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Matt Levine quoting someone else:

Bank of America is bearing the cost of decisions made three years ago to pump the majority of $670bn in pandemic-era deposit inflows into debt markets at a time when bonds traded at historically high prices and low yields.

The moves left BofA, the second-largest US bank by assets, with more than $100bn in paper losses at the end of the first quarter, according to data from the Federal Deposit Insurance Corporation. The sum far exceeds unrealised bond market losses reported by its largest peers.


Unrealized bond losses can become realized if depositors get to know of them and start a run. Happened to regional banks recently.
No chance this will happen to a G-SIB (systemically important bank) like BAC, but still shows incompetence. Why is it better than JPM Chase or S&P index?
WEB bought it cheap but what matters now is whether it can outperform JPM or a broad index going forward. Otherwise, dump it, take profits, buy index. Continuing to hold shows old man's inertia.

On this we agree. For the life of me I can't figure out why he is holing Bank of America.

Matt Levine quoting someone else:

I believe it's the FT article.
Probably paywalled https://www.ft.com/content/df4f343c-5666-43a2-ba01...

Yup, it's a bit of a mis-step for sure.
BofA's mark-to-market losses are over $100bn.
Compare the other 3 of the 4 biggest: JPM and WFC at around $40bn, Citi at around $25bn.
Memo to self: never reach for yield.

It's really crass of me to quote myself, but I will anyway. From a post of mine from spring 2019:
"From 2017 to 2018, pre-tax profit rose 15%, but because of the tax cut the net profit rose 33%.
The tax cut moved their 2018 ROA from would have been 1.03% (truly outstanding for them) to 1.20% (which is actually good) and a double digit ROE.
If they could average that through the business cycle I would recant most of the negative things I've said,
and at today's price (10.25 times estimated 2019 earnings) it would be a decent pick.
A skeptic would note their historically uncanny ability to step into every pile of doodoo that arises anywhere. Maybe that will change.
http://www.datahelper.com/mi/search.phtml?nofool=y...

Foot, meet 12 digits of poop.
Recent ROA is somewhat predictably back down to around 0.9%, their old normal, and may be headed lower.

In some ways it's just temporal poop: they got some small short term earnings in return for foregoing better earnings later.
The article continues:

"BofA has said it has no plans to sell the underwater bonds, avoiding crystallised
losses that for now exist only on paper. The bank's portfolio consists of highly
rated government-backed securities that are likely to eventually be paid back when
the underlying loans mature.
But holding on to the relatively low-yielding investments, many of which are
backed by 30-year home loans, at a time when newly purchased bonds yield significantly
more, could limit the income that BofA can generate from its customer deposits.
'I think the jury is still out,' said Jason Goldberg, a bank analyst at Barclays,
of BofA's bond portfolio. 'When rates were low they were making more money than rivals.
Fast-forward to today and they are making less.'

Huh, the returns from low-yielding bonds turned out to be...low.


Jim

Here is another piece from the FT that puts things in perspective: https://archive.ph/BNWk7

I think it was a huge mistake to put the deposits into these bonds at record low interest rates but at this price BAC looks pretty attractive. The bonds in the HTM portfolio have an average life of 8.5 years and 5.5 years in the AFS portfolio. They will gradually be recycled into higher yielding assets as they mature. The paper loss is pretty much meaningless for a TBTF bank, it could develop into an earnings problem though if they have to pay much higher rates on the deposits.

I think it was a huge mistake to put the deposits into these bonds at record low interest rates but at this price BAC looks pretty attractive...

I guess the bigger question is whether BAC is attractive even at a lower price : )
I have often been in the camp of those who don't really see many charms.

OK, there are some things going for them--
They're big, they won't go bust, they pay a pretty reliable dividend, and can be a destination for a huge amount of capital over very long time frames.
Unlike Wells Fargo, they have had the opportunity of some growth in total assets.
They have used some recent profits to reduce the share count by 22% in the last five years.
Those things may make them a good enough fit Berkshire's portfolio, in the perpetual bond view, but they aren't enough to excite me a lot.

I just don't see their history offering any particular reason to think they're very well run.
OK, they get some credit for improvement: averaging a very impressive 1.33% ROA in the 6 years 2016-2021 (admittedly a very benign stretch), compared to their old norm below 1% where their need to exist was in doubt.
But...they still only managed a double digit ROE four times within memory.
The dividend is all the way back up to 39% of its level in 2007. Is that news too old to be relevant?
I can certainly see why Berkshire bought the first 700m shares--it was the conversion of the warrants, and a price of $7.14 was pretty sweet. Even less when you count the interest on the preferred.
But the $6.6bn of open market purchases in 2018 at average $30.34 still perplex me, and the other $3bn worth later. Is it really that great, or just a place to park money when you have too many billions in cash?

Jim

"But the $6.6bn of open market purchases in 2018 at average $30.34 still perplex me, and the other $3bn worth later. Is it really that great, or just a place to park money when you have too many billions in cash?"

maybe it was T&T buying! - undisclosed you know.


gotta keep a sense of humor

Banks vanished from my holdings in the early 2000's except for East West and Cathay which I sold before the latest interest rate rise CRE or whatever crisis to buy something else (land). I have bought a tiny bit of BAC and WFC and done a couple short term profitable trades on East West recently.

