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... when we longed for the market to recognize that BRK was undervalued.

Now, since we all firmly believe in the value of a share, as opposed to its price, what to do when BRK is overvalued?

My usual answer is to write covered calls, but I already did that $20 ago when BRK approached $420.

My remaining shares are either in 401k (no options) or taxable (don't wanna risk selling).

... when we longed for the market to recognize that BRK was undervalued.
Now, since we all firmly believe in the value of a share, as opposed to its price, what to do when BRK is overvalued?

The deeper irony is that current multiples are levels that we would once have considered low, and buying opportunities, prior to the credit crunch.
The average P/B 2000-2007 inclusive was 1.654

And the business results since then are pretty similar, so the falling valuations are nothing to do with worse results. The step change in Berkshire's rate of value creation was in 1998--it has been remarkably constant since then.

Jim

And the business results since then are pretty similar, so the falling valuations are nothing to do with worse results.

I think it's called "Falling out of favor".

More interesting is why Berkshire is "Getting into favor" lately.

My explanation: The extreme discrepancy in the components of the CNN index between on one side several components showing "Extreme Greed", but also several ones showing at the same time "Extreme Fear" points to many people feeling as more insecure as more expensive the S&P and the glorious 7 get. So what do to when you belong to that group? Stay out of the game (cash) or with something you feel comfortable with, like Berkshire.

More interesting is why Berkshire is "Getting into favor" lately.

I think it's mostly the broad US market going into favour.
Berkshire is up 5.7% since last Wednesday's close.
But the average S&P 500 firm is up 3.4%, so it's not a gap so large that it requires very much explanation.

I assume some of the momentum folks have piled on board for the current ride.

Jim

Now, since we all firmly believe in the value of a share, as opposed to its price, what to do when BRK is overvalued?

If you need the money for some purpose like kids' education or buying a home, go ahead and sell a portion of your holding. Otherwise sit tight and be prepared for lower future returns. I think this is especially a good option in taxable accounts where you benefit from deferred taxes if you are a long term stockholder.

In a retiremet account, taxes are not a consideration, so it is more an opportunity cost issue. What is your best alternative to Berkshire, all things considered? The answer is different for each person. For some it might be that Berkshire is their best option even at a slightly (hopefully temporarily) overvalued price.

In a retiremet account, taxes are not a consideration, so it is more an opportunity cost issue. What is your best alternative to Berkshire, all things considered? The answer is different for each person. For some it might be that Berkshire is their best option even at a slightly (hopefully temporarily) overvalued price.

This all makes sense.

I just sold a bunch of in-the-money BRK calls and bought April 17/2025 T-bills with the proceeds. I'm not sure what a US dollar will buy at that time, but I'll have 3.723% more of them. Annualized that's about a 4.97%/year rate.
Unless Berkshire's stock price falls, in which case I'll close 'em early and probably do the reverse trade.

Jim

"" I just sold a bunch of in-the-money BRK calls and bought April 17/2025 T-bills with the proceeds. I'm not sure what a US dollar will buy at that time, but I'll have 3.723% more of them. Annualized that's about a 4.97%/year rate.
Unless Berkshire's stock price falls, in which case I'll close 'em early and probably do the reverse trade.

Jim""

WARNING, if you are an American in a taxable account, make sure you understand the potential tax consequences of selling, IN THE MONEY CALLS, on stocks you hold long term. Good luck.

"Now, since we all firmly believe in the value of a share, as opposed to its price, what to do when BRK is overvalued?"

I am in the minority here, but I don't think BRK is overvalued. Don't get me wrong, it certainly isn't cheap. I think someone buying at this level and holding for the next 20-30 years will do ok. I am not sure they will outperform the S&P (but I am also not sure they won't either), but it will be close enough and done with a lot less risk.

Maybe I would call it generously valued instead of overvalued.

That said, I recently lightened up my holdings of BRK, but it is still my biggest holding by far.

"The step change in Berkshire's rate of value creation was in 1998--it has been remarkably constant since then."

Yes. The reason, I think, was a step change in the growth rate of Berkshire's equity portfolio, not the growth rate of earnings.

metric______________ growth rate 1981-1998_______ growth rate 1999-2013

BV/share____________ 27%/yr______________________ 9%/yr

earnings/share______ 18%/yr______________________ 16%/yr

S&P 500 index_______ 13%/yr______________________ 1%/yr

Yes. The reason, I think, was a step change in the growth rate of Berkshire's equity portfolio, not the growth rate of earnings.

