Bear market mauls Buffett too
Bear market mauls Buffett too
'Many shall be restored that now are fallen and many
shall fall that now are in honor'
Horace–Ars Poetica
Ben Graham began his seminal piece on value investing with that quote, and several of his disciples built impressive records over many decades using it as their guiding principal. Buy established businesses when their share prices have fallen substantially and are out of favour, the theory goes, and sell them when the world comes to its senses. It worked for the best part of 70 years. Then, in 2008, it stopped working.
US fund manager Bill Miller outperformed the S&P 500 every single year from 1991 to 2005, building himself a record of outperformance that made him one of the highest profile value investors in the world. He bought stocks like American Express and Freddie Mac when no one liked them (usually during recessions) and sold them when the boom times returned.
When financial stocks plummeted towards the end of 2007, Miller began loading up on them again, buying the stocks he knew and in many cases the ones he had owned before. This time, however, low stock prices were not simply a function of investor irrationality. This crisis was different and Miller's purchases became the who's who of corporate failures: Merrill Lynch, Washington Mutual, Wachovia, Freddie Mac, Bear Stearns and AIG to name a few. In the space of 12 months, Miller undid 15 years of outperformance (see Bill Miller's defeat in The Wall Street Journal).
Value investors around the world have suffered a similar fate. We bought stocks we thought were cheap, only to see them plummet from there and, in many cases, permanently destroy our capital through share issues or insolvency. Even Warren Buffett has admitted to Berkshire Hathaway shareholders that he lost them substantial amounts of money in 2008. His investments in two (unnamed) Irish banks have declined more than 90% since his purchase last year and, by his own admission, the losses are permanent, not temporary.
While minuscule relative to Berkshire’s capital, the investments are Buffett's worst ever in percentage terms (of those we know of, at least). Even the great man has been fooled by the great value illusion: what seems to be there one day isn't there the next.
Edward Chancellor, author of Devil Take the Hindmost and columnist with breakingviews.com, has called it the Death of value investing (you need to sign up for a free trial). I wouldn't go that far but it's clear this financial and economic crisis is different to anything Warren Buffett has experienced. Unless you're an octogenarian, that makes it different to anything you or I have seen either. It's time to tread extremely carefully.
Note: Greg Hoffman published his analysis of Buffett's letter on The Intelligent Investor, or you can read it yourself at berkshirehathaway.com. If there’s anything you'd like to add, post it in the comments box below.
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It's got to make you feel a lot better to see investing legends like Buffett and Bill Miller making mistakes as well.
"Value investors around the world have suffered a similar fate. We bought stocks we thought were cheap, only to see them plummet from there and, in many cases, permanently destroy our capital through share issues or insolvency."
Is the logical conclusion of this that value investing no longer works ?
"Value" investing always works long term but you have to make sure you're buying value. What one make think is value may not be. A company trading at below their cash backing with zero debt would be sure value long term. They are hard to find on the ASX but there are a couple on the NASDAQ.
As long as it is a company with a future, which can recover to reasonable levels of return on its capital, OR is a company run by rational (and preferably owner) managers who will liquidate the business rather than destroy it's capital. Ie, if your managers are rational and have integrity, then the 'long term' is your friend, otherwise it's probably your enemy.
Isn't it bazar? Usually people question the worth of value investing during boom market conditions. Here we are, in the clutches of doom/gloom/armageddon - and people are questioning its worth. But we've got to ask ourselves, if value investing doesn't work, then what does? - momentum, charting? Perhaps the best lesson we can take is that human being are just that - human. The moment we start idolising, then we are probably becoming irrational - and THAT is a value investors worst enemy.
"if value investing doesn’t work, then what does? - momentum, charting?"
Maybe nothing works any more, at least not at the moment.
" but you have to make sure you’re buying value"
And how do you do that exactly ? If the best (Buffet, Miller) have failed, what hope do I have ?