Jim's posts along the way sort of reminded me to think, which sometimes I don't do while reverting to instinct and 50 years of investing history. But history to me isn't such a good guide on banks any longer, both managements and the industry itself seem to have endless opportunities for harming themselves.

But anyway, it has been a good back and forth here on banks, particularly BAC. It has served us very well to have this discussion here.

But...they still only managed a double digit ROE four times within memory.

I think in this case ROTCE is a more meaningful number, unlike BRK they are no serial aquirer.
Their ROTCE for the last five years was 15.5%, 14.86%, 9.48%, 17.02% and 15.15%. Even in 2020
they managed to get 9.48%, not too shabby. Assuming they continue to get a similar ROTCE in
the future, what would you pay for such a business? 1.8x TBV doesn't seem crazy to me.
TBV/share has grown ~5.2% per year over the last 5 years, dividend yield is ~3.1%. So from today
I would expect to get a return of 8.3%/year plus a one time bump from multiple expansion of 40%.

But...they still only managed a double digit ROE four times within memory.
...
I think in this case ROTCE is a more meaningful number, unlike BRK they are no serial aquirer.
Their ROTCE for the last five years was 15.5%, 14.86%, 9.48%, 17.02% and 15.15%. Even in 2020
they managed to get 9.48%, not too shabby. Assuming they continue to get a similar ROTCE in
the future, what would you pay for such a business?

You're right, that's a better metric. I also look at like PTPP earnings and pretax income on total tangible assets.

Sure, the company must have something good going for it or Mr Buffett wouldn't be such a big fan.
But I just continue not to see enough of them to interest me.

Let's look at it another way.
For example, in the last six years (2017 - 2022 inclusive) BofA have retained a whopping $115.9 billion in capital, call it a quarter of a Berkshire.
That's calculated simply as net earnings minus dividends paid out. The years in question correspond roughly to the era since Berkshire bought shares at full market price.
Yet earnings before tax are as flat as a pancake over those years. That includes a brief understandable dip in 2020 which doesn't change the trend.
In fact it's a gradual downtrend in real terms, falling around -3.5%/year.
So...what has been their rate of return on that $116 bn of incremental capital deployed? Negative?
A bunch of that retained capital went to repurchases, so earnings per share have done better than pretax total earnings, but still, the whole is not a pretty sight.
As a business they are not nearly keeping up with GDP.

Better run firms do better on this metric, a flavour of ROIIC.
As a random example discussed here lately, DG has retained about $5.5bn total in that same stretch.
On-trend real pre-tax total earnings are up about $1.15bn/year, which is 21% of the total retained capital. Each year.
And again, even more on a per-share basis because of buybacks, with a comparable percentage drop in share count, -18% at DG versus -22% at BofA.
Consequently DG's real pre-tax EPS rose at about inflation + 12.8%/year on trend in this stretch instead of BofA at around inflation + 0.7%/year on trend.
Even if you add the average dividend yield to both figures which flatters the bank, it's still a double digit gap in the rate of value generation.

So why would someone bother with BofA?
Unless you got your first 700m shares at $7, and/or you need to deploy $45bn somewhere "good enough".
Plus, I know which balance sheet I understand and trust more.

As mentioned, there must be charms I'm missing, something I honestly believe. Mr Buffett is much smarter than I am.
But until I spot them, the business doesn't interest me as an investment.

Jim

Sure, the company must have something good going for it or Mr Buffett wouldn't be such a big fan.
But I just continue not to see enough of them to interest me.

Obviously I can only guess what Buffett saw back in 2018. I think it was a wager on more normalized interest rates and higher NIM's. He probably didn't anticipate that they'd buy huge amounts of long duration bonds at generational low interest rates. As I said, it was a huge mistake and a dumb one. BTW, many insurers made the same mistake, that's one reason why I bought/hold FFH and WRB.
But the damage is done and in my view it's more than priced in. The bonds will mature and the proceeds will be reinvested at much higher rates. I think their interest income will increase nicely over the next few years.

Better run firms do better on this metric, a flavour of ROIIC.
As a random example discussed here lately, DG has retained about $5.5bn total in that same stretch.
On-trend real pre-tax total earnings are up about $1.15bn/year, which is 21% of the total retained capital. Each year.
And again, even more on a per-share basis because of buybacks, with a comparable percentage drop in share count, -18% at DG versus -22% at BofA.
Consequently DG's real pre-tax EPS rose at about inflation + 12.8%/year on trend in this stretch instead of BofA at around inflation + 0.7%/year on trend.

I understand where you're coming from and I agree that DG is a better business and much easier to understand, I own way more DG than BAC. If I were certain my analysis is 100% correct I wouldn't own BAC but I'm not Bueffett or Munger so I like to diversify a little bit even if I could put everything in my best three ideas. Usually I don't like to put more than 10% in one idea unless I'm convinced that I can't loose much if I'm wrong.
BTW, I own a basket of BAC, USB and WFC about the same size as my DG position.

In the 1990's and early 2000's First Union for instance was getting a 25% plus return on equity and it basically headed higher for years and years. So that meant great returns...right?

