also, the negative feedback exists as long as people buy that the stock value is related to the company’s underlying value. In major crises, like the crash of 1929, I think people started believing that the stocks they were holding would soon be no more than pieces of paper, so they dumped them as soon as they could (which of course, did cause them to soon be worthless, as “predicted”)
The value of B-H isn’t going to vanish overnight, assuming it will ever vanish unless it’s completely mismanaged. The people buying it in the last 10 years, during its death throes, will pay a significantly reduced price. Since they’re going to put some effort into valuing the company, they’ll see that it’s dying. At each step along the way, people are re-valuing the company and lowering the price based on how much less its assets are worth at that time.
If the company is mismanaged the stockholders (YOU) can vote the current board out and replace it with one who will liquidate the company, or someone will come and buy out the company.
On the political front, if you want to talk about worthless votes, call up a republican in NY during a presidential race. Do we really even need to talk about whether or not the rich can affect politics beyond their individual vote?
So?
Seriously, there are people with 100x your experience in running a company who control the assets and make decisions, and you’re going to bitch about not having a say? You’re choosing to buy partial ownership in the company precisely because the current management is doing a good job. If you don’t feel they’re doing a good job, you exercise control by selling your share of that company and buying part of a company you like better.
Exactly. So the people who will be buying it in the last 10 years will be losing money on average, since the price they bought the stock at will be less than the price they will sell it. And if my math is right, the money lost on the way down will exactly equal the money made by others on the stock’s way up.
This sounds to me like a zero-sum game (though over a timespan of decades)
Yes, a republican’s vote in NY during a presidential race is worthless. And so are the votes afforded to me by my 100 Google stocks. I don’t see how the former fact makes the latter fact less valid.
Let’s face it, most individual inversors who buy stocks, whether based on technical analysis, or based on “fundamentals”, never plan on using their stock to votes or for any other puporse than to sell it later.
They buy a piece of paper and predict (either based on technical indicators or fundamental valuation) that other people will buy that piece of paper in the future, at a higher price. The fact that that piece of paper gives you a “piece of the company” or “voting rights” is never actually utilized. This “partial onwership” is only used to perpetuate the agreed-upon belief that the stock should follow company performance.
If the company starts off worth $0 and ends up worth $0, it’s a zero sum game. I don’t think we can point to that scenario as the expected outcome of the average stock investment.
Until you get to the final transaction, with the end user who will use the product until it’s worthless, every single solitary purchase is made under the expectation that someone else will buy something from you at a later date.
Take something with tremendous inherent value, labor. Even labor only has value if the fruit of that labor is something that others wish to buy. If your labor creates something that nobody else wants, you’ll be doing it for free. The only reason your company buys your labor is that they predict that other people will buy the fruits of your labor in the future for a higher price.
That’s correct - companies with no inherent value will go belly up. That is fairly rare in the general markets (you don’t get listed in the NYSE unless you have some underlying value) but is very common in startups. VCs basically have stock in a company before it goes public, and since the risk is very great, most of this stock will turn out to be worthless. (Ditto for stock owned by the founders.) Publicly traded stocks have less volatility, and stocks with more underlying value have very little. In the old days, when AT&T was a widows and orphans stock, it was never expected to move much, but just pay out dividends.
Not necessarily.
If I buy a movie studio that makes successful movies, I will have a steady stream of money from the movies my studio makes. Even if the studio eventually goes bankrupt and nobody buys it from me, I will have made a lot of money* just from the product of the thing I bought* and not necessarily from having sold the thing I bought to someone else for a higher price.
If there are no dividends to produce a stream of income due to owning stock, selling it is the only way you are ever going to make money off of it. This is not true of all (or even most) investments.
The management you refer to are both in their 70s. There is a continuation plan in place. The company will not be broken up, and they are a lot more than an insurance company. It also happens to be trading at 1.67 times book value. A liquidation value would likely be significantly less, and as a big player in the reinsurance industry they are very susceptible to onetime events that may result in huge nonrecoverably outlays.
I understand your discipline, and I think it’s a good one.
I may have it wrong, but it appears to me that you and others are under something of a basic misconception as regards the valuation of securities, particularly equities.
The only thing that determines stock price is public perception. That’s it. If everybody thinks something is worth $20, than it is. Just like the dollar is a fiat currency that works by consensus, stocks are similarly unattached (provided we are talking about them strictly as investment vehicles) from a tangibility standpoint.
