Back of the envelope 2y

Stocks A to Z
#5

“It’s pretty likely that prices will get cheaper, but ignore that. Nobody calls the bottom, and we might already have seen it. Who knows?
Don’t let the attempt at perfection get in the way of the very good.”

Thanks Jim for sharing all of your data, process, experience and even your “feel” especially during times like these. I subscribe to your philosophy above.

I have received a partnership buyout and have just entered early retirement phase. I am planning on taking all of the buyout money and buying more BRK given its current discount, safety and predictable earnings and returns over time. I am also currently sitting on cash covering 3-4 years (too much, I know) of expenses and have been nibbling BRK as it has been falling. BRK is already >60% position, but it is particularly attractive down here and I must anticipate a draw down phase in a year or two.

Please feel free to share any other thoughts that come to mind given my situation and thinking. Thanks.

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#6

Please feel free to share any other thoughts that come to mind given my situation and thinking.

Doesn’t seem like anything crazy in there.

For those who join me in the empty room of Berkshire investors who try to predict stock markets:
My indicators of market bottoms are silent so far.
To the extent that a spreadsheet can have an opinion about emotions, it sees insufficient panic and indiscriminate selling to call it capitulation yet.
Another 2-3 days like Thursday would change its mind.

I mention it because, with the tight short term correlation between Berkshire and the S&P recently,
it seems there is a decent chance that the market bottom will be a good day to buy Berkshire.
And, by extension, the day that the market bottom detector triggers might be an above-average day to buy.
Or not, of course.

The interesting thing to me is the sector divergence, in the sense that some things have sold off enough to become cheap, others not so much.
Taken overall, US stocks still look like prices are building in a lot of optimism.
The implication is that the market might have a lot more to fall (always possible), but in this case it might also have a sensible reason to be expected to do so.
For us, the implication is that Berkshire might possibly trade way lower following the market (briefly), whether rational or not.

One metric I watch is the median price-to-sales ratio among non-financial S&P 500 firms.
P/S is a terrible metric for a single company, but for a large group it’s not so bad.
It gets rid of most of the wild cyclical variation of earnings–sales are much steadier.
And clearly earnings and value can’t rise faster than sales over long periods.
Anyway, that median figure is 3.23 right now.
It never exceeded 2.0 in all of US history prior to October 2013.
Times have been good and taxes have been low, but is a dollar of sales really worth more than 1.6 times what used to constitute an all time record?
This isn’t just a few outstanding firms–this is the middle of the pack boring big company.
This metric usually gives a message pretty similar to the ratio of market cap to GDP,
but it takes out the variables of a varying fraction of private companies and the problems of exporting and importing firms.
The median P/S metric uses the same set of firms for the numerator and denominator.

FWIW, market cap to GDP gives a similar result. Despite the sell-off, it has merely fallen from
over 200% of its average since 1970 down to 162%, still higher than the pre-Covid all time high.
Maybe the “new normal” valuation level is higher, but not THAT much higher. It peaked at 140% in the tech bubble and 105% in the credit bubble.

Jim

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#7

Congratulations on the buyout and early retirement! Nice to see a happy result.

Question, why the VIG and VUG instead of just Berk? Honest question. Just looked at the comparative performance and VUG only beats because of this last year…Will it continue to from here, though? Seems like an aberration that will be averaged out going forward.

But what do I know?

#8

The interesting thing to me is the sector divergence, in the sense that some things have sold off enough to become cheap, others not so much

In the past market bottoms also, some sectors (for ex: high growth, tech names) have bottomed at least 1 to 3 month ahead of Index bottom AKA market bottom. The big companies of the Index, so called generals, will bottom along with the market/ Index. I consider Berkshire/ Apple’s big, generals.

Some of the fintech names have seen the low’s of the cycle it seems. You may want to nibble those names and wait on Berkshire, Apple.

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#9

Nice. Thanks for sharing, Jim. Gotta love that steady growth in BV/share and in estimated value/share. Just wondering, though, how your forecast changes if you use today’s approximate P/B (maybe 1.34?) rather than P/March 31 BV(1.16). Thanks.

