Latest memo from Howard Marks: Something of Value

[specuvestor]

Inversely, Book Value is the best ESTIMATOR of intrinsic value for Berkshire value for past 50 years, if one doesn't want to spend too much time in different components of the businesses. To be roughly right rather than precisely wrong

And this book value, over or understated, affects the ROE of the entity so it helps to balance out in some sense when you adjust by price to book that you pay. Understanding the underlying business and cash flow is always better without a doubt.

As for tech stocks it's similar in that you pay high price to book but your ROE adjusted by price to book continues to grow. The problem with tech is as per my example above, the difficulty to forecast earnings stream in the development stage.

And just a side note on Amazon, which is not a development stage company anymore, it's interesting that till now few people realise their strategy is simply to have zero profit and cashflow positive, not aiming for negative profit or cash burn like many startups. You can have zero profit for extended period of time; but you cannot have negative profit for extended period of time. So the business model actually already shows that profit is not a good way to understand the company

In 2016 retained earnings was $4.9b from $1.9b in 2012; vs $52.5b in 2020, when past few years they have been finally shifting on raising operating margin to monetise their mindshare. End of day still their ability to GROW the book value via ROE over time period (that you are able to stay with them). When their ROE comes down their price to book will also come down.

Berkshire Annual Report consistently use Book Value as an indicator of worth

..

In the past, Book Value has been used by Berkshire as a rough (quick and dirty) proxy of it's intrinsic value. 

2000 Shareholder meeting (https://finance.yahoo.com/news/warren-bu...49202.html):

In our case, when we started with Berkshire, intrinsic value was below book value.

Our company was not worth book value in early 1965. You could not have sold the assets for that price that they were carried on the books, you could not have -- no one could make a calculation, in terms of future cash flows that would indicate that those assets were worth their carrying value. Now it is true that our businesses are worth a great deal more than book value. And that's occurred gradually over time. So obviously, there are a number of years when our intrinsic value grew greater than our book value to get where we are today...

As Berkshire's business and portfolio change over the years, its intrinsic value's correlation with book value has drifted further and further apart. 

2018 Shareholder's letter (https://www.gurufocus.com/news/1319777/b...ires-value):

The fact is that the annual change in Berkshire's book value which makes its farewell appearance on page 2 is a metric that has lost the relevance it once had.

Three circumstances have made that so.

First, Berkshire has gradually morphed from a company whose assets are concentrated in marketable stocks into one whose major value resides in operating businesses. Charlie and I expect that reshaping to continue in an irregular manner.

Second, while our equity holdings are valued at market prices, accounting rules require our collection of operating companies to be included in book value at an amount far below their current value, a mismark that has grown in recent years.

Third, it is likely that over time Berkshire will be a significant repurchaser of its shares, transactions that will take place at prices above book value but below our estimate of intrinsic value. The math of such purchases is simple: Each transaction makes the per-share intrinsic value go up, while the per-share book value goes down.

That combination causes the book-value scorecard to become increasingly out of touch with economic reality."

A simple demonstration why Book Value is a poor indicator of Tech and Growth companies in general. Amazon's book value in early 2016 was approximately $15bil and net income was $1.1 bil; market cap was $300bil (20x price to book).

Today it earns around $27bil TTM net income on book value of $103bil. 

Most analysts' linearly extrapolated projections would have missed the mark by a large degree. But analysts who understood exponential growth rates, market strength (near monopoly), and TAM of it's retail, ads and AWS businesses would have understood why it was valued that way.

[Wildreamz]

Sharing something I read that reminded me of this thread.

Michael Batnick is one of the hosts of The Compound financial podcast on Youtube (https://www.youtube.com/channel/UCBRpqrz...ZcWw75JSdw); in 2017 he published an article titled "My Friend is Beating Me" (https://theirrelevantinvestor.com/2017/0...eating-me/).

In 2017, people who simply invested in FAANG stocks in the past years, have beaten the market by a large margin. Some quotes he brought up:

“It is strange the way the ignorant and inexperienced so often and so undeservedly succeed when the informed and the experienced fail.” - Mark Twain

"First-level thinking says, “It’s a good company, let’s buy the stock.” Second-level thinking says, “It’s a good company, but everyone thinks it’s a great company, an it’s not. So the stock’s overrated and overpriced; Let’s sell.”

First-level thinkers see what’s on the surface, react to it simplistically, and buy or sell on the basis of their reactions. They don’t understand their setting as a marketplace where asset prices reflect and depend on the expectation of the participants. They ignore part that others play in how prices change. And they fail to understand the implications of all this for the route to success."

-Howard Marks

In this case, what would "Third-level thinking" look like?

Perhaps an old Chinese saying fits the bill: "大智若愚: 真正有才智的人表面上像愚笨的。 形容有大智慧的人因超出常人不被理解，其言语行为被人看作是愚钝的。"

Maybe the simplest decision-making procedure is actually also the best: i.e. the best returns are generated by investing in the best businesses and managements (with significant stake in the company, whose long-term goals aligns with shareholders and stakeholders) for the long-haul, and having the stomach to ride out market volatilities.

Of course, this sounds simple but not easy. To identify good management, one needs to be a good judge of character, motivation, and business acumen. To identify good businesses, one needs to understand long term market trends, and competitive landscape, even when it is not obvious from the beginning. To ride out market volatility, one needs to have the temperament and mental tenacity to remain focused on the facts on the ground (business performance) instead of short-term price movement against your position.