Eddie Crutchfield (klutzfield we labeled him) was the cigarette smoking CEO who said, "With the accounting we use we can pay 5 times book for community banks and make it work out." That was because they flushed equity, past and future costs too, with each acquisition.

I would caution anyone ever usinging returns on equity of any sort to understand this simply statistic is often meaningless. It is meaningless for multitudes of reasons, buybacks can flush equity fast when the stock is selling well above book for any number of reason, logical or not; write-downs of assets too can run up returns on equity.

Finally if you are a business like Berkshire and much of your business value is equities that don't pay much out in dividends, then your return on equity is going to be mostly an illogical valuation point.

First Union, the ever progressing return on equity bank of the late 1990's early 2000's, had stagnant book value. Wonder why?

I would caution anyone ever using returns on equity of any sort to understand this simply statistic is often meaningless.
It is meaningless for multitudes of reasons, buybacks can flush equity fast when the stock is selling well above book
for any number of reason, logical or not; write-downs of assets too can run up returns on equity.


Personally, I think you have reached a 100% incorrect conclusion here.
The ROE and ROA of a business are more important than perhaps all other possible metrics combined.

When you start a business, you're going to put in capital.
About the only thing that you're aiming for is the highest safe return on that capital put at risk: the return on your equity.

The "gotcha" is that the metrics have to be calculated and used correctly.
The correct conclusion from your observation of occasional pitfalls is that the equity figure has to be the correct one.
If it needs adjusting because of a historical event distorting the balance sheet, correct it.
The shareholders' equity figure should ideally be the replacement value of the assets used to generate the income, minus the debt.
For most firms, most of the time, GAAP book value is close to this, or close enough. But you have to give it a sanity check.
The three most common things needing adjustment are dud goodwill from bad purchases, off-balance-sheet liabilities, and assets like real estate carried far from current value.
Depressed equity from a history of share buybacks is surprisingly rare: the number of shares bought back has to be very large, AND done at prices far from book value, before it's a material issue.

And second, one should never even bother to look at ROE for a firm with a dangerous level of gearing.
Check the leverage first, and if it isn't safe, immediately move on to the next firm.
Since you don't want to calculate anything else, you don't have to worry about calculating it or using it correctly.

When done properly, there is nothing to compare with ROA and ROE in terms of measuring the effectiveness of both management and the business franchise.
Not all firms with a high ROE will be good businesses.
But all great "moated" businesses have a high ROE figures.
For very good ones, the equity will be rising over time and the ROE will be steady or rising on trend without rising leverage.
This is an indicator that they are likely able to deploy significant amounts of new capital at the same old high rates of return.
For the very best franchises, ROE may be infinite as they require no net equity at all to generate their profits.


As an aside, even when calculated and used badly, a high ROE number is still (AFAIK) the best single predictor of good stock returns.
S&P 500 proxy, last 26 years:

All 500 stocks equally weighted: 9.3%/year

30 of those with highest "naive" ROE: 12.3%/year
30 of those with lowest "naive" ROE: 3.7%/year

30 of those with highest "naive" ROA: 12.0%/year
30 of those with lowest "naive" ROA: 1.3%/year

Jim

Of course Jim, my point isn't a conclusion. It is the introduction of what you finished.

Not interested in low ROE entities.

Your first two sentences assume something I didn't state.

Jim just remember that some of us have been around a long, long, long time. I've been on one forum after another where one person is the dominant poster, the love and skills of writing seem their best skill.

Some of us just maybe do not elaborate in our writing, maybe because we are not so much interested in doing so or possibly because when we do it doesn't come out so well.

Writing well and investing well are two completely different skills.

Some of us just maybe do not elaborate in our writing, maybe because we are not so much interested in doing so or possibly because when we do it doesn't come out so well.

Agreed, mungofitch writes well, but he also rather consistently presents (and has here presented) sound logic, and facts - and this time a one-off bonus of some original empirical research. I have find in my own backtests that ROE is often pretty reliable in offering benefits as far as any single measure, other than momentum which for technical reasons (pun not intended) is about the only mechanical investing variable that cannot be arbitraged away with heavy widespread use.

Are you implying that he merely wrote elaborately in his last post, but in some sense rhetorical such that there was a weakness in the actual argument? If so, can you clarify the logical or factual weakness rather than blaming just his clear style of writing as the problem?

Your central argument against Return on Equity:
It is meaningless for multitudes of reasons, buybacks can flush equity fast when the stock is selling well above book for any number of reason, logical or not; write-downs of assets too can run up returns on equity.

You also mentioned dividends disturbing the ROE. If you are referring to the Return on Equity for firms paying dividends, their earnings are not marked down when dividends are paid, so the ROE figure should not be effected by the dividend. If you meant, however, the ROE on firms like Berkshire Hathaway that owns dividend paying companies, then the Berkshire's ROE also doesn't change substantially whether or not dividends are paid by the public subsiduaries - if s dividend is paid, there will be additional earnings from the dividend, but if it is not paid then there is a higher capital gain, and as Berkshire uses GAAP reporting (where the gains and losses are marked to the earnings) the earnings are also marked up by the higher capital gain. Either way, the ROE is about the same.