I'm beginning to think whoever said the whole sharemarket is one giant Ponzi Scheme could well be right :-)
I find Chancellor's argument a bit silly. Buying stocks for less than they're worth will always work. If we suffer permanent impairment (measured over the long run), it's because we got it wrong and bought stocks for more than they were worth. There are two reasons the investing community is questioning value investing today - the first is that perceived 'value' stocks (low PER, low price to book, high dividend yields) have performed as poorly as other securities the past 18 months. And the second is that most value investors, ourselves included, got it wrong and suffered in line with everyone else. When the market got so advanced that there was nowhere to hide (unlike during the tech boom), we should have been moving more to cash or other safe havens. One should regularly question how they execute the principles of value investing, but the principles themselves are sound and will always be relevant. The falls of the past year have significantly improved the odds of great returns for good value investors over the next decade or two, so don't lose faith.
Sick of fawning and hero worship of financial guru's who are way overated and followed like messaihs.
Atleast with this debt deflation we won't hear so much of their advice.
Buffet,Peter schiff and Jim rogers they all got it wrong and some of their investors are down 40% to 80% .
Buffett buy and hold zealous plan has never been tested in a long bear market like example Japan.
Like Nassim Taleb said richest traders are often the worst traders as the most successful traders are likely to be those that are best fit to the lastest cycle.
Good example is Macquarie Bank with easy credit and high overvalued highly in debt assets.
A sample path that was free of the evolution rare event and longer these animals can go without encountering the rare event the more vulnerable they will be!
Stephen Johnston
Very true. During the boom we should all have read and re-read, and re-re-read, Ben Grahams "The Intelligent Investor". He would have counselled putting a fair chunk of ones portfolio into high quality bonds. Sure, the yields were low on these, but hey, so were the earnings yields on shares - and that is the point.
I agree, idolising is never good and impairs thinking - and is probably not the mindset of the true value investor. However, I think it's all a bit knee-jerk to proclaim that the likes of Warren Buffet have failed. EVERYONE makes mistakes. A mistake in one year, or even one economic cycle, does not necessarily undo a lifes work. As for 'zealous plans' - I would have a thought a long bear market is even more reason to focus on value.
In my humble opinion - proclamations of the death of value investing are likely to provide the juiciest opportunities. We can buy a bigger slice of the economy for less - what more can we want?
Firstly, using Berkshire Hathaway's performance measure of relative performance of per share book value compared to the S&P 500 they have just had their 7th best record in the entire 44 years of reported results. Their 44 year gain has been 362,319% versus 4,276%. There are many reasons this will not be repeated but the "death of value investing" seems premature.
It seems to me from reading the annual reports over several years that Buffet has got a little lazy on some of his analyses behind his acquisitions. Maybe he has been too quick to "like" the way an old family company does business and just shake hands and do the deal.
Where he still seems to excel in my view is as a poker player, calculating risks using basic principles as outlined in the setting up of BHAC in 2008. He seems good at letting heavy things weigh heavy and light things weigh light.
If we (and TII) had have had the courage to take appropriate action when TII was giving good reasons why profits would not defy gravity forever we would not be looking for someone to blame at present. It is my proposition that the principles are as sound as ever but the appliction of those principles as difficult as ever.
I think you're spot on David and courage is the right word. Or perhaps conviction. I re-read that article more than I should (we published an article titled Profits won't defy gravity forever way back in 2005), and today I stumbled across Hangover will follow global binge from June 2007. I still scratch my head as to how we got so many buy recommendations wrong given such an accurate macro view, but a lack of conviction or confidence probably sums it up.
"Buying stocks for less than they’re worth will always work."
How do you know that ? The problem is how do you accurately value a stock ?
The value of those stocks can and has changed, sometimes dramatically and swiftly, leaving holders in the lurch.
Just because something has always worked doesnt mean that it will continue to do so - especially in these unprecedented economic times.
