I was just playing around with my spreadsheet of historical prices and P/B values.
Some people might be worried about a big price drop.
Forget the question of how sensible that is. How likely is it?
Starting on any random day since 2003, there has been about an 11.5% chance of a drop (in real terms) of -25% or more in the next year and a half.
Dose that proportion vary with valuation levels? Yup.
Using ratio of market price to peak-to-date known book per share as the valuation proxy,
and breaking all days into 5 equal buckets by valuation level:
Starting on 20% of cheapest days, chance of real -25% drop within 18 months: 1%
Starting on next 20%: 5%
Starting on next 20%: 11%
Starting on next 20%: 16%
Starting on 20% of most expensive days: 25%
So, about as you might expect: when things are cheap, big drops are unlikely, and vice versa.
The stock price for B shares in pre-market is $308.50, equating to $462750, or P/peakB of 1.462.
Since that valuation level is very typical since 2003, the odds of a big drop are pretty typical–
Starting from the 20% of days closest to this P/peakB since 2003, a real drop of -25% happened 11.3% of the time.
No big conclusions, just fun with numbers.
It should probably be noted that the inflation-adjusted price recovered, and more, after all such drops.
One might be coming, but it’s best thought of as a buying opportunity, not a reason to sell today.
I’ve been thinking about the role of tax considerations when contemplating selling because the shares might be over valued versus selling because you need the income. We hold most of our Berkshire in a taxable account. Because our cost average is so low, we would have to pay about 13% of the proceeds in cap gains. Since we don’t need the money right now, we have too much cash, and there are a paucity of obvious alternatives for the money, i don’t think it makes sense to pay 13% to avoid the risk of a 12% fall. Does that make sense?
Of course this line of thinking proved faulty when I passed on selling Costco at the end of last year.
i don’t think it makes sense to pay 13% to avoid the risk of a 12% fall. Does that make sense?
Sure sounds like it makes sense.
Though to be technical, your cost to compare isn’t the tax hit, it’s only the time value of the tax hit.
The usual situation is that you’d sell the stock eventually and pay the tax then.
So you’re just pre-paying some tax that would be due later anyway.
Same general conclusions though…why sell just to avoid a potential price dip you aren’t sure will happen, but are sure will be transient if it does happen?
I suspect–just an informed hunch–there may be some good buying opportunities coming before the end of next year.
So I am keen to have some medium cash allocation to take advantage of that.*
Beyond that, riding it out makes plenty of sense.
Jim
I have no reason to believe a big market crash or bear market is imminent, but I am enlarging my mortgage at the moment to add to the dry powder…just in case, y’know.
I do hate to miss a clear-out sale. And the cost of borrowing and carrying the cash these days is pretty low.
Jim how does that correlate with overall market valuation though? Eg everything gets dragged down…
The answer depends on the time frame.
Short term, Berkshire will probably track the S&P point for point.
Valuation won’t help defend Berkshire’s price at all.
Especially as we might get to the point that people start selling what they can sell, not what they want to sell.
Like November 2007. The price went from over 1.88 times book to under 1x book in two months.
But it’s likely that it won’t matter over a time frame longer than a year.
Berkshire’s market correlation fades rapidly with time horizon. The weighing machine kicks in.
Ignoring ending dates on crashes when correlation of everything hits 1, there is essentially no market correlation by the two year mark.
Consequently, it’s reasonable to expect that Berkshire will come all the way back and more, but the S&P might not for a long time.
That is the reasoning behind my (bold?) recent prediction that Berkshire would outperform SPY by 4%/year over seven years:
That there was no reason to expect a lasting drop from Berkshire, but there WAS some potential reason to expect a lasting drop from the broad US market. https://discussion.fool.com/7-year-prediction-34863782.aspx
So far Berkshire is beating SPY total return by 7.48%, not annualized since it’s less than a year.
Since we don’t need the money right now, we have too much cash, and there are a paucity of obvious alternatives for the money, i don’t think it makes sense to pay 13% to avoid the risk of a 12% fall. Does that make sense?
Makes sense to me. I wouldn’t consider selling in a taxable account unless there was clear overvaluation of the shares, not this middling valuation that we see at the moment.
Certainly I can’t predict the future, but if the rotation toward value continues, BRK may do just fine going forward and you might not get a good opportunity to rebuy any time soon, or even if one appeared, you might miss it expecting even further decline.
One consideration for any of us who
-have a few years to go before age 65
-are contemplating retirement/have already retired before that age
-are US citizens
-and are thus using/considering the ACA (Obamacare) for their high-deductible health plan between retirement and Medicare:
The original ACA criteria had an income cliff: one dollar over the magic number, and no (~$20K/yr) subsidy.
The current criteria have replaced this cliff with an income shelf: the subsidy gradually decreases with increased income.
As I understand it, word is the shelf may well be replaced by the original cliff after 2022.
Hence, if you’re weighing a significant LTCG in the next few years, you might consider running the numbers and seeing if it’s in your best interest to pay the tax now…so an unexpected large expense in 2024 doesn’t have you unable to cash out that equity without also having to pay back the entire ACA subsidy for the year (in addition to your LTCG tax)
It’s only one consideration of many, but helped persuade me to sell a multiyear position of what I considered overvalued COST late last year @ $529
Another way to keep the income down when selling is to open a Donor Advised Fund.
If you’re going to be giving money to charity anyway, you can front-load it using a DAF.
Yes, the shelf has a sunset scheduled after this year. But I view that actually coming to pass more as a likelihood than a certainty. One can never be sure what comes out of the sausage factory at the last minute. There’s a lot of electioneering as well as a lmae-duck session between now and the end of the year. But one should certainly count on it going away after 2022.