It seems to be mainly due to the complete restructuring of the firm, and the investment portfolio, as a result of the Gen Re acquisition. In the portfolio, it was a huge switch from an equity emphasis towards bonds. From end-1997 to end-1998, equities as a percent of book fell from 115% to 69%, (even though equities were up in absolute terms), primarily due to the ocean of bonds that came with Gen Re.

It's easy to forget how transformative that deal was. Total assets rose by a factor of 2.18

Jim

"The deeper irony is that current multiples are levels that we would once have considered low, and buying opportunities, prior to the credit crunch.
The average P/B 2000-2007 inclusive was 1.654"

One of the reasons I don't think BRK is terribly overvalued is because the interest rate environment is going back to normal. It is for certain that ever since the 07/08 housing crisis, but even for a decade or more before that monetary policy was loose and easy. I am old enough to remember when the FED talked about tightening rates to cool off an overheated economy. When Greenspan took over as FED Chair, talk like that stopped. Since Greenspan monetary policy has always been loose. The only argument has been over the degree of looseness. There has been no doubt that since the 07/08 credit crunch, monetary policy has been extremely loose.

Here is the thing, an extremely loose monetary policy hurts a company like BRK more than it helps.

Don't get me wrong, BRK benefits from loose monetary policy. Warren was able to do his negative interest rate SQUARZ deal. The subs can all get cheap financing to fund their expansion. However, other companies benefit far more from access to cheap money. For example, cheap money allows any Tom, Dick, or Harry to set up an insurance company in the Bahamas and start competing with Berkshire. Or if an outside company hit some distress and had their stock price tank, hedge funds or private equity was there with access to cheap loans to bid up the price of the company so Buffett would never really have a chance to get the company cheap.

One of the biggest advantages BRK has ever had was using float as a means to have access to cheap money to invest. My keeping monetary policy loose for over 30 years, the FED negated (or at least minimized) Berkshires advantage of cheap capital by giving it to everyone. But now that monetary is going to go back to being closer to normal, BRK will once again have an advantage with access to capital.

That will add something to the long term value of BRK.

I just sold a bunch of in-the-money BRK calls and bought April 17/2025 T-bills with the proceeds. I'm not sure what a US dollar will buy at that time, but I'll have 3.723% more of them. Annualized that's about a 4.97%/year rate.
Unless Berkshire's stock price falls, in which case I'll close 'em early and probably do the reverse trade.

Sounds reasonable. An easier option for US residents is to put the proceeds in short term T-bills which currently yield 5.3% with zero risk (though likely to be 0.25% lower soon) and wait either for better entry points back into Berkshire or look for other attractive alternatives.

One of the biggest advantages BRK has ever had was using float as a means to have access to cheap money to invest. My keeping monetary policy loose for over 30 years, the FED negated (or at least minimized) Berkshires advantage of cheap capital by giving it to everyone. But now that monetary is going to go back to being closer to normal, BRK will once again have an advantage with access to capital.

Another way of saying this is that Berkshire was hurt by zero/very low rates of the last 20 years+ and benefited recently from higher rates. But who the hell knows what the future rates are going to be? Its seems that markets are predicting virtually a 100% chance of the Fed cutting rates by 0.25% in September.

While I think it is quite possible (and even likely) that normalized rates would be far higher in the future than they were before the pandemic, that is by no means certain. There are people who think it is very hard for the Fed to continue to have high rates given the high govt debt relative to GDP (100%) and very budget deficits (6-7%)as far as the eye can see.

Another way of saying this is that Berkshire was hurt by zero/very low rates of the last 20 years+ and benefited recently from higher rates. But who the hell knows what the future rates are going to be? Its seems that markets are predicting virtually a 100% chance of the Fed cutting rates by 0.25% in September.

A 0.25% cut in September doesn't trend line out to 0% - my guess (prediction?) is that short term rates settle in the 4%-5% range with the 10Y slightly higher; based on inflation figures in the 3% range. We will probably get a cut of roughly 2% at most during the next recession (which is always just around the corner).

So basically, 2-3 rate cuts in the next 12 months or so (assuming no recession).

tecmo
...

