Subject: Re: Value, when to buy
The devil made me do it, I'm a devil's advocate: "Forget value, just use price. Make a table similar to Jim's."
Below is such a table, I made it using a price-only measure, i.e. no explicit valuation measure is used. It looks pretty similar to Jim's table (and to tables in previous posts where he binned P/B and related this binned ratio to forward returns).
Bin ForwardTwoYearReturn
1 17.8%
2 15.4%
3 13.8%
4 11.4%
5 12.8%
6 12.1%
7 7.9%
8 6.5%
9 5.7%
10 4.1%
To motivate the above table, consider the conventional P/E ratio. For BRK we often use P/B instead of E, where B is book value because book turns out to be a decent surrogate for intrinsic value. Or, get fancier and use Jim's two-and-a-half column valuation figure to stick in the denominator instead of book value. Whatever, stick something in the denominator. The devil told me to stick a price-only measure in the denominator, so the ratio depends only on famously irrational prices i.e. the very thing that value approaches are constructed to avoid.
To make the above table, I used a four year simple moving average (SMA) of BRK price (four years because Jim used 16 quarters to average his two-and-a-half column valuation figure) and I stuck this price SMA in the denominator of P/E for 'E'.
So, the ratio used is
Ratio = Price/SMA
where 'SMA' is a simple moving average of BRK price over the past four years.
I binned this ratio into 10% bins: bin 1 is the 'cheapest' bin i.e. contains the lowest 10% of the Price/SMA values, bin 2 is the next cheapest, and finally bin 10 is the most 'expensive' bin i.e. contains the highest 10% of the ratio's values. The associated return for each bin is the average annualized forward two year price returns within each bin, because Jim used average annualized forward two year returns in his table. I didn't take time to adjust prices for inflation, but I don't think this matters much to the main point of this post. BRK prices are from Yahoo and start 1996-05-09.
CONCLUSION:
The table above looks fairly similar to Jim's table built using his two-and-half-column valuation measure. But the table above was built using the price-only ratio above, which measures how far BRK's current price is above/below its four year simple moving average. No valuation involved. This table has significant predictive power, clearly it's best to buy when BRK is 'cheap' and not so great to buy when BRK is 'expensive', and the average two year forward return pretty much linearly depends on the bin.
Make of it what you will, the devil made made me do it.