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#10

Times have been good and taxes have been low, but is a dollar of sales really worth more than 1.6 times what used to constitute an all time record?

Jim,

As someone who rarely posts I would like to express my appreciation for your many and varied comments and thoughts.

This one is especially interesting to me as I am sure we have further to fall but unsure, of course, how much further. Your figures suggest a possible further decline that is far more than I had considered likely.

As a UK based investor the UK and other European markets are less highly priced than the US so I have that to consider but still, another 30% or so as a possible further fall is an interesting thought. I clearly need to think more about when to start nibbling away (albeit mainly at my preferred small caps).

This board is an island of sanity (bar a couple who are blocked) that is quite rare, even more so now than is usual. Long may it continue.

deucetoace

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#11

Remarkably steady!
I guess the inflation adjusted share price, suitably scaled with some multiple to fit on the graph, noisily oscillates around the trend.

#12

Nice. Thanks for sharing, Jim. Gotta love that steady growth in BV/share and in estimated
value/share. Just wondering, though, how your forecast changes if you use today’s approximate P/B
(maybe 1.34?) rather than P/March 31 BV(1.16). Thanks.

Certainly book value will drop when the June 30 statements come out.
But I have found it doesn’t matter much. All such drops are transient.
Peak-to-date book per share, which I’ve been using, is a better predictor of forward returns than simple most-recent book per share.
More importantly:
Remember that book is just a proxy for the value of a share; the value is higher now than it was at March 31, not lower.

Of course, a formula based on book value will change.

But I also use models which include a big haircut on any overvalued positions.
The predictions are lower, but not that much lower. The general conclusion is that it’s a good time to buy.
Not the best time ever, but much better than average.

Jim

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#13

But I have found it doesn’t matter much. All such drops are transient.

Does in the past, Berkshire had any investment like Apple which is significant, like 40% of its equity portfolio, almost 10% of its Book? If Apple goes to < $100 and stays there for couple of years (think of post dot.com Microsoft to any number of solid tech companies), are there sufficient drivers in Berkshire portfolio (not just equity, operating business, etc) to overcome such a hit?

Separately, the word “transient” is not evoking any positive feelings. LOL.

#14

<f Apple goes to < $100 and stays there for couple of years (think of post dot.com Microsoft to any number of solid tech companies), are there sufficient drivers in Berkshire portfolio (not just equity, operating business, etc) to overcome such a hit?>

BRK’s operating earning is about $28b in 2021, it would take about 2.5 years to make up the $70b loss if Apple stock drops to $100.

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#15

if Apple drops to $100 I suspect Berkshire would take their position up to 10%

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#16

Times have been good and taxes have been low, but is a dollar of sales really worth more than 1.6 times what used to constitute an all time record?

…
This one is especially interesting to me as I am sure we have further to fall but unsure, of course, how much further.
Your figures suggest a possible further decline that is far more than I had considered likely.

Well, the future is uncertain.
I’m not predicting such a big fall.
I rather expect some low prices in the next couple of years, but that’s not at all the same thing as predicting it. A prediction requires a justification. (for me)

Net margins are very high in the last few years in the US in particular, so profits are very much higher.
Ultimately it’s the profits that matter, not the sales, so to that extent it really is “different this time”, for now.

The difficult part is deciding how much of the increase in profitability (particularly net margins) is lasting.
Partly it’s because of lower taxes, partly it’s because labour has had to compete globally instead
of locally and so is now taking a much smaller share of the pie, and partly it’s just the business cycle.
A minuscule amount is because corporate debt service costs are very low.
How many of those are permanent effects, and how many are transient?

The #1 rule for macro is never to mistake the cycle for the trend.
I’m willing to extrapolate that microprocessors will get faster, but not that net margins will keep expanding.
After the obvious things like that, it’s a tough call. Will labour regain its mojo? Beats me.
Conservatively, given my uncertainty, I’ll pick something in the middle:
It truly is a bit different this time, so profitability and valuations will be on average higher than they averaged in the Olden Days.
But not THAT much higher.

