Saturday, November 30, 2019

Malone Interview (CNBC), Iger Book, Bubble Watch

People keep talking about how crazy the market is, up more than 25% this year. It's a big year to be sure. But on the the other hand, even though the market has been decent in recent years, it hasn't been particularly bubblicious.

To put the 25% return into context, I think it's a good idea to look at it over 2 years or 3 years.  Since the end of 2017, for example, the market has return an annualized 8.4%/year.  Pretty good to be sure.  Since the end of 2016, its up around 12%/year.  Going back five years, it's up 8.8%/year (these figures exclude dividends).

Not bad at all, but not bubble-like either. If you were going to train an AI machine to look for bubbles, you would look at valuations (interest rate adjusted), sentiment etc. But one of the biggest factors that I would include would be historical returns over various time frames; strong performance reinforces the positive loop of increasing positive sentiment -> higher prices -> better-looking historical returns -> increasing optimism and 'proof' (both statistical and social) of the greatness of stocks etc.

The 10-year return is 10.9%/year, but that's off a depressed level due to the great recession. Over 20 years, the market has gone up only 4%/year.

Here is a table of the S&P 500 index change over various time periods.

S&P 500 Annualized Returns Through November 2019 (excl. dvd)

1-year return:    25.30%
2-year return:      8.39%
3-year return:    11.95%
4-year return:    11.34%
5-year return:      8.81%
10-year return:  10.91%
20-year return:    3.87%
30-year return:    7.55%
50-year return:    7.31%

S&P 500 Annualized Returns Through December 1999 (excl dvd)

1-year return:   19.53%
2-year return:   23.05%
3-year return:   25.64%
4-year return:   24.28%
5-year return:   26.18%
10-year return: 15.31%
20-year return: 13.95%
30-year return:   9.67%
50-year return:   9.36%


This is pretty insane. The annualized return over 5 years to December 1999 was 26%! And we are sort of freaking out that the market is up over 25% year-to-date in a single year, and not even double digits annualized over 2 years.

So anyway, that's why it doesn't really feel like a bubble. People aren't quitting their jobs (to trade stocks), buying new cars (with their capital gains), bigger houses and things like that we saw back in 2000. Most people I talk to still tend to hate stocks, the financial crisis still fresh in their minds.


Iger Book

I just finished the Iger book, and it was also a pretty great read. Iger seems like a genuinely nice guy. CEO's tend to have an image of not being nice guys, so it's great to see someone like him make it to the top. It's possible to be decent, honest and honorable and still do well.

Buffett did mention DIS as one of the well-managed companies (along with GE at one point); his relationship with DIS goes back to when DIS bought Capital Cities during the Eisner years (and Iger was working for Thomas Murphy / Dan Burke). And I think it goes even further back than that, actually.

It's fascinating to read about the events that we've been reading about in the newspapers from the people that were involved. This one involves Buffett / Murphy / Burke, Steve Jobs, George Lucas, Pixar and a lot of what is going on in media today. This connects (unintended) to the Malone interview below.

Anyway, this book is a quick read so go get it. By the way, I have not subscribed to Disney+ yet as I am big into Netflix and there is just so much stuff there that I can barely scratch the surface of what I want to watch (by the time I cancelled the DVD part of my Netflix subscription, I had more than 400 DVD's in the queue). My favorite things are the European cop dramas (French, Belgian, German, Norwegian etc.), the Indian and Japanese shows, and of course many U.S.-based shows too. I just watched The Irishman which is really good (creepy is the special effects to make these close-to-80 year olds look middle-aged), but at the same time I also thought, gee, do we really need another wise-guy movie?

OTT Tangent
People keep talking about the competition in direct-to-consumer streaming and how increasing competition will hurt Netflix etc. This is probably true to some extent; when Netflix was the only game in town, that's one thing, but with many participants jumping in, that's another story altogether.

On the other hand, when you think about it, this is not really an either-or world. People aren't going to sit there and debate whether to switch from Netflix to Disney+ or Apple. Netflix charges $14/month or some such thing, and Disney+ is even cheaper.

A lot of people are still paying $100/month or more for the conventional video package ( I dropped that a couple of years ago mostly because I don't watch most of the channels (ESPN, for example), but what bothered me even more was that they were charging me $14/month for each cable box in the house, which seemed ridiculous to me. Those things can't cost more than $100 (look at Roku at $20; and if it actually does cost more than $100, it's for functionality that I don't need), and they are charging $14/month forever; this makes absolutely no sense.

If you cut the chord, you have $100/month in video budget you can allocate (you still need to pay for the internet), so you can have Netflix, Hulu, Disney+, HBO and a few other things and still be under $100...


Malone Interview
There are a few annual events that are really exciting to me. Of course the Berkshire annual meeting (I just watch the video later), annual report, JPM annual report etc.

And another one of those is the CNBC John Malone interview by David Faber. Faber is one of the few people (of the reporters/anchors), if not the only one, who seems to understand the market and business.

Anyway, I jotted down some notes while watching the recent interview (done during the Liberty Media investor day). This is not everything, though, but a large part of it. He also talked about regulation, GOOG etc, for example, so go check out the video.

Here are Malone's thoughts on various topics:

Who is best positioned in streaming right now?
Malone answered by rephrasing the question to, "Who will be around in five years?"
Disney and Netflix.

DIS
Disney has great content, a great global brand, but doesn't have a large direct relationship with customers so must piggy back on those who do, like Verizon.

NFLX
Netflix, so far in the lead, good base / revenue stream.

AAPL
Apple may surprise. Slim content, but has great distribution in their direct customer relationships. They offer free for one year to buyers of AAPL products etc...
AAPL has optionality; see how it goes and decide how much they want to spend (how much they can afford).