Things like dividends, earnings, liquidation values, “valuable underlying assets,” or what have you simply affect public perception which in turn is the sole driver of price. I would be the first to concede that a correllation exists between price and the metrics you use for valuation, but is fallacious to conclude that it is a causative one. Stocks can and do trade up and down outside of the ranges that your logic would dictate they should remain in, and sometimes for very good reasons.
When I teach equity and valuation models I point out that they are simply ways of looking at a company and trying to compare apples to apples. Companies like people need to be judged on their own merits (or lack thereof.)
Your system is a valuable one for judging Bonds, Reits, Utilities, and it’s quite sophisticated and reasonable. I’ll bet it works pretty well. One of the keys to success in investing according to Buffet is finding a strategy that you understand, and that makes sense, and that you can implement. Usually you can get it trouble when you are making investments without understanding why you are making them. Chances are a that a lot of other people in that investment also don’t understand why. That’s what I consider speculation. You should stick with your strategy. I’d only suggest that you not make the mistake of considering it universal.
Marcus Aurelius said words to the effect that for each thing we must ask what it is to itself. I think that translates well to stocks.
If you ask that question before applying a valuation method it can help you choose one that’s most appropriate.
Your model would work exceptionally well for choosing among utilities or companies that have a history or raising their dividends. You’re analyzing their ability to return capitol to the shareholders (which is a very reasonable way to look at things.)
There are risks inherent with your way of looking at things. You are specifically prone to wants known as a “value trap.” A nice example of a value trap might be a cyclical. Let’s say XYZ company makes cranes. Last year they paid a 3% dividend, and grew their earnings by 25% so that even though the stock went up 10% their PE is actually lower than it was last year. This year their business is exploding their earning are up 50% and they are raising their dividend. They have a five year history of accelerating growth, lots of cash, good management, the who tamale. You might be tempted to buy such a stock. What you might not consider is that the reason that their earnings are growing so fast is that ten years ago nobody was buying cranes and during the housing market boom there was a lot of aged equiptment that needed replacement and now everybody is in a panic to buy the cranes they need. The housing market appears to be slowing though so some of those orders may be cancelled. Even if they are not once everybody has a nice shiny new crane they probably won’t need another one for many years until the one they have today wears out.
Car Companies work this way, too and have historically represented classic value traps. You want to buy them when the earning are going into the shitter, they are cutting their dividends, laying off workers and can’t sell cars. The time to sell them is the year after everybody in the world has brought a new car, earnings and sales are high, and dividends are up.
You need to buy these stocks when they look like crap from every sane measurement and sell them when they look great, because if everybody bought a new car last year, they probably won’t buy another this year.
Currently, I am trying to decide if DE represents a value trap.
I would imagine without hearing you describe it further that it would apply less well to, say, small companies in developing markets, or growth companies like BRK, DELL, INTC, or MSFT during their high growth phases, and it would likely prevent you from investing from other companies in high growth phases.
Beleive it or not, there is a rational reason to buy GOOG today. We may argue whether or not it’s flawed, but it is completely rational.
The other issue is that if you buy stocks from the same sort of strategic thinking you will do very well indeed when the market favors that strategy and poorly when it doesn’t. Your type of strategy probably did poorly in the late 90s but has done very well since 2003. What you need is some noncorrellated assets. Find a fund or a strategy that is diametrically opposed to what you are doing now, and that has done poorly for the last five years or so and put a small amount of money in it. If your strategy falls on hard times for some reason, it is likely that the new one will do well and provide you with a source of appreciated capitol to invest in your favored strategy at bargain prices. Similarly as your strategy continues to make money, take a portion of profits and continue to feed your noncorrellated strategy.
That’s a principle that’s saved me more than once.
You should listen to me, I’m a professional with 15 years money management experience. Just be sure and read my disclaimer.
[sub]past performance is no guarrantee of future returns. Consult a tax advisor before investing. Principle may lose value. Your losses may exceed your initial investment. The investment strategies described herein have in fact been designed by a syphilitic hermit in a tangiers prison with the help of an imaginary cow, and an opiate addicted spider monkey who writes prospectuses for his fix. All profits described from the aforementioned strategies are known as a paper profits, losses however are real.[/sub]
The last part of that disclaimer is the best.
I left the market in 1999, bought a house. I remember looking at the market, deciding the only thing that made sense was gold, but realizing that it would be monumentally stupid to invest in that in the middle of that crazy bubble.
In the summer of 2000, I began to average into gold stocks. At that point, you would have had to be completely nuts to buy them on their fundamentals, because they had none to speak of.