Jim

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#17

If Apple goes to < $100 and stays there for couple of years…
…
BRK’s operating earning is about $28b in 2021, it would take about 2.5 years to make up the $70b loss if Apple stock drops to $100.

For a long term position, the question is whether the drop to $100 is a drop in price or a drop in value.
A share of Apple appears to be worth more now than it was at the beginning of the year in every meaningful way I can think of.
Higher cash balance, higher rate of trend earnings, lower share count and so on.
Does the drop in market value really matter to someone not intending to sell for years?

Sure, it’s useful to pay attention if the price is really high and you think you might sell.
Or if it’s really low and you think you might buy.
But otherwise? Nah.

The market price is just the most recent observation of the price at which one guy (or bot) sold to one other guy (or bot).
That seems much less important. The only thing we know for sure about their opinions is that they disagreed about whether the cash or the share was better to own.
At least one of them was wrong.

Now, if it’s a drop in value to under $100, that’s a big deal.
For example, say, their Chinese operations including everything from assembly to sales is nationalized for a token fee.
Berkshire would survive it, but it would be like living through a very bad bear market or a nuke-scale insurance catastrophe.

Jim

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#18

A question for Jim (first time posting in a very long time - had to establish a new account just to do it!),

The growth rate of Berkshire has been remarkably stable for many years, as is born out by the graph that you posted a link to. My question: what is behind your thinking that growth can maintain rates that at least somewhat compare to those of the past?

I ask because those of us that are older have seen many companies fail to sustain growth at this level (over the long term especially), and as USA demographics also could start to shift in the relatively near future (e.g., less population growth, etc.), I’d love to hear your take on what will drive the continued growth of Berkshire, and how you monitor for that growth potential…

Thanks in advance for any thoughts on this.

Lee

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#19

My indicators of market bottoms are silent so far.
To the extent that a spreadsheet can have an opinion about emotions, it sees insufficient panic and indiscriminate selling to call it capitulation yet.
Another 2-3 days like Thursday would change its mind.

I mention it because, with the tight short term correlation between Berkshire and the S&P recently,
it seems there is a decent chance that the market bottom will be a good day to buy Berkshire.
And, by extension, the day that the market bottom detector triggers might be an above-average day to buy.
Or not, of course.

Another excellent post and I thank you for your willingness to display both sides of your thinking and not just that which supports your recent additions to the stock as it continues to edge down.

You display a remarkable lack of extreme ego that is often found on these boards.

As I have said, I do not yet hold BRK and being 60% in cash am looking for a good entry point for a significant sum of money, (for us anyway.) It sometimes is hard to resist the seemingly almost cult like conviction to buy now, particularly after the stock went sub $300 and then rose again, making me concerned that I had missed my window of opportunity. But only slightly concerned, because I have strongly felt the market in general was over valued and that the macroeconomics indicated it was poised for a strong correction. (Yes, market timing. I know you all disapprove.) Much of BRK is publicly traded stock, which yes the team bought for a reason, but over which they have little to no control. The shares not owned by BRK can be emotionally dumped along with the stock shares of companies not held by BRK, even if the strong loyalty to BRK itself keep shareholders holding BRK as the market corrects. Given their large stock holdings of other companies, why should the BRK valuation escape a downward trending market?

IP

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#20

A question for Jim (first time posting in a very long time - had to establish a new account just to do it!),
The growth rate of Berkshire has been remarkably stable for many years, as is born out by the graph
that you posted a link to. My question: what is behind your thinking that growth can maintain rates
that at least somewhat compare to those of the past?

The chart I posted wasn’t intended to suggest that the line will continue.
I guess it is strongly suggestive purely based on its shape, but that wasn’t my intent.
The main insight is that the value metric is pretty stable, and remains quite close to the trend line, whether the trend line is straight or not.