HBO, AMZN
HBO is a decent service, but doesn't have the revenue stream to match Netflix.
AMZN has a totally different monetization strategy so... not primary biz.
Content is for marketing. AMZN may evolve to become a bundler of others' content

Tech companies want to be the platform, get info on customers, be gateway,
let others waste money on content.

DIS will be successful.

Direct relationship w/ customer in scale with growth and pricing power is a powerful business model.
DIS knows they need direct consumer relationship.

HBO Max: HBO content budget was $2bn/year.
If you want HBO, you already have it, so not much gain in new customers in the U.S.?   Malone doesn't see the growth. Maybe even attrition.
HBO budget is not enough to protect for the long term.  Takes years to develop content internationally. Don't own rights to intl distribution.  Problem seeing scale at HBO to get to top of direct consumer biz.  HBO is the same as it's been for 25 years. If you want it, you already have it so where is the growth?HBO may capture wholesale spread (as big bundle moves to direct).

ATT will face challenges. Historically has been the biggest dog in every fight, but not now, and not in this space (streaming media). About scale and globality. Need global scale, or won't get enough scale to compete in this space. This will be the challenge for ATT, HBO. FANG companies are all global. If you're only in the U.S., how do you compete?

Sports is glue that keeps big bundle together... will eventually blow up. Not sure when... big bundle still overpriced due to sports content...

Content Cost
At some point, hail Mary passes for some will prove to not be working so content cost will moderate. Some will fail (and stop spending) etc...

NFLX will have to moderate spend at some point.  Bundling of these services will happen too. Distributors may bundle too, if it reduces churn etc... will evolve like traditional cable. Comcast offers Netflix etc.

Cord cutting will level off. Erosion won't stop completely, though...

Cutting video increases margins at cable companies as margins for broadband is higher. Happening naturally.

Satellite will end up serving people with no other options, rural etc.

Linear TV will lose subscribers, ads, but as you get direct relationships, value of ads go up as you know more about customers.  Ad rev potential goes up; more focused ads etc.  Have to fight decline in reach due to decline of big bundle.  Provide content direct through app and sell content to others etc. Random access via app; if you subscribe to Discovery Channel, you get stuff through app too (not everything).

Cable industry changed when congress changed retransmission constraints; Margins started to go down. Content providers were able to extract more and more...

Will be profitable for people with unique situations, consistent, stable demand, pricing power, level of uniqueness...  those businesses ultimately gets regulated. 

Discovery
Discovery owns content globally, generating free cash, need to migrate to direct to consumer.
Malone bought more stock this week (November 2019).  Discovery will solve issues. Stock is dramatically undervalued. Malone bought $75 mn worth of stock. Growing, generating free cash. Market cap to levered free cash flow, cheapest on screen... They own all their content, generates tons of cash, investment grade b/s, they are growing while others are shrinking (5.5x cash flow). Cheap for good company...
Malone paid $28.03/share. 

CBS/VIA
They have no global presence. Lot of content is bought. CBS is totally dependent on sports rights so not sure about long-term profitability.  Not sure if CBS has enough power to carry all the channels.
VIA underinvested for many years, bought back stock at high prices, tactical mistake.
How important is MTV, Nickleodean to distributors? Question sustainability of model, and also they are U.S. only.

Yes, stock is historically cheap, but...  licensing out content to others. Ice cube melts faster when you don't put content on your own channel.

CBS/VIA needs to get global for long term sustainability. Find niche, glue to make customers sticky. Something unique.

Lions Gate
Sold LionsGate; didn't see them execute strategy of using library/content to drive Starrs. They focused too much on selling content instead of driving their own distribution.

Need global scale, or niche in small area that big guys don't care about to survive.

Wired and Wireless Together
Liberty Global followed strategy based on belief that combination of wired and wireless would lead to synergies. Turned out to be true.  Belgium, Holland (combined with Vodaphone).  Once they built scale, they were able to acquire. Synergies were real and very substantial.

In U.S, for Charter, same idea. Keep growing until they understand the economics of a combination. At the moment, not far along enough on that path.  Once scale is achieved, think about building own network. Hybrid tranmission over time. Could be joint ventures, mergers etc.

Malone interested in Altice, but Patrick wants control etc...

Uber
Not an expert, but doesn't understand Uber, how is scale going to make it profitable? Like selling hot dogs at a loss and making it up in volume. Can't see how scale changes economics. Can't understand why Dara took job.

Politics
Worries about attack on success and wealth in this country.
Worries about where country is going.

If Warren wins, wealth destruction will exceed wealth transfer.  Has places in Ireland, Canada, Bahamas etc... (that he can escape to),  but Malone rather stay here, be optimistic about balance.

Malone is Libertarian, would vote for Bloomberg.

Trump has right strategy, but not the right guy; he doesn't build a team. A lot of people that worked for him trying to take him down now. 

Thursday, November 14, 2019

What It Takes, Dimon, Twitter etc.

Recently, I've gotten some emails asking about the blogger email updates. I googled around (again) recently for a solution and couldn't find one, and also looked at some mass email services and they aren't free over a certain number of subscribers.

So, as has been suggested here by some over the years, I just set up a Twitter account to announce when I have a new post.

My handle is: @brklninvestor

I know many of you are not on Twitter, so I will figure out an email solution too, eventually.

Dimon on 60 Minutes
Jamie Dimon was on 60 Minutes this past Sunday. He is still one of my favorite CEOs and is great to watch. I thought his response to the question about running for president was pretty funny; "I thought about thinking about it..."  That reminds me of one of my favorite Dr. Who lines (from the Eleventh Doctor, Matt Smith), "Am I thinking what I think I'm thinking?"