Perhaps, his friend that beaten him, isn't as ignorant as he seems on the surface.

2c.

[specuvestor]

The best decision process is tested over a cycle. Not over a bear market or a bull market. Bitcoin made that even harder to gauge with FOMO So the verdict is still out if his friend beat him without going through a bear market

Amazon is an outstanding survival of dotcom but in my memory 9 out of 10 dotcom flopped. Out of the FAANG stocks Microsoft was not even considered dot com while FaceBook, Netflix and Google was not even listed while Apple was then struggling. Like Buffett's presentation during AGM last month on the automobile boom, in 20 years it's quite a story to tell, just as now 20 years after dotcom. In my view 10 years from now will be sufficient to see who has been swimming naked.

But I agree that long term investors should look at owner, management, business model including Porter's 5 forces, cashflows (I use the A-B-S framework) And as Buffett realised, over longer term it's better to buy a good business at fair price than a fair business at good price.

[Wildreamz]

IMO strive not to invest at the peak of exuberance (e.g. peak of Dotcom) but early in the growth phase (e.g. Amazon at IPO, or in 2002 when it's clear they will keep growing and survive), or when the company is already winning (e.g. in 2012 - 16 when there are years of data to back that up).

But on hindsight, even those who invested in Amazon at the peak of the Dotcom bubble, did well for themselves. So maybe I'm overthinking it as well

Edit: Would you consider early 2016 Recession, late 2018 Tech Rout, 2020 Corona-Correction etc.; bear markets?

[specuvestor]

As any good marketing person would tell you: just adjust the dates to get your desired results

If you bought Amazon at around peak 31 March 2000 you would have lost 90% 18 month later. Whether you have the conviction to hold on for the subsequent recovery is another matter. That's why even when I'm a believer of value investing, I don't believe in buy and forget ie I believe in cut loss when things change.

So are those bear markets will depend on when you define the bull market Then again I personally believe and of course hindside that Amazon is an Alpha stock. If you have bought a basket of dotcom stocks with equal weight and held for 20 years, what would your portfolio return be?

[Wildreamz]

As any good marketing person would tell you: just adjust the dates to get your desired results

If you bought Amazon at around peak 31 March 2000 you would have lost 90% 18 month later. Whether you have the conviction to hold on for the subsequent recovery is another matter. That's why even when I'm a believer of value investing, I don't believe in buy and forget ie I believe in cut loss when things change.

So are those bear markets will depend on when you define the bull market Then again I personally believe and of course hindside that Amazon is an Alpha stock. If you have bought a basket of dotcom stocks with equal weight and held for 20 years, what would your portfolio return be?

Dotcom is a single event, you could have invested in a pure Dotcom stocks portfolio exactly at the peak (and not added any more money after that, for 20 years), or you could have maintained a traditional 40-60 portfolio (10 year Treasury was 6% during Dotcom peak) before the boom and after the crash. I don't think buy and hold is necessary all-in the same counters for 10-20 years with 0 recalibration; i.e. when fundamentals of the companies you invest changed (e.g. you invested in Yahoo pre-Google) you are free to sell out and change position. When it is clear that price is depressed even though fundamentals are improving (e.g. Amazon post Dotcom crash) you are free to add, or even go all-in (like Bill Miller did during 2008 and Covid Crash: https://www.businessinsider.in/stock-mar...259310.cms).

Another case in point, I sold out of Facebook a few years back after it is clear to me that management do not respect their users and is slow to innovate. I have not looked back since.

[specuvestor]

Bill Miller is one of the investor that I respect but he also basically lost his job and 16 years track record by averaging down financials during GFC. So that's the flip side that I see as well

Though he was eventually right... Just as Nick Leeson was eventually right. Asset allocation is important if one doesn't desire the lifestyle of "hero or zero" type of situation.

So whether his call on Bitcoin etc is eventually correct will depend on what he or ARKK does when things change.

[Wildreamz]

Bill Miller is one of the investor that I respect but he also basically lost his job and 16 years track record by averaging down financials during GFC. So that's the flip side that I see as well

Though he was eventually right... Just as Nick Leeson was eventually right. Asset allocation is important if one doesn't desire the lifestyle of "hero or zero" type of situation.

So whether his call on Bitcoin etc is eventually correct will depend on what he or ARKK does when things change.

Yes, he not just averaged down on financials but used extensive leverage, which got blown up. All things considered, he made 1 really bad call in his career and still managed to come up on top. Full props.

[Wildreamz]

Howard Marks: Ben Graham Centre for Value Investing's 2021 Virtual Value Investing Conference

[weijian]

I am a subscriber of Howard Marks' pendulum model. It is not perfect but it is considerably a center piece in building an arsenal of tools (or swiss knife) for my OPMI journey.

Markets can be overvalued or undervalued for long periods of time, and hence valuation isn't a good timing. But swings in market psychology might be a better indication. Again, it is not perfect but could be approximately correct.

Bull Market Rhymes

In the happy season (all of a year ago), the tech bulls said, “You have to buy growth stocks for their decades of potential earnings increases.”  But now, after a significant decline, we instead hear, “Investing based on future potential is too risky.  You have to stick to value stocks for their ascertainable present value and reasonable prices.”

Likewise, in the heady times, participants in IPOs of money-losing companies said, “There’s nothing wrong with companies that report losses.  They’re justified in spending to scale up.”  But in the present correction, many say, “Who would invest in unprofitable companies?  They’re just cash incinerators.”

https://www.oaktreecapital.com/insights/...ket-rhymes