Your other criticism of ROE was the wite-downs. Write-downs indeed lower the equity, but they also mark the earnings down. Let's say you pay $50,000 for some asset and find it to be worth $30,000 later, then that -$20,000 should be represented as a loss, and your ROE that year should be reduced. Indeed the equity is also marked down, but it is the larger denominator so doesn't change the ROE much. For example, if your equity is $1 million and your earnings $100,000 then your ROE is 10%, but with the $20,000 write down your earnings are $80,000 and your equity $980,000, so your ROE is now 8%. The write-down has lowered your ROE from 10% to 8% (despite the lower equity), as it intuitively should in the economic sense. We are worse off for the write down, and our ROE gets punished correspondingly.

Sure, ROE will be a little higher later from the reduced equity if earrings are maintained, but deservedly so if it can keep on earning from the lower capital base.

Mungofitch already discussed the effect of buybacks upon ROE as being benign, but I would go further. Buybacks simply do not mark the earnings down, so are practically irrelevant to the ROE. If a company earns $100 million and the company buys back $30 million of their stock, the reported earnings doesn't change to $70 million but stays at $100 million. The cash flow is lowered by the buy-back, but we aren't looking at the cashflow/equity ratio.

Mungofitch's backtest of high/low ROE and high/low ROA shows their efficacy in the past. You didn't even acknowledge the backtest as contradicting your post's conclusion (stating ROE almost meaningless).

To the extent that reported earnings are representative of a typical year, the ROE is not meaningless. It is very much what business owners think when either buying a business, or expanding a business. When you start a venture, or otherwise lay down cash to make purchases, you want the best return upon the cash laid out. Whether or not your capital is scarce, what matters is the income produced relative to capital deployed. If you see an Return on Equity of 50%, you will throw as much equity in that direction as will allow.

Interestingly, you did not mention what I think is the obvious vulnerability with ROE, which is that earnings fluctuate from one year to the next. A better metric might be the five-year average inflation-adjusted earnings divided by this year's equity. I did some backtests with this, however, and didn't get better results than the straight forward ROE. The other problem is that you can elevate earnings just by borrowing more, so either use Return on Assets instead, or just make extremely sure the the debt is both sustainable and historically typical.

Writing well and investing well are two completely different skills.

This is straw-man argument as no-one has claimed good writing and good investing as the same skill. If someone (not mungofitch) has poor investment results, but presents good arguments and ideas, then I recommend to focus on critiquing their ideas rather than changing the subject to questioning their investment results which has no relevance to the arguments in the post.

- Manlobbi

I would caution anyone ever using returns on equity of any sort to understand this simply statistic is often meaningless. It is meaningless for multitudes of reasons...
...
Of course Jim, my point isn't a conclusion. It is the introduction of what you finished...
Your first two sentences assume something I didn't state.

Sorry if I misconstrued your post, obviously not my intent.
I perhaps hastily took the post to be mainly dismissing the entire concept of using ROE as being "meaningless", a stance I would not endorse.

An ROE figure can sometimes mislead if something big and odd has happened to the net worth on the balance sheet, but that's actually pretty rare.
With those few exceptions, firms with consistently high ROE generally fall into one of two very simple categories: either good businesses, or over leveraged ones.
Occasionally both : )

Jim

The three most common things needing adjustment are dud goodwill from bad purchases, off-balance-sheet liabilities, and assets like real estate carried far from current value.

Remembering to check the first two things can keep you out of a whole heap of trouble.

FWIW. AFS portfolio is specifically hedged.

The HTM portfolio is mostly matched to fixed rate long term deb and capital.

So opportunity cost exposure is big, but not current operating income which reflects the matched securities and hedges.

Mungofitch wrote:


30 of those with highest "naive" ROE: 12.3%/year
30 of those with lowest "naive" ROE: 3.7%/year

30 of those with highest "naive" ROA: 12.0%/year
30 of those with lowest "naive" ROA: 1.3%/year


Am I wrong in thinking this is an absurdly simple (in the best possible sense) model for an ETF?

Just sayin', in case you have time on your hands.

Baltassar

Am I wrong in thinking this is an absurdly simple (in the best possible sense) model for an ETF?

I'm sure it has been done.
Much to my amazement, there are more funds than stocks in the world these days.

Another possibility--
Even the things that work on average over time don't work all the time.
After all, if you want to beat the market you have to diverge from it.
A lot of things that work well over time have doldrum stretches, often many years at a time, and people trying it for a living go out of business.
There is a substantial graveyard of remarkably sensible investment managers who got thrown out of the industry in the late 1990s.

Jim

I have find in my own backtests that ROE is often pretty reliable in offering benefits as far as any single measure, other than momentum which for technical reasons (pun not intended) is about the only mechanical investing variable that cannot be arbitraged away with heavy widespread use.

Excellent post in addition to mungofitch's. May I ask what tool you used for your ROE backtests? Is it something publicly available?

Just a comment, backtesting ROE advantages in different universes for the last 20 years confirms it is and has been an advantage. However like most other factors the advantage is much bigger for smaller companies. Better in midcap than sp500, better still in small caps. But this is true for all factors.
On P123 using their Prussel 2000 the smallest 2000 of the largest 3000 market caps the highest ROE quartile has had a 5% advantage over the sp500.
GTR1 is still the best free place to backtest and research factors like ROE. GTR1 results from 1997 to 3/2023 for almost any factor, ratio, and dream up your own universe.
RAMc

May I ask what tool you used for your ROE backtests? Is it something publicly available?