Anyway, in this environment, there is no way people like Dimon or Bloomberg would gain any traction in the Democratic party. I think either of them would make great presidents, but it just won't happen. No chance at all, unfortunately.

When Lesley Stahl mentioned the bailout of the banks during the crisis, Dimon should have pointed out that it wasn't really a bailout; all the money was paid back with interest (at least the major banks paid it all back). Schwarzman in the book below talks about how he cautioned Paulson about this; to try to avoid the use of the term bailout as it could become a problem if that word stuck. To this day, I still talk to people who think that the banks were "bailed out". They think that the government just gave the banks free money with no strings attached. They are often surprised to hear that the money has been paid back in full, with interest.

Having said that, the definition of "bailout" seems to be to offer financial assistance to an entity on the brink of collapse, so maybe TARP was a bailout. But still...

When asked about CEO pay, Dimon said, "what do you mean?",  or something like that. It was clear he was trying to just avoid the question. To say he has nothing to do with his own compensation, while it may be technically true, wasn't really convincing to people who wouldn't understand. He could have just agreed that CEO pay is too high in this country, and that it should be dealt with at the tax level but probably shouldn't be resolved legislatively or whatever. No need to dodge the question. There is nothing wrong with saying that high income people should pay more in taxes (at higher rates), and that some of the crazy loopholes that reduce tax rates for the rich should be closed etc. He is not running for public office, so he is not taking any risk in saying stuff like that.

But anyway, it was nice to see him on 60 Minutes. Although I am progressive on many issues, I find the current anti-corporation sentiment to be unfortunate. Companies can only change their image by their actions. More and more companies are acting like they are the solution rather than the problem, which is good.

Markets
The markets are kind of crazy. I don't mean this rally, necessarily. A lot of this rally is just recovery from last year's drop and valuations are still in a zone of reasonableness, so I am not at all alarmed by it or worried about it.

I mean the way the markets react to every Trump tweet, or nowadays, Elizabeth Warren ideas. I like Elizabeth Warren a lot, actually, even though she seems to hate Dimon and everything Wall Street.

Whenever the markets tank when Warren's poll figures go up, just remember what happened on election day in 2016; the markets freaked out and tanked when it realized Trump is going to be our next president. But before the next morning, the market took off and hasn't looked back.

Remember what happened to health care stocks in 1992 (Hillary-care), and 2009 (Obama-care). When widely publicized problems hit the market, it is very hard to predict what will happen. Howard Marks would call reacting to these headlines first-level thinking.

First of all, we don't know if Warren is going to be nominated. Even if she is, we don't know if she will beat Trump. Even if she wins, we don't know how much of her plan can be executed successfully (will she run to the center for the general elections? Will she take a more prudent, realistic course of action once in the White House? I'm not saying her ideas are bad or impractical, but she can calibrate her goals according to the reality she confronts once she's there).

There are so many levels of "unknowns" that it makes no sense, really, to try to discount these things so far ahead.

Anyway, if any of these things move the markets too far in any direction, it's probably a great time to take advantage of it and go the other way.

Growth vs. Value
I hear and read about this all the time, and I totally get it and agree. I am a believer in mean-reversion. On the other hand, there are secular realities hidden in these figures too. For example, Bed, Bath and Beyond (BBBY) is one of my favorite stores and was one of my favorites in terms of management. I followed them closely for years, and eagerly looked forward to their annual reports. But it was always a pretty expensive stock. When it finally started getting cheap, it seemed to have lost it's way.

BBBY



Maybe I am putting in the bottom in this stock, but these days, it's hard to figure out what this company is trying to be. Not too long ago, you would walk into a BBBY and then, suddenly, in the middle of the store, there would be like a miniature supermarket, with potato chips, cereal and whatnot. I was like, what?

It's like the newspaper business. As Buffett says, if you wouldn't start the business from scratch today, then it's probably not a good business. And if it's not a good business, you probably don't want to own the stock.

Again, I loved BBBY for many years (and it's just luck that it hasn't been a part of my portfolio), but it's hard to think of a reason for it to exist. A lot of what they sell is exactly the sort of thing Amazon is very good at selling, and for lower prices. Stores like Target are also selling similar things for competitive prices, so I guess it's a similar story where Target/Walmart/CostCo and others (Amazon) are killing the category killers; same as CD stores, book stores, toy stores etc.

This is not to say necessarily that we should go long AMZN and short BBBY, JCP and other retailers (well, that's been a great trade for a long time!). It's more of a question about how much of this growth versus value is the usual cyclical thing that will eventually mean-revert, and how much of it is secular destruction of multiple industries (I don't think most retailers will recover).

WeWork/Softbank
This is a fascinating story. I really admire the vision and conviction of Masayoshi Son. He is fun to watch and follow, and I have always wondered when and if I should buy Softbank stock. There were many reasons to buy it, especially the usual discount to the sum-of-the-parts valuation and things like that.

But one thing that has always bothered me was his almost reckless aggressiveness. I guess that's a good thing for someone in that area, but it was always a little too scary for me. I remember watching him in an interview, laughing at the fact that the price of Softbank stock went down 99% (or whatever percentage it was). I don't want the steward of my capital laughing about something like that. It is definitely not funny to me.

Also, the sheer size of some of these investments makes it highly unlikely that they can achieve high rates of return over time. Yes, Alibaba was a huge home run. So was Yahoo Japan and some others. But what were their capitalizations when the investments were made? I don't think they were valued at $40-50 billion. How much money were they losing? Probably not billions. Things are truly insane these days.

Thankfully, that unicorn bubble, at least, seems to have popped for the moment.