Another way of saying this is that Berkshire was hurt by zero/very low rates of the last 20 years+

Real after-tax interest rates haven't shifted all that much in the grand scheme of things.

I prefer to think of this as Berkshire having been hurt by a lack of periods that capital was scarce. That's the superpower, and it hasn't been needed. Like Aquaman in a desert.

Or, to reverse the metaphor, the tide hasn't gone out in a very long time, and even then it was all too brief.

Look on the bright side (for us): It seems likely that there will be some waves of distressed firms in the next few years, maybe that will create some opportunities. An awful lot of firms are zombies: they don't have operating profits sufficient to cover their interest once they have had to roll their debts up to new paper at current rates. Assuming they can refinance at all.

Jim

Real after-tax interest rates haven't shifted all that much in the grand scheme of things.

Perhaps but I recall Buffett repeatedly say during annual meetings that low interest rates are not good for returns of Berkshire. To make an obvious point, the float (which is a form of leverage) earns better returns when rates are higher. Also competition from PE was way higher during the time of low rates.

A 0.25% cut in September doesn't trend line out to 0% - my guess (prediction?) is that short term rates settle in the 4%-5% range with the 10Y slightly higher; based on inflation figures in the 3% range. We will probably get a cut of roughly 2% at most during the next recession (which is always just around the corner).

Of course a 0.25% cut doesn't automatically put the rates on path to 0! That is obvious. My point is that it is very difficult to predict "normalized" rates (short or long).

One of the biggest advantages BRK has ever had was using float as a means to have access to cheap money to invest.

And during the GFC Buffett was pretty much the only guy who had money. The general sentiment snow seems to be he should have done more at the time, but he was able to buy preferreds of Wrigley, Goldman Sachs and General Electric at amazing rates. With interest rates at near zero it was like printing money.

"From end-1997 to end-1998, equities as a percent of book fell from 115% to 69%, (even though equities were up in absolute terms), primarily due to the ocean of bonds that came with Gen Re."

Good point. However the rate of growth of the equity portfolio also changed markedly, from 31%/yr during the period Jan'86 to Jan '98,(starting portfolio value, before purchases, sales and dividends) to 8% during the period Jan '99 to Jan '17.

To make an obvious point, the float (which is a form of leverage) earns better returns when rates are higher. Also competition from PE was way higher during the time of low rates.

The latter is a big deal. The first one isn't, really.

Nominal rates are up. Real after-tax rates, not very much. At the very short end at the moment, yes, but that won't last. At the long end they've barely budged.

e.g., 10 years ago, 10 year US T bonds yielded 2.49% and inflation was about 1.33%, real return before tax 1.16%
At the moment the bond yield is 4.16% and MCT inflation in the last year has 2.36% and fairly steady, leaving real return before tax 1.80%
An increase of 0.64% before tax isn't much of a leap.
If the tax rate were unchanged and at current levels, the net real after-tax increase in returns would have been 0.51% on typical long bonds.
(It's a pretty similar story for corporate bonds)

We do have a lot at the very short end, and for several months the real return on T-bills has been positive, but that is the exception not the rule. It's likely to fade away within a year given what the yield curve is saying. And bear in mind that 1% interest with 1% inflation is a higher real after-tax return than 3.5% interest with 3.5% inflation.

Jim

The first one isn't, really.

I don't think this is correct. Let us assume the following to simplify the analysis. Let assume Bershire balance sheet has no liabilities other than equity & float, no debt. Float = 50% of equity. Furthermore, float is invested in short term T-bills only. Let us also assume that ST rates are 0.5% above inflation and LT rates are 2.0% above short term rates, and equity risk premium = 3.0%. Let us assume taxes are 0.

Case 1: Inflation = 0.5%, ST rate = 1.0%, LT rate = 3.0%. Return on equity = 3.0+3.0+0.5*1.0 = 6.5% nominal or, 6% real.
Case 2: Inflation = 2.5%, ST rate = 3.0%, LT rate = 5.0%, Return on equity = 5.0+3.0+0.5*3.0 = 9.5% nominal or, 7% real.

SO it does appear that Berkshire would better off in a higher inflationary, higher rate environment due to leverage from float.