If something can be bought for less than net current assets then I would say you have bought it for less than it is worth. And we have seen stocks trade on this basis lately, RHG for one. From that point on ‘worth’ is of course subjective. But, still, if somebody came to me and said, ‘I want to sell you my business for 2x earnings, it has no debt and low capital requirements’, then I’d probably say it’s worth a shot. For that matter, 3x and 4x doesn’t sound unreasonable either (FLT anyone?).
If this sort of ‘value’ can’t tempt people then maybe the stock market is not for them. Maybe they should take shelter under a negative, zero, or near zero yield on government bonds?
My understanding on Mr Taleb’s argument is that traders, and others, take naked risks that if they pay off, pay off big time, and if they blow up, they blow up more than the previously accumulated profits. This seems to mis-understand what Mr Buffett has done, which is to write an insurance policy over various stock indicies that has a capped liability (at a small % of book value), requires the premium to be paid up front and does not require any collateral to be posted until maturity. I would say this is the exact opposite of Mr Taleb’s ‘Black Swan’ trade - or Mr Buffett’s ‘picking up pennies in front of a steam roller’ for that matter.
I have just come home from a breakfast with a mate of mine who has just lost his job as an analyst with a Brisbane broking firm. I will not go into all the details but we spoke about the markets of course and broking analysts etc etc. He reminded me that analysts are not machines. They are human beings and as such, they are the same as you, me and anyone else. They do panic, they do get scared and in the case of the broking firm he worked for, the majority of analysts had only ever worked in a bull market and the one's that had worked in bear markets were so "beat up" that they had also lost their nerve. They are simply washed out, beaten and when fundamentals mean next to nothing in the short term, why would an analyst bother going against the current sentiment. He also said that there was lots of friction between analysts and dealers because the dealers cop the brunt of it from the retail clients. When analysts have been saying BUY BUY BUY on a certain stock all the way down and then when the stock has lost 90%, they say SELL, it doesn't go down too well with the dealers who have put clients in at higher prices. An interesting chat it was.
An example of an analyst "going to water". This is hot off the press from ABN Amro Morgans. Note he values the stock at $1 but applies a whopping 95% discount...just in case.
"Valuation and target price trimmed . We have reduced our underlying valuation to A$1.00/share and target price to A$0.05/share. While we believe there is long-term value in BBI.s portfolio of assets, until a substantial portion of debt is removed, we struggle to see the stock trading above current levels which is why we apply a 95% discount to our fair value."
Complete BS. These people were irrational at the top, and now they're irrational at the bottom. That's why we musn't be too harsh on TII - we don't want their valuations/assessments to be too undully influenced by all tghe negativity surrounding current results. Personally, I place more credence on the words that TII utter, their principles and insights, than on their results over the last 7 years. Placing too much emphasis on results over this relatively short time span, especially when current performance is heavily weighed by a serious bearmarket, can be misleading.
We should be watching share prices which reflects the sentiment , if seemed a good buy , no matter how "good" the company is, sell again if it reaches the buy price , must not , hold for _any_ reason . No place at all for emotions or second guessing (crystal balling )in these times .
I disobeyed this rule , just after buying in , the rest is history , 24hrs later it bit me and gapped down on open. Ouch ! It worried me so me much , because I had borrowed some of the $$ I sold and made the loss from paper to reality .
Please be careful what you do , or the dog will savage you too .
If it worried you so much why did you even bother buying in the first place. No room for worry or emotion in this market or any market. If the kitchen is too hot, exit.
Let me put up the ultimate contrarian view - my father in law has just spent an hour telling me about 10 ways that he is currently trying to make money out of the markets with the overriding assumption it will decrease (CFD's puts, calls swaps - blah blah blah).
I have formed the view that with increased real time information, ease and cheapness of trades etc that the market is purely a large casino where the majority of money is not there for value investing rather put in and out at great velocity (unprecedented volatility) and that the pain that can be caused my massive decreases in share price (driven by the thousands of people like my father in law) now represents the real power in the sharemarket.
If we assume that the past 3/4 years have been irrational or a mirage for many business, I fail to see the scenario in the future where normality returns.