Great Book
And by the way, the original intent of this post was about a book. I just finished  Schwarzman's book, What it Takes: Lessons in the Pursuit of Excellence and thought it was great. This is not a book you want to be reading in the company of your progressive friends (most of my friends and neighbors are progressive;  many are even democratic socialists). Even some conservatives roll their eyes at a guy who throws himself expensive birthday parties and puts his name on library buildings. But I don't care about that. Not everyone has to be like Buffett or Munger.


But what I can say is that after all these years on and following Wall Street, I've mostly heard good things about Blackstone. When they IPO'ed, I followed closely and it was clear that they are a really well-run shop. At the time, Fortress Investment Group was the other private equity firm to go public before Blackstone, and I was really not all that impressed after following them for a while. Their performance was not great, hedge fund was not doing well etc. But Blackstone was at a totally different level.

Whether its their conference calls, presentations, it was all done very, very well.

The only reason I never bought the stock was that, like others, I was worried about the huge increase in AUM at all of these alternative asset managers. How are they going to maintain the high rates of return with ever-increasing AUM and ever-increasing competition, not to mention the corresponding ever-increasing prices? Schwarzman, in the book, makes the case that size has become an advantage for them; they get first call (or are the only call), often because they are the only ones that could close a deal of certain sizes.

I had the chance to grab some shares at under $4.00 during the crisis, but then there were many other things that were cheap too...  But still, knowing what a solid shop it was, I shoulda grabbed some shares then. I guess one rule should be that any time a well-run company is trading for the price of an option, one should buy at least some shares!

Special Situations Trade
By the way, I should also mention that these private equity firms are in the process of converting from partnerships to corporations; this expands the range of potential buyers (institutions that wouldn't or can't own partnerships), which would serve to increase liquidity and most likely valuations of these companies.

I know many of us berk-heads think private equity is nothing but leveraging and cost-cutting, but I still think these guys have a high quality shop.

Persistence
One thing that surprised me was how hard it was for Schwarzman / Peterson when they first started up, sending hundreds of letters to investors with no response, visiting potential investors and getting rejected for months on end. This reminded me of what Barbara Corcoran said in an interview once. The interviewer asked her what the difference between a good broker and a bad broker was, and she said the great brokers know how to take 'no'. If they can't close a deal, they move on to the next one and keep going. The bad ones aren't good at taking 'no', and it wears them down; they get discouraged and it impacts them too much to keep going.

I'm sure we've all seen examples of this. A friend once told me a relative wrote a novel, sent it to a publisher and it got rejected and they gave up writing and blames the over-commercialized, corporate-controlled, dumbed-down American culture for their failure as a novelist (and the friend agreed with that). I was a little shocked. So you write one novel, send it to one publisher, it gets rejected and it's all over? Well, I don't know anything about writing novels and have no idea how that world works, so I didn't say anything.

But I was thinking back to the many famous novelists who kept getting rejected from publisher after publisher, writing story after story before getting published. I think Haruki Murakami got published on his first try, but those are probably rare cases.

Going back to Schwarzman, even with his credibility / reputation (and Peterson by his side), they struggled to get Blackstone off the ground. You can imagine how much work it's going to take to get anything done without that sort of advantage.

Having said all that, it is an autobiography so we hear everything from his side. I'm sure there are people with tales out there somewhere he doesn't want told (and this goes for someone like Buffett too!).

But, it's still a good read. 

Friday, September 27, 2019

Bubble Yet?

Bubblicious?
People still speak of bubbles a lot, bubble in the bond market, stock market, unicorns etc. But I still don't really see a bubble except in certain areas of technology. Otherwise, things seem to be in a normal range to me, except interest rates. They do seem a bit low, but having said that, I still see 4% as a decent 'normalized' long term rate for the U.S. (as I have said here before many times).

The Valuation Sanity Check shows the Dow trading at 20.6x current and 16.4x forward P/E,  and the Berkshire portfolio (largest holdings) trading at 17.4x and 14.3x their current and forward earnings. Browsing down that page, there is nothing really alarming about anything, really. Some things look expensive, but nothing insane.

Also, here are some charts I plucked off the internet. The first bunch is from the JP Morgan Asset Management's Guide to the Markets. This is a nice report that they put out every quarter, and is fun to flip through. 

These charts too show nothing really crazy.

I keep hearing people talk about how crazy it is that the market is up 20% this year, but given that a lot of that is recovering from losses last year, it doesn't sound crazy to me.

Also, people keep saying that the returns of the last 10 years suggests the market is overvalued. But again, given that the much of the returns is recovering from the financial crisis bear market, I think it's irrelevant. If the market had double digit returns over 10 years from a market high, then I would be more inclined to agree; something bad might be about to happen.

But this is clearly not the case here. In fact, from the October 2007 high, the market has gone up less than 6%/year (excluding dividends), and 3.4%/year since the 2000 peak. This is hardly the long term performance figures you see in a real bubble.

I won't look for them, but look at the similar figures for the 2000 peak, Nikkei 1989 peak etc. It is very different from today.




S&P 500 Index Forward P/E Ratio

The above forward P/E chart shows a normal range, nothing alarming. Of course, people will argue that the market has been consistently overvalued for the past 25 years so this is not indicative of anything. But interest rates are a lot lower now than in the past too, and this chart doesn't show any abnormally high P/E level due to lower rates. I suppose one can argue about the validity of EPS estimates a year out. That is certainly a valid point.

Forward P/E and Future Returns

This X-Y plot of forward P/E ratio versus future returns show potential returns solidly in the positive. I did something similar using Shiller's CAPE ratio and found similar results.