“e.g., 10 years ago, 10 year US T bonds yielded 2.49% and inflation was about 1.33%, real return before tax 1.16%
At the moment the bond yield is 4.16% and MCT inflation in the last year has 2.36% and fairly steady, leaving real return before tax 1.80%
An increase of 0.64% before tax isn't much of a leap”

That is one way to look at it. Sadly for anyone who bought the 10y UST 10 years ago, they didn’t realize anywhere close to that 1.16% real return before tax because inflation has been running high.

Break-even inflation rates may not be any better predictors than the current reading of inflation, but for what’s it’s worth the 10y BE is roughly at the same level today as it was 10 years ago at 2.2%.

https://fred.stlouisfed.org/series/T10YIE

For anyone that wanted to lock in 10y real yields they could have done so with TIPS securities at about 0.15% 10 years ago and today at about 1.9%.

https://fred.stlouisfed.org/series/T10YIE

Berkshire is up 5.7% since last Wednesday's close.
But the average S&P 500 firm is up 3.4%, so it's not a gap so large that it requires very much explanation.

The gap is constantly increasing. At the moment I am writing this it's BRK up 6.7% vs. S&P up 2.3%, so Berkshire up nearly 3x as much. Sure, that will be different in an hour, in the one or the other direction, but it makes Berkshire clearly stand out, so I still think there's more behind (flight to safety, fitting the very polarised CNN index components).

The gap is constantly increasing. At the moment I am writing this it's BRK up 6.7% vs. S&P up 2.3%, so Berkshire up nearly 3x as much. Sure, that will be different in an hour, in the one or the other direction, but it makes Berkshire clearly stand out, so I still think there's more behind (flight to safety, fitting the very polarised CNN index components).

Quite the move, at any rate. ($444.22 as I type)
The market is inscrutable, so it's hard to ascribe a motivation to any market price move. I do think the momentum boys have jumped on for now.


For the first time, I'm thinking of buying a few puts. Not that my portfolio need protecting, but I might make a buck next time the market dips. It's hard to pick a suitable one, though. Not only do you have to be right about the direction, but also the timing and size of drop. If the idea is to make most of the profit on rising time value, (the most difficult way to make a buck from options), you'd want long dated ones. Time value is maximized the first date that the strike price hits the option's strike. $4.70 will get you a January $400 put, but that might not be long enough. Maybe $9.15 would get you a June 2025 $400 put.
But then again, surely there are other stocks that would drop a whole lot more in a market blip, and perhaps more predictably.

Jim

Current rally is driven by many small cap value stocks— usually they are heavily shorted , leveraged, have low P/B but high or negative P/E.

Imo, if you want to buy puts, better buy theses.. ie put on Russell 2000 or SP 600

Current rally is driven by many small cap value stocks— usually they are heavily shorted , leveraged, have low P/B but high or negative P/E.
Imo, if you want to buy puts, better buy theses.. ie put on Russell 2000 or SP 600

That misses the bigger picture of what's going on here. Have a look at the glorious 7 during the time Berkshire is rising, especially at the 2 most "glorious", META and Nvidia, and try to see the connection between those 2 developments.

Mungofitch:For the first time, I'm thinking of buying a few puts. Not that my portfolio need protecting, but I might make a buck next time the market dips. It's hard to pick a suitable one, though. Not only do you have to be right about the direction, but also the timing and size of drop. If the idea is to make most of the profit on rising time value, (the most difficult way to make a buck from options), you'd want long dated ones. Time value is maximized the first date that the strike price hits the option's strike. $4.70 will get you a January $400 put, but that might not be long enough. Maybe $9.15 would get you a June 2025 $400 put.
But then again, surely there are other stocks that would drop a whole lot more in a market blip, and perhaps more predictably.

Im just trying to understand everything about options and how they work before I start using them to bankrupt myself :)

So I'm looking at this and thinking, why would you choose going long a put instead of going short a call? I think I have my answer: if you are long a put you can keep your put open with no risk to upside gains from your stock. But if you write a covered call, you will always cap your upside gain and indeed you are "paid" to cap your upside even lower if you dare.

And to fill in the blanks on the long put strategy. Your goal is to buy an OTM put for a low price, and then sell it for a higher price on a price dip.

Your tradeoffs include

1) going further OTM (to a lower strike price) lowers the cost to buy the put, but also increases the size of the price dip you need in order to drive the price of the put up enough to make it worth selling.