Sorry, it's not a public tool : (

Jim

30 of those with highest "naive" ROE: 12.3%/year
30 of those with lowest "naive" ROE: 3.7%/year

30 of those with highest "naive" ROA: 12.0%/year
30 of those with lowest "naive" ROA: 1.3%/year


Am I wrong in thinking this is an absurdly simple (in the best possible sense) model for an ETF?

In fact that was a proposed screen a few years back.

"Using a broad market index (like S&P500 or VL1500 or Russell 1000)
Or using the Value Line ~1500 stocks with any Timeliness.
Take only the 90% of the stocks closest to their 52-week high.
(Drop the lowest 10%)

Take the top 100 by ROE ...
and those with earnings >0 and book value is < 0.

then of those, top 25 by 5 Yr sales Growth.
Re-evaluate and/or rebalance every 1 or 2 or 3 or 6 months."

In fact that was a proposed screen a few years back.

"Using a broad market index (like S&P500 or VL1500 or Russell 1000)
Or using the Value Line ~1500 stocks with any Timeliness.
Take only the 90% of the stocks closest to their 52-week high.
(Drop the lowest 10%)

Take the top 100 by ROE ...
and those with earnings >0 and book value is < 0.

then of those, top 25 by 5 Yr sales Growth.
Re-evaluate and/or rebalance every 1 or 2 or 3 or 6 months."

I'm not sure when I suggested that : )
But, ignoring the few stocks with negative book value, and run every 2 months with 0.4% round trip trading costs, this has beat the S&P in pretty much every rolling year since late 2018.
Advantage versus SPY 5.5% in the 12 months to May, 13.6%/year in the last 3 years, 10.4%/year in the last 5 years.
I would not expect figures that good on average in future, but I would continue to expect a bit of an advantage.

Jim

Manlobbi you too are a great writer and I guess those who write and get the most likes are most valuable to a web site and thus will get praised. Thru the years, once again, we've had dominant posters who gain staus as...well...dominant posters. And the stocks chosen to be discussed end up quite narrow and interesting.

All the while great businesses, without Elon or Jeff, are all around but gain no traction because...well...

So we day trade Berkshire and Dollar General. DG is in my neighborhood, a new location of 4 years ago that is currently shut down with a "closed" sign. Rumors are that the business was run understaffed, that being understaffed is the "profit" model. Problems come from understaffing though, that the store is hit with theft and disrumption on the shelves and is dirty. Basically, "We make money with 1 or 2 employees but lose with 2 or 3."

So this is the fabulous business model we trade with Carmax?

There's a point where those of us who came to Berkshire with years of ownership (mine began with mom's suicide and dad's early 1975 death) who have also owned may other wildly successful businesses along with some dogs that went to zero or close...or stocks that just don't "perform" - but anyway we came to a Berkshire forum to openly Bershire and other businesses and without the anxiety of being one-upped slaughtered by the superior poster on the board.

I somehow, some way, through...well I guess it is grand luck given I can't write a 1000 word narrative on return on equity or whatnot, have progressed nicely in financial terms since my abrumpt beginning owning stocks decades ago. I didn't need the cutsy, but rude, genius to precisely inform me of what intricate details I've missed, or maybe left out because I wasn't in the moood to write (again) a 1000 word narrative on some subject that has about zero meaning as to whether you "outperform" or not.

My experience is quite different that Jim's. My experience is that men/women who were patient, men/women who held stocks their entire lifetime ended up with the eggs in the basket. Those who traded on precise and often menaningless short term "valuation" metrics? Well, they aren't the ones making the multi-million dollar donations.

Yea, somehow and someway businesses like the rail, the insurance brokers, the exchanges, and many others that can't gain traction - while being extremely relevant - survive and thrive.

As I've mentioned before it has been 25 years since I gained incredibly unpopular status by debating the very popular babyb on General Electric (she loved Jack) and Cisco (she adored John). I just debated and gained the villian...the dominant poster? Was the dominant poster.

I do remember debating a couple posters on a couple other businesses, one in particular was BPY which for whatever reason became the 1000 word narrative super-stock for years and years. All while owning it...and the entitiy it fell under since well back, and I mean really far back, in the Brascan days.

So 69 year old dealraker comes to discuss business, not one-up other as to my supreme knowledge or the particulars such as detailed ROE. Again the best investors I have known, and I know a few, skipped by this topic in 3 seconds 50 years ago as it is plain obvious and plain slapping you in the face it is so low level obvious. Do I need then endless 1000 word elaborations? Really?

Anybody want to discuss business?

As to day trading Berkshire on book and daytrading DG on its viscious cycles here's an article that may should be read. Seems 9 of 10 of us....well are kidding ourselves by daytrading and spending all day one-uppping on the forums.

https://jasonzweig.com/from-the-archives-did-you-b...

A second thing that should, or maybe could, be discussed is without a doubt the major theme on the Berkshire board here by of course the dominant poster. Manlobbi's surely going to kick old dealraker right off the site of this one! LOL.