I also feel we can forget about paying anything more than 4-5 times earnings for any business in the future - 99% of the market is not looking to the long term.
All very interesting; in fact I was very recently told by an extremely reliable source that one of Buffett's key (non-investing) lieutenants, whom I consider to be of genuinely comparable calibre to Buffett, is presently applying a cost of equity of around 50% p.a. to his calculations!
That fact more than anything else drove home to me just how unbelievably extreme the current situation is. Although I'm personally still buying stocks with my ears pinned back; I constantly explain to friends and family that there is nothing to stop indices falling a further 75% or more from here.
So you're saying there is now more volatility, and there will be more in the future too. Surely this only benefits the value investor, and only increases the chances of stocks being available for "4-5 times earnings". If you buy because you want to buy a big chunk of earnings, or of dividends, or of assets - then volatility has to be a good thing. If you're buying because you want to be vindicated by the market, or because you want to make a quick capital gain - then I suggest you look into the mirror and ask yourself, "am I thinking like a value investor" (Sorry to be preachy!).
Steve
I refer to the excellent comment by David Groom and to your very appropriate response.
It is always a comfort to me that I.I. readily admit to their mistakes. I make these points:
As David said, and as I have previously said to you, I.I. gave subscribers ample and early warning of the impending risks. As subscribers we only need to look at our own actions.
Many of your critics should re-read the 2005 and 2007 articles that you referred to.
As you observed, there is a clear incongruity between the I.I. macro view, well prior to this crisis, and many of your buy recommendations. As some of your other subscribers have inferred, this crisis even as early as 2007, has always looked like a big one.
There has to be something that I.I. can learn from this. Perhaps all the I.I. analysts also need to re-read your own well written warnings.
The fact that I.I. is self critical gives me confidence. Good Luck.
I think you're exactly right, Steve. I sold out of LPTs early on your advice (thankyou) but hung on to other stocks which have fallen a long way since. It's hard to sell seemingly good companies when their price is high and the future looks rosy. Anyway, buying good companies below their true value and holding should work over the long term - the hard part is knowing true value and then knowing when the value becomes overstated. That's why I subscribe to TII and hopefully you won't make too many mistakes in the future - after all, we've all learnt a few lessons recently, haven't we?
Rene
In adding to the David, Steve and Russ show above:
David, an excellent summary and really like the observation/quote:
"It is my proposition that the principles are as sound as ever but the application of those principles as difficult as ever."
Steve, an excellent response also.
One must balance TIIs macro calls with the business of essentially providing equity recommendations. If they were entirely 'sell' calls, the average subscriber would really struggle to comprehend what they were paying money for.
On that note, Buffett is still probably one of the only managers of funds EVER to have made the call to wind up his operation (BPL) and give everyone their money back (pre BRK) when the market reached levels he could no longer justify.
I think one of the reasons for having the buy recommendations wrong in the last 12 months is that we're in something unusual. With the exception of the Great Depression (about 50% fall at the start and then a gradual decline to 90% down over a 3 year period), the recessions in between have been fairly short-lived.
So you analyse, expect to find value, and then the next left-field event comes along rendering the analysis invalid.
The value investing approach is still perfectly valid. Right now, its a matter of finding well-priced stocks that won't get clobbered further. Ideally, well priced stocks bought close to the bottom to yield impressive results. But we don't know where the bottom is - perhaps we've not found it yet.
The proof will be found 10 years from now, not next week, next month, or next year.
The Death of Value Investing? Surely not. Ben Graham himself got severely burned in the Depression when the same thing happened as has happened now - after a large initial drop, valuations fell much more. He had already borrowed money and loaded up, though. It was only AFTER this had all happened tat he invesnted value investing.
Spot on, Craig. In fact, Ben Graham's disastrous experience with debt through that period has always served as a salutary lesson for me regarding margin debt. If Graham could get caught, then it could happen to anyone. And, unfortunately, it seems to have happened to too many Australian investors and I feel for them. Dealing with this market when you've invested your savings is tough enough, let alone adding other people's money and paying interest on top.