2) going further time-to-expiration raises the amount of put price appreciation as stock price falls, due to its higher time values, but raises the cost of buying the put due to its higher time values.

3) while a covered call pays you the maximum time premium up front, to get that max you have to be at the money (ATM), or Strike = StockPrice, which means if the stock price goes up, you lose your gain on that stock into your loss on the covered call, whereas a long put you completely preserve your return on stock price going up.

4) while a covered call requires that you own one share of stock per call option share you short, a long put can be bought without needing to own the underlying stock.

If I got something wrong, or am just missing a point, please chime in!

One of these days, I am going to fully understand options, and will probably conclude that I should mostly just own straight stock. But in the meantime, what a fun (and sometimes expensive) ride it is learning about them!

R:)

Mungofitch:For the first time, I'm thinking of buying a few puts. Not that my portfolio need protecting, but I might make a buck next time the market dips. It's hard to pick a suitable one, though. Not only do you have to be right about the direction, but also the timing and size of drop. If the idea is to make most of the profit on rising time value, (the most difficult way to make a buck from options), you'd want long dated ones. Time value is maximized the first date that the strike price hits the option's strike. $4.70 will get you a January $400 put, but that might not be long enough. Maybe $9.15 would get you a June 2025 $400 put.
But then again, surely there are other stocks that would drop a whole lot more in a market blip, and perhaps more predictably.

Im just trying to understand everything about options and how they work before I start using them to bankrupt myself :)

So I'm looking at this and thinking, why would you choose going long a put instead of going short a call? I think I have my answer: if you are long a put you can keep your put open with no risk to upside gains from your stock. But if you write a covered call, you will always cap your upside gain and indeed you are "paid" to cap your upside even lower if you dare.

And to fill in the blanks on the long put strategy. Your goal is to buy an OTM put for a low price, and then sell it for a higher price on a price dip.

Your tradeoffs include

1) going further OTM (to a lower strike price) lowers the cost to buy the put, but also increases the size of the price dip you need in order to drive the price of the put up enough to make it worth selling.

2) going further time-to-expiration raises the amount of put price appreciation as stock price falls, due to its higher time values, but raises the cost of buying the put due to its higher time values.

3) while a covered call pays you the maximum time premium up front, to get that max you have to be at the money (ATM), or Strike = StockPrice, which means if the stock price goes up, you lose your gain on that stock into your loss on the covered call, whereas a long put you completely preserve your return on stock price going up.

4) while a covered call requires that you own one share of stock per call option share you short, a long put can be bought without needing to own the underlying stock.

If I got something wrong, or am just missing a point, please chime in!

One of these days, I am going to fully understand options, and will probably conclude that I should mostly just own straight stock. But in the meantime, what a fun (and sometimes expensive) ride it is learning about them!

R:)

My remaining shares are either in 401k (no options) or taxable (don't wanna risk selling).

I will mention the obvious here. When someone exercises an option and you are assigned, you don't have to deliver the shares that have been in your account for a long time and have large embedded capital gains. You can instead buy new shares and deliver those. You just have to decide quickly. Let's say you sold July 430 strike calls and they get assigned over the weekend. You can buy shares at ~441, deliver those to the option holder, and then they will pay you 430 for them, and you suffer a loss of ~11 per share. If you received more than 11 for those calls when you sold them, then you will be net positive. But you don't have to dispose of your long-term held shares.

I will mention the obvious here. When someone exercises an option and you are assigned, you don't have to deliver the shares that have been in your account for a long time and have large embedded capital gains. You can instead buy new shares and deliver those.

I didn't know that. Even easier is to buy back the calls near expiration for a comparable loss.

Maybe $9.15 would get you a June 2025 $400 put.

Let's say you buy this put, and let's say that sometimes between now and next June, the market swoons a bit. And perhaps even drags BRKB down to 380 or so next spring. So the put will be around $20 near expiration, and you make 10 bucks or so. I wonder if it would be a lot easier to simply sell a June '25 510 or 520 call and get the 10 bucks into your hands right now (can put the proceeds into a T-bill) and when the market swoons, that call essentially goes to zero?

Now, if you expect the market to drop a full 20% or so between now and then, and also expect Berkshire to follow suit, then BRKB drops to about 355 and that 400 put will be worth $45 and your gain would be $35 or so.

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