The major theme here has been now for years and for trillions that:

Apple is massively over-valued. The dominant theme from the dominant poster. Really?

So it goes like this, and has gone like this now for literlly hundreds of billions and even trillions:

"I value Berkshire slashing the value of Apple."

Ole deal's view: It is OK to be wrong, even really-really-really-really wrong, we all are from time to time. But at some point do you ever learn to quit digging your hole or are you so popular from digging that hole that you simply can't stop?

'' Basically, "We make money with 1 or 2 employees but lose with 2 or 3." good morning , great post. Last week I wanted to buy new ears buds for my Apple phone, with a new design. They were 15$$ but, they were locked up, on the rack. After the WMT employee rang up three customers, I was fortunate , he was free so he could come to me and unlock my 15$$ item. I love the product so I'll order two more via Amazon. The Nike store near me was totally redesigned, a small area is under lock and key , and there is an armed security guard. Costco opened a new store about two years ago, so naturally that entire area has exploded, new apts and a beautiful open outdoor mall. Dollar Tree opened last month. It's very well stocked, the spacing is fine, let's see how it does? Net net, costs for retail brick and mortar keep rising, can price increases continue to overcome the inconvenience and the hassles? Btw, I'm 73 and I type with one finger. Take care.

You seem rather bitter. I like you, am a terrible writer and struggle to get my thoughts across but I for one am grateful for Jims posts and am learning lot from them. Unfortunately reading yours are less insightful

I enjoy the posts of both Dealraker and Jim. I've learned from both of them.

You seem rather bitter.
Which is very understandable.

Saying something controversial and getting immediately hammered down by the as he would put it "two dominant posters" is depressing. Especially if this which ignited it:

I would caution anyone ever usinging returns on equity of any sort to understand this simply statistic is often meaningless.

clearly was misunderstood, ignoring that he did not say "meaningless", but "often meaningless", which in this respect is completely different. He explained that, Jim acknowledged it, in theory all good.

But: Imagine that happened to you. That dominant poster's post gets gazillions of rec's, although it is attacking you for something you did not claim. Those gazillion recs might have been not for that, but for the rest of Jim's post which - as usual - was great. But: Wouldn't you take that being hammered down and everybody clapping to it personal?

Oh, and then the other one comes after you who is even more eloquent and able to attack more subtle - and everybody is clapping again.

I can understand the poor chap.

P. S. : With great power comes great responsibility.

On separate occasions (on the prior board, under a different name), I've had Jim and Manlobbi respond to me, including on a point I had only half-made. In some ways they simply used my point to discuss an investing point they had put a lot of thought into. Both received more "recs" than I had.

I admit to some mild, initial annoyance at the collective event, but my larger impression was that both Jim and Manlobbi went on to discuss things that were worth listening to, and that I had learned something from their posts, even when I disagreed. I've generally found both to be generous in spirit, and polite, often exceedingly so. I didn't reply to their posts, as I had nothing left to contribute. None of it was personal. They are two smart people with things to say.

(I've also always read dealraker's posts, and have learned from them. I also don't disagree with him that having a thought leader or two on a board can stifle genuine discussion.)

All of this is to say that I think words and phrases like "attack", or "attacking you", are entirely out of place here. It's a message board. Sometimes meaning is misunderstood or lost in exchange. Sometimes the meaning of one poster simply prompts another to say something that is on their mind. This is all a normal part of human conversation and language, especially when the conversation is done via a format that is less expressive and lacking the normal human cues as compared to real life conversation.

As to day trading Berkshire on book and daytrading DG on its viscious cycles here's an article that may should be read. Seems 9 of 10 of us....well are kidding ourselves by daytrading and spending all day one-uppping on the forums.

https://jasonzweig.com/from-the-archives-did-you-b...

Good article, enjoyed it.

This is kinda where I land:
Finally, ask yourself why you want to beat the market anyway. I once interviewed dozens of residents in Boca Raton, one of Florida's richest retirement communities. Amid the elegant stucco homes, the manicured lawns, the swaying palm trees, the sun and the sea breezes, I asked these folks ' mostly in their seventies ' if they'd beaten the market over the course of their investing lifetimes. Some said yes, some said no. Then one man said, 'Who cares? All I know is, my investments earned enough for me to end up in Boca.'

And figuring out if you beat the market is pretty difficult, anyway, unless it's very obvious. I use the Quicken IRR calculation. It shows a pleasing number, and I'm happy.

As for the day-trading, who here is advocating such? I don't read every post, but I can't imagine anyone here is even suggesting it.

All of this is to say that I think words and phrases like "attack", or "attacking you", are entirely out of place here

I agree with you. Why then did I use this word? Because it was not only about the objective reality of those posts (for which this word might be too harsh), but about trying to describe a subjective feeling they together with the gazillion recs for them might have caused, the feeling of "being under attack", of "all against me".