One year forward returns based on P/E

My analysis goes back to 1985, so is longer term than the JPM study (which goes back to 1994), but hasn't been updated (a couple of years shouldn't make a difference!).


MSCI World vs. S&P 500 Index



These charts show nothing extraordinary either. Yes, the U.S. market is doing really well versus the rest of the world. But who cares, right? Unless you are some sort of mean-reversion trader, it's not really relevant. I too tend to like investing in U.S. businesses, mostly because I live here and have access to all the filings, conference calls and things like that, and I do feel U.S. companies are more responsive to shareholders and the system works better (compared to Japan, for example, where I have very little faith that managements care about shareholders).

Median P/E Ratio
And here's something I found. The S&P 500 is market-cap weighted, so the index P/E ratio tends to be influenced by the large cap stocks. When you have a bunch of large caps that are overvalued, it tends to push up the P/E ratio of the whole index.

To get a more 'typical' P/E ratio of the random stock, a median P/E can be more useful, as half the companies would be more expensive, and half would be cheaper than this level.

I found this chart in Yardeni's September report: Yardeni P/E report

Here's the median forward P/E ratio:


Again, nothing spectacular here. Looking at this (and the other charts), if someone is net short the market, you would have to examine their brains. Why would anyone be net short in a market like this? It doesn't really make sense to me.

Just flip through these charts again, and imagine you are the head of the trading desk at a hedge fund or bank somewhere. And say some guy is massively net short the market. You ask him why he is so short, and he tells you that it's because the market is way overvalued. What would you say? Would you feel comfortable going home and sleeping well? Of course, this trader may contribute to reducing the overall exposure of your desk, but don't think of it that way as you can always adjust your market exposure with futures.

If you think of it this way, it's sort of insane.

The other non-bubble thing is that you don't hear people talking about the market at all. Usually, in a real bubble, people really like to talk about the stock market in situations where that is not normal. A couple of years ago, everyone was talking about bitcoin. I don't hear much about that anymore these days.

Also, the news flow is so negative these days, whether it be Brexit, Trump tweet, U.S./China trade, Iran... Wherever you look, it's just bad, scary news. And yes, the market responds by going down, but it comes right back up. This is not to say that the market will always come back up. We will have a bear market at some point.

But if you are net short and all these 'favorable' developments to your position is not making you money, that's kind of a serious problem.  What happens when any of these things resolves itself? What if we do get a blowoff that has happened in most other bubble tops (2007 top was not really a bubble in terms of valuations, so bear markets can happen from normal valuations too).

Value-Growth Gap
The other thing is the huge gap between growth and value stocks. I am not that big a fan of this as the division seems arbitrary and kind of meaningless. But what is encouraging is that despite this slightly higher valuation of the overall market, the gap between value and growth seems to suggest that one can avoid a lot of pain by being more in the value area than growth.

Back in 2000 when the market was actually really overvalued, value investors did fine despite a 50% drop in the S&P 500 index as the drop was driven mostly by expensive companies going down in valuation. I think value stocks actually went up back then.

This may be true this time around too.

Market Timing
Most of us value investors don't believe in market timing at all. It is so amusing to watch the market go down 200 pts (or more) on a tweet only to reverse itself within a day or two by another tweet. Why anyone would trade based on this stuff is beyond me. I am a believer that headlines almost never mark turning points in the market. If the market is making a new high and then plunges on some negative headline, you can bet that that high will not be a high of any significance. I have seen various attempts over the years to analyze peaks and troughs in the market and matching it with news headlines; there usually is no headline that marked the top or bottom of a market.

It's just silly to try to figure out when the next bear market will happen.

There is one thing, though, that I would watch out for. If the U.S. market goes into a situation like the Japanese stock market in 1989, then I would obviously react. I would definitely lighten up equity holdings (still on a case-by-case basis based on valuations, of course) and maybe even consider buying puts, going short or whatever (OK, maybe not as I watched many bears lose a lot of money in 1998-2000 period only for them to be proven right but already having lost too much money made no money on the decline).

In any case, it would be a valuation call; I would lighten up when I can't accept the valuation levels. And it would be by each individual holding, not some vague notion about the directions of the overall market or economy.

Japanification of Markets?
The other worry is the Japanification of global markets. We were all baffled by the low interest rates in Japan for decades, and here we are with multiple countries and trillions of dollars in debt trading with negative interest rates.

Many commentators thought it won't happen here, and yet here we are with long term rates under 2%.

What about the stock market? Can the U.S. go into a bear market like Japan's that lasts 30 years? This sort of thing worries me too a little. We can't say it won't ever happen here as we were wrong about interest rates. Well, I've actually been in the camp of "lower for longer" so am not really all that surprised by how low our interest rates are.

But it would not be fun if the market went into a 30-year bear market.

Here's why I don't think it would happen, at least any time soon:
  • The Japanese market went up to 60-80x P/E at the time. That sort of valuation takes decades to grow out of, and it's that much harder when there is no growth! We are nowhere near that kind of valuation
  • The Japanese government and companies spent most of the time since then hiding things rather than fixing them. When the U.S. had a credit crisis, banks were encouraged to raise capital and fix their problems, not hide them. 
  • Regulations are meant to maintain the status quo, protect large companies (who are contributors to the LDP) etc.
  • In Japan, companies are discouraged from right-sizing. They run under a system the Canon CEO, Fujio Mitarai, calls corporate socialism. He says that since the Japanese government doesn't offer much of a social safety net, that burden falls to large corporations; they are strongly discouraged from firing employees. This is why there is a word for this category of employee: madogiwazoku (google it!). Here's an article about it: Boredom Room. It's no surprise that the stock market has been dead for so long with so many zombie employees at zombie companies. This is very different than in the U.S.