I have long assumed that the trend rate of growth of the value of a share will gradually slow.
I even came up with a formula, since that’s the kind of person I am:
The average US stock in the average year has historically returned about inflation + 6.5%.
Think of that as the “monkey with a dartboard” rate or return.
(nothing like that right now—that also implicitly presupposes you’re buying in a year of average stock prices! but I digress)

Let’s say Berkshire outperforms that monkey average in a typical year by 2.5% in the current era.
I assume that a certain percentage of this year’s (on trend) outperformace will be gone next year.
That gives a rate of decline in performance which asymptotically approaches the rate of return of the average stock.
Specifically, I think I picked the number 6%: that is, the lift above the monkey rate each year will be 94% of the lift the prior year, on trend.
So, if today’s “on trend” outperformance is 2.5%, then the next few years of outperformance on trend might be expected to be 2.35% 2.21% 2.08% 1.95% 1.83%…

However, it turns out this has not been a very good fit since I first proposed it about 15 years ago.
After all that fancy thinking and typing!
The rate of value growth has, so far, stubbornly failed to appear in the numbers.
The rate of growth is essentially unchanged since 1998, if anything picking up a bit lately.
However, I take each new such year as a pleasant surprise, and continue to expect a very gradual trend slowdown starting immediately.

A very short version is that I’d expect Berkshire to return inflation plus 7-8% pretty much indefinitely. Gradually falling towards 7%.
Berkshire does have some structural advantages–a strong culture of not overpaying for a good story, not smoothing earnings and so on.
That alone ought to be good for half a percent edge over the long run, setting a floor of around a real 7%.
Note that inflation plus 7-8% is a whole lot less than the recent results, which are about inflation plus 10%-10.3% over various time frames ending now.

Jim

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#21

As I have said, I do not yet hold BRK and being 60% in cash am looking for a good entry point for a
significant sum of money, (for us anyway.) It sometimes is hard to resist the seemingly almost cult
like conviction to buy now, particularly after the stock went sub $300 and then rose again, making
me concerned that I had missed my window of opportunity. But only slightly concerned, because I have
strongly felt the market in general was over valued and that the macroeconomics indicated it was
poised for a strong correction. (Yes, market timing. I know you all disapprove.)
…
why should the BRK valuation escape a downward trending market?

It’s not that I disapprove of timing.
I have precisely 1063 spreadsheets in my “market predictors” directory. (honest)
Nor that I think that Berkshire will escape a market rout.

But, beware certainty. Market timing is very fallible.
Seeing a good entry price for a core position, but passing it up because you have a hunch it’s going to get better, is probably not optimal.
Even if the hunch is a very well informed one.
Berkshire is cheaper than it has been 90% of the time since the post-crunch cheaper prices have been the norm, give or take. Maybe 85, maybe 95.
That valuation level probably falls into the category of “good enough”. Heck, for a core position, it’s not really necessary to do better than any “cheaper than average”.

Using timing to give you a slight edge averaged across 1000 small trades makes some sense.
For one big move, perhaps a little less so.

One way to outsmart your emotions:
Buy half now, half when you think the market has bottomed. (which might be higher than now)
If the market falls between the two, you’ll feel like a genius for having waited to buy the second half.
If today is the bottom and the second half it bought at a higher price, you’ll feel like a genius for having bought half now at the bottom.

All that being said, my gut feel matches yours.
I very much doubt that Friday’s close for Berkshire’s stock will be the lowest that is ever again seen.
But I was buying anyway, on the reasoning above: it’s a good price.
Don’t let striving for perfection distract you from snatching the merely very good.
Berkshire’s market valuation is about 25% cheaper than it was at its peak in March, in round numbers.
So, for a ten year hold, you’ll do 3.1%/year better than you would have with a purchase then.
That’s nice.

Jim

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#22

It’s not that I disapprove of timing.
I have precisely 1063 spreadsheets in my “market predictors” directory. (honest)

LOL. I’ve learned the need to speak in spreadsheets with my engineer DH, which is one reason why I run a 10 year profit projection spreadsheet when presenting a real estate opportunity to him. Just the construction of a spreadsheet helps you to think through the validity and breadth of variables used for the calculations. So Bravo and thank you.