C'mon dealraker, why so thin skinned? I enjoy many your posts but this one wasn't one of them!
Jim is not only a gifted writer but his posts are extremely rational and well thought through and
deserve praise. We are all lucky that he chooses to share his toughts with us! I couldn't even write
in my natural language half as well.
Personally I don't mind one bit if I get corrected or someone disagrees with me, I consider the merit
of the reasoning and if I'm wrong I change my mind. In this respect I really have no ego.
BTW, I didn't like your stabs at Ms. B on the old Yahoo board decades ago, she also was a poster with
a gift for writing who generously shared here views.
How about enlightening us with some posts about insurance brokers or banks? I'm sure we can learn something!

Apple is massively over-valued. The dominant theme from the dominant poster. Really?

What a curious complaint.
First, I have never said that Apple is massivily overvalued.
Nor do I always say it is overvalued...I noted it was a great buy in March 2013 before Berkshire ever got on board.

I think we can all agree that it's certainly valued much more exuberantly at some times than at others.
It traded at under 12 times (smooth) trailing earnings around end 2018, and at over 40 times (smooth) trailing earnings around end 2021.
Using earnings as the value proxy with or without cyclical adjustment, expanding valuation multiples have accounted for over 14%/year of Apple's price return in the last decade.
Wide variation in valuation levels is a given, no matter what metric of value you choose.

It's a mathematical necessity that either (a) the peaks of price exuberance are ALL still below true fair value, or (b) sometimes the price gets ahead of the value: temporarily overpriced, in other words.

I merely assume option (b) when I'm estimating the conservative value of Berkshire's position in Apple. I allow for the possibility of temporary overvaluation.
Is that so crazy?

The only other approach, option (a), is to conclude that the market price of Apple is *always* an underestimate of fair value, no matter how high it ever gets.
I can't see any way to defend that approach as being superior.


The purpose of my valuation exercise is simply to estimate conservatively the true intrinsic value of a share of Berkshire, which necessarily involves assigning a value to Apple stock.
When estimating what my position is worth, I would rather be pleasantly surprised than unpleasantly surprised.
(I would never use a valuation based on this figure to suggest someone sell Apple stock, nor to short it)
The reason for leaning towards conservatism is that surprises do happen to even the most admired of firms. Some good, some less so.
Most of the time I use the market price of the stock positions.
When the market price of Apple (or Coke or whatever) seems to include a bit too much optimism, I cap my value estimate to a (rich) multiple of earnings, maybe 1/3 of the time in recent years.
Apple's earnings are relatively smooth and predictable, so it's not too hard to do a cyclical adjustment, and not too risky to use that figure as a proxy for the trajectory of true fair value.
For a while I used the value of cash-minus-debt, plus a multiple of adjusted earnings, but that's no longer really needed as the cash pile has become less material.
As I often mention, I hope that Apple stock is worth more than my more conservative value, I am merely unwilling to assume this is the case.


It is OK to be wrong, even really-really-really-really wrong, we all are from time to time.
But at some point do you ever learn to quit digging your hole or are you so popular from digging that hole that you simply can't stop?

I track the progress of the value of Apple based on the progress of its cyclically adjusted earning power rather than solely the progress of its market price (which is what Berkshire's book value tracks).
I think temporarily over-optimistic market prices are possible, so I make a rough guess at the magnitude when it seems like it might be happening.
Maybe my threshold is a little too strict, maybe it's a little too lax. Nobody's perfect.
But if allowing for the mere possibility of overvaluation represents being really-really-really-really wrong and digging a hole of craziness, I'll happily keep my shovel, thanks.

Jim
New motto: Dig on!

Jim
New motto: Dig on!

I'm glad you're taking this with humor!

Jim,

Please, what are, in your opinion, the most recommended books on stock valuation?

Thanks a lot.

Juan Carlos

I would caution anyone ever usinging returns on equity of any sort to understand this simply statistic is often meaningless.
=======
clearly was misunderstood, ignoring that he did not say "meaningless", but "often meaningless", which in this respect is completely different.

It is true that the word 'often' is in there, and qualifies the claim. But then, there are other words that make the affirmation stronger: 'I would caution anyone ever usinging returns on equity of any sort to understand this simply statistic is often meaningless.

And then, the sullen refusal to back down, appealing to age and experience against what he infers is just nice sounding prose.

If you want to make brazen claims about general investing principles and can't back them up with strong arguments and data, then you have to expect some pushback, especially when you're wrong. And if you are lucky, it will be from someone who rebuts your argument politely by saying something like 'I would draw the opposite conclusion', without attacking you personally.

I have been known to overstate a claim or three, but when this next happens to me, and someone pushes back with a better argument, I hope I will be honest enough to admit it gracefully, saying something like 'I have overstated my case', or 'I stand corrected', or at the least, just mumble 'Whatever', and not attack my critic. The capacity to acknowledge error is being lost in our public discourse, and so you may be right about the psychology behind the refusal to back down, but I very much agree with Manlobbi's insistence that it is the argument that needs to be addressed, not the argument's author.

what are, in your opinion, the most recommended books on stock valuation?

Not as many as you might think.
Though it is not really that great a book in some ways, one that really changed my way of thinking about valuing a firm is
"Value Investing from Graham to Buffett and Beyond", by Greenwald et al, which recaps some of the content of the Columbia value investing course.
Comments here http://www.datahelper.com/mi/search.phtml?nofool=y...
Long story short, it made me appreciate how incredibly rare moats are, and how the valuation of those firms is different from the valuation of "normal" firms.