There are many other problems, but those are just some big ones off the top of my head... You may think of better reasons why Japan has been stuck for so long.

None of these are true in the U.S. That doesn't mean we can't go into a 30-year bear market, of course. But it just seems to me that it is not likely at the moment.

Hard Left Turn in Politics?
Others worry about the progressive left; Leon Cooperman joked the other day that if Elizabeth Warren gets elected, the market won't open. I understand that fear, and as a big fan of JP Morgan, I totally get it.

I am actually pretty progressive myself (I used to be conservative but have been moving left over time), but I wouldn't worry about this at all.

First of all, we really have no idea what's going to happen. We don't even know who is going to be the democratic candidate; it's possible that someone else not even running now will come up out of nowhere (well, not sure if that's possible, actually, but we still have a long time to go).

We do know that Warren is as progressive as she presents herself, so this may not apply, but it's possible that she runs hard left to take Sanders' and other voters only to run back towards the middle if she wins the nomination.

We don't know what she can accomplish even if elected, right? This is a president, not a dictator. Did FDR or Kennedy destroy the country? I haven't looked at the market action around their elections, but I don't really think there is a big, visible dent or bend in the long term charts based on who was president.

So this is certainly a risk factor, but my guess is that things, as usual, will not turn out the way we expect even if Warren wins the election. It's a complex model and things aren't going to be so easy to predict.


Thursday, April 4, 2019

JPM 2018 Annual Report, Website etc.

JPM's annual report is out, and maybe a good time for another post here. I know it's been a few months. Honestly, I have been coasting recently on what's been working and haven't been digging around too much in the stock market. Most of my time recently has been spent on programming, having taken on a few freelance gigs for fun (and beer money).

Website
Anyway, I have updated my website. A lot of things there were broken, but everything broken there was just due to the Google and Yahoo Finance APIs being shut down completely. This is really annoying. There are a lot of books out there on AI, data science, quantitative finance and all that, and a lot of them depend on those APIs, so it's like those books are worthless now. Well, not really... you just have to find an alternative source of data. But who wants to deal with that hassle?

Anyway, the website is here: brklninvestor.com

The Market Today
One of my favorite pages there is this one: Valuation Sanity Check

People are still talking about how overvalued the stock market is and how it has to go down, and how valuations do matter and that perma-bulls are saying valuations don't matter.

Well, I have been telling people to ignore those people for the past few years, and I, for one, would not say that valuations don't matter. Valuations do matter. The higher the valuation, the lower the future returns. Duh. This is not rocket science. This is no different than bonds. The higher the bond price, the lower the yield, the lower the future return.

Where I disagree with the bears is their conclusion: that if the market is overvalued, then the market must go down. (I am not arguing that markets won't ever go down; they will with 100% certainty. But I doubt anyone can tell us with any consistent accuracy when it will!)

I also quantified this and put the data on the website.

Future returns in an overvalued market

I didn't update it, but since the market has been up, the conclusion would be the same or better. Plus, the analysis uses decades of data, so a couple of years is not going to make a difference.

As for all the worries and concerns, Buffett's 2018 letter has a great section called "American Tailwind", and it basically says that the market has done well over the past 77 years and there were always things to worry about, but the market did pretty well. Maybe more on that in another post.

Anyway, the home page shows the trailing P/E ratio of the S&P 500 index at 21x, and forward P/E of 17x.  This may seem high to some of us who started in the stock market business when interest rates were around 8%. They are now much lower than that. I've said in posts that with a "normalized" interest rate of 4% over the next decade, I would not be surprised if the market P/E averaged 25x P/E.   So a 21x P/E is not at all alarming or shocking to me, and the 17x forward P/E actually looks pretty attractive, even assuming that forward estimates tend to be over-estimated.

Also, looking at the Valuation Sanity Check page, the Dow 30 stocks seem to be trading at 17.5x 2019 estimates and 15.4x 2020 estimates.  The Berkshire stocks (just the stocks listed in the annual report) are trading at 15.4x and 13.4x 2019 and 2020 estimates.

Again, there are issues of the validity of 'estimates', but even still, these figures are nowhere near bubble levels.

My thoughts about the market hasn't changed at all in the past year. Yes, it was a little scary in the fourth quarter of last year, but I was not that particularly worried as none of my work (as shown in previous blog posts) has shown any rubber band stretched to it's limit that must snap back.

OK, anyway, maybe more on that another time. Going on to my next pet peeve...

Data
Google and Yahoo have no obligation to continue their finance data APIs, of course. But what is really annoying is how expensive simple financial data is. It has always been so, and Google/Yahoo made it affordable (or, well, free) for the little guys without big corporate budgets. But that is gone now.

As the world continues to move towards open source and open data (look at this great source of free data related to NYC: NYC Open Data), the financial industry continues to be closed and expensive.

There was an article in the FT today about people (even rich corporate users) complaining about stock exchanges gouging them on price for access to basic data.

As I see it, stock exchanges are basically public utilities. I don't think they should be profit-making entities so long as they are given a legal monopoly (or oligopoly or whatever).

It's just makes no sense that we stock market traders/investors must go through the exchanges to trade and the exchanges then accumulate and use that data and sell them for profit. It just makes no sense at all. This stuff should be public information and easily available to the public in various forms. It doesn't cost that much money to provide an API where people can access this information. We can see they are already making tons of money on exchange fees etc.

So this is just nuts.

OK, so it's not a huge issue for me as stock prices / data is not a big part of what I do. As you know, I am more about listening to conference calls and reading 10-K's and stuff. The only time I use financial data was when I was putting stuff up on the website for fun; I don't need that stuff to invest (and that's why I haven't paid for any data service, and don't really plan to).