But, beware certainty. Market timing is very fallible.
Seeing a good entry price for a core position, but passing it up because you have a hunch it’s going to get better, is probably not optimal.
Even if the hunch is a very well informed one.
Berkshire is cheaper than it has been 90% of the time since the post-crunch cheaper prices have been the norm, give or take. Maybe 85, maybe 95.
That valuation level probably falls into the category of “good enough”. Heck, for a core position, it’s not really necessary to do better than any “cheaper than average”.

I understand what you are saying, and perhaps it’s my own ego getting in the way, or upbringing for that matter, being a New Englander raised by Depression babies. Frugal to the core. But when I look at the delta between the initial urge to buy and Friday’s price, waiting provided a year’s worth of expenses in savings to buy the same number of shares.

Using timing to give you a slight edge averaged across 1000 small trades makes some sense.
For one big move, perhaps a little less so.

Sorry, you lost me there. I would have thought it the opposite, particularly given my example above of already saving 1 year’s expenses. Either way I am likely to do the buy in at least 3 moves, set via GTC limit orders to avoid further equivocation, unless the value hits me in the face like AVGO did at $185 in 2020. Or our current home where we threw caution into the wind and scooped up when I realized just how underpriced it was. Both DH and I can admittedly get mired in analysis paralysis and I have to push HARD for quick action. It’s one reason why I loved Mechanical Investing. Decide on the screen and then the screen decides for you.

I know that buying and selling of assets is about 2 parties agreeing to a price, and have lost out on buying specific stocks or real estate for that matter by not moving fast enough or compromising on prices more. But something better always came along, with stronger seller motivations to give me my price.

We used to be 40% cash, 60% stock, the cash position in part due to my exiting bond funds in unwinding what a “professional” financial planner had put us into, and the taking of a lump sum for a couple of pensions when it looked likely the company could fail during Covid. We are now 60% cash because the value of stocks has declined. I recognize the folly of being so cash heavy long term, but also the benefit of buying/selling at the right price. Lots of moving parts, some of which I may be unintentionally ignoring which is why I keep on trying to understand what you say. Sometimes we just don’t know what we don’t know, and I respect the opinions on this board, even if I don’t always agree with them.

TIA,

IP

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#23

Using timing to give you a slight edge averaged across 1000 small trades makes some sense.
For one big move, perhaps a little less so.
…
Sorry, you lost me there.

My thinking is this:
Say I give you a model that tells you with 60% accuracy whether a given stock will be up or down in the next month.
It would be fantastic to use this model to build a long/short portfolio of 100 small positions: the predictions are good, on average.
But it would be folly to use that prediction to put 60% of your portfolio into a single position.
The individual predictions are not reliable enough.
That’s true of pretty much every market timing system, and every market direction call.
Some are extremely useful on average, but not good enough to make big moves.

It’s like card counting, or playing with a slightly stacked deck.
You’ll do well on average placing lots of little bets based on that edge.
But don’t go all in based on one prediction.
The art of using market timing models is to benefit from their predictive power,
while not really losing anything meaningful when they’re inevitably wrong.

The same is true of informed hunches.
I have a very strong hunch the market will be materially lower at some point this year.
And it’s highly likely that this will be true of Berkshire’s stock price, as well.
But I’m not going to make any big bet on that.
I’m just calmly adding to my position on the way down, reacting to the risk/reward on offer today rather than where I think it will be tomorrow.
The lower the price, the bigger the upside and the lower the downside. So, the bigger the position is warranted.

Jim

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#24

But when I look at the delta between the initial urge to buy and Friday’s price, waiting provided a year’s worth of expenses in savings to buy the same number of shares.

Isn’t this just hindsight bias though? Just because it worked out ok doesn’t mean it was a good decision. I mean, I played russian roulette last night and I’m still here and I’m up $10 from the bet. Would you say that was a good decision?

SA

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