This led me to understand why a boring ordinary non-special firm is often worth only the replacement value of its assets (roughly approximated by book), not the earnings power value.
This led me to change the way I categorize companies, summed up in this old post of mine from 2010:

http://www.datahelper.com/mi/search.phtml?nofool=y...
When valuing firms, I like the approach that breaks it down as follows:
(1) A firm you're not absolutely 100% sure is a going concern: value at net liquidation value.
(2) Going concern subject to competition: value at replacement cost of assets no matter how profitable at the moment.
(3) Going concern subject to high cost of competitive entry: value at cost of competitive entry.
(4) Going concern subject to barrier to entry: value on earnings power value.
(5) Going concern subject to barrier to entry and able to invest large amounts
of new capital within the same moat: value on earnings power value plus a bonus for growth.
(6) As above, but with no foreseeable obsolescence or tail risk: just buy that sucker if it isn't a crazy price.


Rather than a long list of books, I've occasionally wrote down my thoughts of how I distilled what I read about valuing businesses.
Maybe interesting, maybe not.

The distinction here is #3 and #4, the difference between a high cost of
competitive entry and a true barrier to entry. No matter how big
the cheque you write, there are a few firms you couldn't pull even with.
Carmax isn't one of those. But, it might be (at best) one with a high
cost of competitive entry. Lots of good firms in that category.

A follow-on post from that one, sort of a PS:
http://www.datahelper.com/mi/search.phtml?nofool=y...

And another post discussing the same distinctions
http://www.datahelper.com/mi/search.phtml?nofool=y...

Tangentially related posts, my definition of a moat
http://www.datahelper.com/mi/search.phtml?nofool=y...
http://www.datahelper.com/mi/search.phtml?nofool=y...
...how to sift through companies looking for one that is a keeper
http://www.datahelper.com/mi/search.phtml?nofool=y...
...and how to spot when a moat is drying up
http://www.datahelper.com/mi/search.phtml?nofool=y...


Jim

The purpose of this post is to add my endorsement of Jim's recommendation of Greenwald's book on Value Investing. Chapter 3 alone is worth the price of the book, particularly Figure 3.1 - the slices of value. These are:

Asset Value - Reproduction cost of assets under conditions of Free Access and No Competitive Advantages.

Earning Power Value - The franchise value from current competitive advantages

Value of Growth - Only if the growth is within the franchise and benefits from the competitive advantage.

Greenwald cautions that the last slice, the difference between the EPV and the VOG, is the most difficult to make and therefore the least reliable. Our investor will understand how much detailed knowledge of the industry and good judgment this decision requires. Thus the need for a margin of safety.

Jim breaks down these concepts into finer detail and expanded discussion. I highly recommend that one read all of Jim's comments and links - you'll learn a lot.

Tex

I started "Value Investing from Graham to Buffett and Beyond", by Greenwald et al, on my vacation and my initial impression was "I wonder if mungofitch is one of the et al's"

I started "Value Investing from Graham to Buffett and Beyond", by Greenwald et al, on my vacation and my initial impression was "I wonder if mungofitch is one of the et al's"

Other way around!
I just spout the stuff I learned there, over and over. At best I rephrase it my own way.


I really dislike the conventional formulae for valuing growth which they mention. (I'm working from memory here).

I prefer something simple, which doesn't give silly answers with infinite growth horizons or negative interest rates.
My fave:
What's the "pretty darned sure" real EPS on average 5-10 years from now, what multiple do you expect at that time so what is the annualized rate of return that implies?
I use ([Future multiple] X [future average EPS 5-10 years out]) ^ (1/7.5) - 1, annualizing it to the middle of the future earnings era.
If that rate of return looks good to you, buy it!
I recommend never assuming the future multiples will be higher than the teens, i.e. max 19.
I don't think any firm is so predictable that high growth (and valuation to match) can be counted on to be existing a decade in the future.

The nice thing is that it works for all kinds of companies, from dead end cash cows to currently-unprofitable sellers of future stories.

You can turn it around, if you want a real return of X%/year from here, what rate of growth of EPS will do it starting from this price?
Does the rate of earnings growth sound plausible enough that you'd call it "pretty darned sure"?
This backwards view only works for firms that are already profitable.

Jim

Oops, typo, should say

I use ([Future multiple] X [future average real EPS 5-10 years out] / [Current Price]) ^ (1/7.5) - 1
Add the dividend yield, if there is one.

Jim

At the Nebraska meeting didn't Buffett say something to the effect of - he can't sell BAC....because the CEO is such a great guy?

It was a bit like a boy talking about his puppy or childhood stuffed animal

My fave:
What's the "pretty darned sure" real EPS on average 5-10 years from now, what multiple do you expect at that time so what is the annualized rate of return that implies?

I admire the sensibleness and simplicity of this approach, but I struggle with developing a 5-10 year forward EPS estimate that I have confidence in.

I assume there is much more to it than simply extrapolating earnings data from the recent past, though that is likely an important starting point.

Would you be willing to share an example, or perhaps a case study, illustrating the data and considerations you take into account to arrive at a 5-10 year EPS estimate for a given company?

I suspect it would be incredibly informative/educational.

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