The idea of open-source is that if you make the information free and widely accessible, more people can play with it and more ideas can come out of it.

OK, enough of that...

JPM 2018 Letter
No offense to Mr. Buffett, but I sort of look forward to Dimon's letter more than Buffett's these days. Buffett still writes great letters and I read them as soon as they come out. But I feel like I am very familiar with what he has to say and there are usually no surprises, and I am not sure I really learn anything from reading them lately.

But Dimon's letters are much more granular and deal with a lot of specific, current issues etc.

Anyway, I don't plan on going into detail here as you can just go read it yourself (and I know many of you won't, but I don't care... it's your loss if you don't!).

Here are my usual favorite charts.







Dimon Tenure Performance
These tables are really great; they show how Dimon has done as a CEO.

For reference, BRK BPS grew +9.5%/year from 1999-2018 and +10.0%/year from 2004-2018. So you can see that JPM has done better than BRK in both time periods, which is kind of shocking when you think about the fact that one period includes the popping of the internet bubble in 1999/2000, and both time periods include the financial crisis.  (BRK time periods are based on year-ends, so don't match up exactly, but whatever...)



Below is the same look but based on the stock price instead of TBPS. BRK's stock price appreciated around +9.3%/year in both time periods (1999-2018, 2004-2018).  This is kind of insane.


Social / Political Issues
I will not repeat them here, but Dimon goes on in great detail about how we can make things better here in the U.S. It's too bad that our system does not allow for people like Dimon to become president. He would make an incredible one.

Anyway, he does caution us away from the creeping socialism and rising progressives from the far left. I am actually very sympathetic to this recent movement even though I am a hard-core capitalist. But I can see how it can be dangerous for us to veer too hard to the left and destroy things that have worked for us.

But the fact is that what has worked for "us" hasn't really been working for a very large number of people.


Conclusion
It's been a while, but I haven't really changed my mind on anything at all. Nothing new to report, really. The market looks fine. No bubble at all as far as I'm concerned. Maybe not cheap, but not really that expensive either.

The way stock exchanges use data as profit centers is deeply disturbing and is not consistent with what I think of as their mandate as virtual public utilities. The whole system of exchanges charging money for data, and a whole industry of data vendors runs contrary to the worldwide trend everywhere else of open-source and open-data. 

OK, way back in the old days when you needed expensive mainframes to manage this stuff, it may have been understandable. But with technology where it is today, this whole data industry setup and cost makes no sense at all. The industry must be laughing their way to the bank as costs keep going down and the prices they charge keep going up.

JPM continues to do well and it looks like in may ways they are disrupting themselves, which is really great. It assures (or increases the odds) of their continued success.

They have come a long way since I opened my first bank account at Chase many years ago.

I probably told this story here before, but I'll tell it again. When I had my first job in the city, I needed to open a bank account somewhere so my employer can deposit my paycheck.

I figured all big banks are the same, so I went to the World Trade Center (near where I worked and lived) and walked into Citibank. There was a reception desk at the front and I said I wanted to open a bank account.

A big-haired girl, loudly chewing gum and filing her nails barked at me, "I'm on break. Come back later...".  She was sitting at the reception desk/booth. I was shocked at how rude she was, so I just walked across the hall to Chase and said the same thing, and someone immediately came and helped me out. Chase was not that much better; it was pure chance that the Citi employee was on break and Chase's wasn't.

This is the only reason why I started at Chase. Unbelievable. But that's how big banks were back in the 90's. Just terrible. Like the post office.

Anyway, JPM is no longer no-brainer cheap like it was when this blog first started (2011), but it still seems pretty cheap.

Thursday, November 22, 2018

Why BRK?

Every now and then, BRK comes up in conversations with people (and often with people not in the business) and the topic becomes, what to do with BRK post-Buffett. I tell them I own BRK and plan to own it for a long time, and sometimes I wonder why myself.

Too Big
First of all, it's really big now so it's going to be hard to grow the way they used to. With a market cap of more than $500 billion, it's going to be hard to keep growing at a high pace. This used to be sort of the cap in big company capitalizations; a lot of the bit techs went to $500 billion in 1999/2000 before they all came crashing down. The barrier today seems to be $1 trillion; Maybe these $1 trillion companies hit that wall and come crashing down. Who knows.

In any case, BRK is just too big to get too much alpha going forward.

Buffett
Buffett is not so young anymore, so the historical performance is getting increasingly less relevant; Buffett created the performance of the last half a century, but he is clearly not going to lead the charge for the 50 years. This doesn't mean BRK can't outperform.

Buffett hired some great managers to help manage the equity portfolio, but their historical performance is sort of irrelevant too.  Those guys posted great returns with a much, much smaller capital base. They will eventually inherit a $200 billion+ equity portfolio. If they want to stay focused, they will need to invest in companies they can buy $10-20 billion worth of. And there aren't a lot of those. Their universe will be no bigger than the one Buffett is fishing in now, so it's hard to imagine they will improve on what Buffett can do with this size.


Returns Not So Great Lately
And people say that BRK hasn't even been performing all that well lately, underperforming in the past five years. The rolling five-year BPS growth vs. the S&P 500 index total return has been negative for the last five years in a row (through 2017):

2013  -4.0%
2014  -3.9%
2015  -2.3%
2016  -3.2%
2017  -2.7%

People often point to this to show that the era of BRK outperformance is over.

But this sort of misses the fact that back in 2008, the S&P 500 was down -37% while BRK's BPS declined only -9.6%. So in a sense, the S&P 500 index had a lot of catching up to do compared to BRK. Looking only at the above table of the last five years misses a lot of crucial information.