I noted the latest figures from the Reserve Bank of Australia (for the December quarter). Unfortunately, but not unsurprisingly, they showed the highest number of margin calls since the RBA began gathering the data in late 2000. The figure was an avergae of 9.77 margin calls each day for every 1,000 accounts. And with more than 205,000 accounts nationwide, margin clerks would have been well and truly earning their keep in recent months.
Anyone looking for coverage of Warren Buffett's lengthy appearance on CNBC yesterday can follow this link to the appropriate part of the CNBC site.
Agree with most of the comments,...could there however be a place for some technical analysis alongside the value investing at TII? I cannot see the point of buying a business that is trending down and having to 'sit it out for years' while the market decides to like it (recognise the value) again. To make money we are relying on the instos buying the company eventually and if the price is falling there are more sellers than buyers so why not wait until it had stopped falling then pull the 'BUY' trigger. Just a thought!
Regards
To make money you should be buying a nice chunk of annual dividends - or earnings that you hope will one day become dividends. Otherwise, you should be buying a nice chunk of assets, that will be somehow distributed back to shareholders, or will one day result in lots of earnings. Easier said than done, I know... but them's the brakes! If the market one day offers us more than what our asset is worth (in our own estimation) - then that is a bonus. Relying on the market giving more than what something is worth, however, is speculation - which has nothing to do with value investing.
Why does there have to be something that works? We have to remember we're dealing with predicting the future. Should we be surprised that, in 2006, we were not able to predict the regulator's decision to let Lehman's go bust in 2008? I don't know of a method that can reliably predict things like that. It's almost like asking "Why can't I predict who my grandson will marry?" or "Why can't I predict the age of my death?"
I'm reminded of the quote "Predicting is hard, especially about the future."
It's not a question of predicting. It's a question about putting the odds in your favor. That's what value investing is all about. You can't predict how long any particular person is going to live, but you can bet that those that don't smoke, have a healthy diet and regular exercise, are, on average, going to live substantially longer. That's what value investing is about.
Totally agree. Value investing is an inaccurate description. A more accurate description is business investing. When you invest in a business, let's say a start up, you use capital to lease space, hire staff, fitout, marketing, etc. All this capital is gone, and the most likely way to recoup your capital is from business takings. Once you have business takings, you may get lucky enough to be bought out, but that is a secondary consideration to ensuring earnings. Value investing is really applying this to shares. You work in a margin of safety, which is really a discount for owning a business without the control premium. The fact that shares can be readily sold is the little devil that stuffs everything up.
Once you start talking about odds, it sounds more like gambling to me. You can get favourable odds, but if things don't go your way, you'll lose the bet. And issues with approaching this from a rational, odds calculating approach is that 1) you cannot reliably determine the odds in the first place, and 2) even if you're able to, odds change. Bill Miller would've taken the approach you described, and look where that's got him. I'm not saying that I think value investing is dead, but just that there's a lot less certainty of making money than most think there is.
Now that the dow jones is up 10% because of profits from Citigoup Bank and GM needs no more cash.
Is it good value buying?
Buffett would think so Goldman Sachs and GE.
Suppose when your stealing taxpayers money and you don't have to mark to market your crappy low quality assets any idiot could make a profit and it looks like the market agrees.
This is unsustainable and we are a long way from the bottom.
Value buyers beware!
Stephen Johnston
Without getting into the specifics of Bil Miller, 'betting' when the odds are heavily in your favor cannot be considered gambling, in any meaningful sense. If someone offered you $1 for making a correct call on a coin toss, but charged you only 50 cents for the privelige, then you would be silly not to take the 'punt'. Ofcourse, you have to have confidence and self belief in your assessment of the odds. And the less certainty you have, the greater margin you need. In the end, it comes back to putting the odds in your favor.
OK, my numbers above are up the creek! You would be 'silly' to waste your time on the above punt, as eventually you would only break even. If you were charged only, say 30c for the punt, THEN you would be foolish not to take it(!!).
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