However, they have been the best performing sector from that time to this. I’m still trying to figure out why I’m not writing this from my yacht in the Mediterranean rather than from my semi-modest home in an inadequately drained swamp in Northern NJ. Must be a conspiracy.
Which is a long way of saying, yes, I do know all about noncorrelating assets, and buying companies at the absolute bottom of their cycles. That was good advice you gave, though, especially that last sentence in your disclaimer, which is, tragically, very true.
However, getting back to Buffett and MSFT and all that, yes, it’s true I would have missed all those high-growth companies. But that doesn’t bother me much. The competition to stocks is bank accounts paying 3 or 4 or 5%, and I have done significantly better than that hurdle, which is really all I need. I’ll let you guys do the supercharged stuff.
But the valuation of Berkshire is to a large extent determined by the underlying asset of Buffett’s (and the rest of them’s) expertise, and the value of the stocks that they buy and of the insurance business itself. All of which is extremely valuable stuff to a private equity group or another company wishing to take it over. That payoff at the end of the rainbow is what underlies the stock, even if it’s a low-probability event. Just like it was for Equity Office and Sam Zell.
And the threat of having your stocks diluted by overissuance of options is very real if you’re investing in non-dividend stocks. In that case, corporate governance takes on an outsized importance. It’s the reason I thought making dividends partially tax exempt was a great idea, since it means that pushing a company into huge debt - which means the company pays a lot of tax-deductible interest - became not as great an idea as it was before. Something to think about.
Commissions.
Nothing succeeds like success. It sounds like you are doing quite well and therefore I would urge you not to do anything stupid that might change it… such as listening to me.
No. And, this is in my opinion, a critical misconception. Those things do not determine the stock price. What people think about them, does. BRK is one of those stocks that “everybody knows” is a great well-managed company. There are some excellent arguments that can be made that this is no longer so, and the stock is dramatically overvalued.
Ok, I suppose a takeover of BRK is, stictly speaking, possible. The reason that I chose that as an example is that is just really incredibly unlikely. First, the market cap is so large that it’s difficult to picture as a takeover. They, on the other hand, have enough cash and financing leverage to buy most anybody. Next, the stock is very tightly held. It doesn’t trade a lot of volume compared to it’s market cap. Holders tend to hold for the very long term and their are a huge amount of retail holders. It would be almost impossible to acquire anything close to a controlling block, especially when you consider what Charlie and Warren hold.
Never say “never,” but it’s really not a viable takeover candidate, and I doubt that anybody is buying the stock thinking of a takeover or a spinoff. Philosophically this is anathema to BRKs strategy.
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While I admire your discipline and think much of your strategy, you really are incorrect in this. BRK cannot be reasonably valued according to the criteria you describe. They simply do not apply to this circumstance.
Oh, I agree. Dividends are hard to fake. They do not, however make you immune to such or similar shenanigans. Dividends and options are not mutually exclusive, and there are quite a few pitfalls to be found in dividend paying stocks as well. Consider ALD with its rather juicy dividend of 8.7%. Historically, a lot of that’s been funded by secondary offerings to show one example.
I agree. Too, increasing the value of dividends is bound to enhance the value of companies that issue them and subsidize a less volatile and bubbly stock market.
Only if there are people willing to pay money to see those movies. The studio (and you, through them) invests money in each project assuming that there will be someone down the road paying more to see it than they spent to make it.
Rule of nature, you can’t make money on an investment unless there is another person in the future giving you the money. It doesn’t make sense to distinguish a person giving you money for your share in a company and a person giving you money to watch a movie your company produced. In both cases, your investment has given you an asset that someone else considers valuable, and that person compensates you in trade for the asset or use of the asset.
I think there is a huge difference in these two cases (not least of which: in the former case you are losing part of your company, and in the latter you are not).
You’re not LOSING something, you’re SELLING it. Selling things where ownership is transfered is not exactly unique to the stock market. People buy things on the expectation of selling them to someone else for more money constantly, they’re not all part of a ponzi scheme.
LET’S ALL START USING CAPS.
Seriously, can you not see the difference between making 20 million dollars from movie profits vs 20 million dollars from selling part of your studio?
But selling things where ownership transfer is the only way to make money is, I think, largely confined to the stock market.
In real estate, you could make money by renting the property you own, and not just from selling it.
In high-end art collections (i.e. the guys who pay millions for a Picasso) you could make money from exhibiting the art, and not just from selling it.
When you own stock, especially a small number of stocks, as is the case with most individuals, if the company is not paying dividends, there is nothing you can do to make money out of it, except sell it.
That seems to be unique to the stock market, though I expect someone will come up with some counter-examples.