Having said that, it's true that the supergrowth of BRK ended back in 1998, but has been a steady grower since then.

Check out the below log chart since 1980. You can see two clearly different eras in terms of performance. 1980-1998 was just amazing, but 1998-2018 has been much more modest (data just happened to be available since 1980 as I was playing with daily data; no cherry-picking start/end points. Good enough for this analysis).

BRK, Log Scale Since 1980


BRK's BPS grew +28%/year from 1980 through 1998 vs. +18%/year for the S&P 500 index for an outperformance of 11%/year. BRK's stock price rose +33%/year in that period, beating the index by 15%/year.

Since then, things have flattened out a little, but the returns aren't that bad at all. 

BRK vs. S&P 500
I haven't updated this table in a while, but let's take a look at BRK's performance against the S&P 500 index (total return) in various time periods.


BRK vs. S&P 500: Various Time Periods


Of course, we know how great the performance has been since 1965. But check out the past five years. On a BPS basis, BRK underperformed the S&P 500 total return, but outperformed based in BRK's stock price.

If you look at all the time periods, though, BRK has outperformed both on a price and BPS basis in most time periods.

This year, it just so happens that the 2007-2017 is the same as the 10-year comparison so be careful to not double count...  

But to me, more interesting than looking at the past 5 and 10 year returns (which are no doubt important), is to look at 'through-cycle' performance.

The lower part of the above table shows returns from various market peaks (year-end basis). You will see that on a BPS basis, BRK has outperformed the S&P 500 index since the 1989, 1999 and 2007 market peaks, and also on a price basis in most of those time periods.

The 1998-2018 BRK log price shows a more modest pace of growth than the 1980-1998 period, but you will see that BRK has still grown 10%/year since then, bettering the S&P 500 index (including dividends) by 3%/year on a BPS basis and 2%/year on a price basis. Not like it used to be, but not bad! (How many funds can you name that has done as well?)

So all this talk of Buffett not performing well is not so relevant to me.

It looks funny to have both 1998 and 1999 in there, but 1999 is there as a market peak, and 1998 for sort of a momentary peak in relative performance of BRK, and sort of the end of the high-growth era for BRK.

Why BRK?
Despite the size, and the potential risk of a post-Buffett BRK, why do I still like BRK? First of all, the recent performance, I don't think, is as bad as people make it out to be. They are still outperforming in most time periods, especially from various market peaks.

There is something about BRK that makes me more comfortable than owning the S&P 500 index, even with the post-Buffett risk. The first thing is that BRK will probably not do anything irrational or stupid. This is not an assurance we get when investing in the S&P 500 index. The index committee will add bubble-ish stocks at bubble-ish prices. BRK will not be 'forced' to buy stocks just because they are 'big'. They will only buy stuff when it is high quality and is priced rationally. These are two things that the S&P 500 index committee do not seem to care about too much.

Sure, this inflexibility with regard to price and quality will be a drag on performance during certain time periods (like now, and back in the late 1990s), but I would feel more comfortable when my money manager is not chasing big stocks.

Also, check out the below chart. It's just the S&P 500 index since 1980 along with the BRK/S&P 500 index ratio. I just wanted to see, visually, how BRK has performed (price-wise) versus the index over time.

And what I see is kind of interesting.

S&P 500 Index and BRK/SP500 Ratio Since 1980

BRK seems to not do too well in late periods of raging bull markets (like the late 1990s) but seems to pick up a lot of relative performance during rocky times. This is kind of important for conservative investors. Whatever you think of the stock market now, there are pockets of bubbliness, and if that pops, it wouldn't surprise me if BRK has another big step up in relative performance like in the two circled periods above.

This sort of makes sense, right? As BRK doesn't have a whole lot of exposure to FANG/FAANG stocks. And if the market does decline a lot, that will provide a lot of opportunities for BRK to deploy cash so you are kind of sitting on cash optionality by owning BRK.

Yes, BRK declined 50% during the crisis, no better than the S&P 500 index, but if you look at the above table and charts, you will see that BRK does ratchet up relative performance during tough times. So just comparing peak-to-trough drawdowns sort of misses some important information.

By the way, here are some large declines in BRK stock over their history (from the 2017 Letter to Shareholders):


Stunning Discovery
OK, maybe not. But I just noticed something. Look at the above chart again; BRK price / S&P 500 index ratio. If you look at this chart, you will notice that the uptrend is pretty consistent and linear. OK, I am not going to go back and put a regression line on it (too lazy), but you can sort of imagine a straight line going through it from the mid-90's even through today.

Here is the chart again with the line I sort of see (this is not a regression line, but one I just drew by hand). The lower chart is the BRK/S&P index ratio:



And, importantly, there is no kink, bend or flattening after 1998!.

What does that mean?! It means the rate of BRK's outperformance against the index has been pretty consistent and hasn't tapered off at all! 

The ratio will measure the 'rate' of outperformance, not the absolute difference.

Here's what I mean. The above chart is based on prices, but I will look at BPS growth instead as the prices data is a little too spikey (and too sensitive to start/end points). As we saw above, in the period 1980-1998, BRK's BPS grew at a rate of 28.2%/year versus 17.7%/year for the S&P 500 index (total return), for an outperformance of 10.5%/year.  Since then, BRK's BPS grew 9.5%/year vs. 6.2%/year for the index for an outperformance of 3.3%/year. Looks like big degradation in relative performance.

But the linearity of the above ratio chart made me look at this another way. The 1980-1998 28.2%/year is 1.6x the index return, and the 1998-2017 BPS growth of 9.5%/year is 1.5x the index return! 

So, from now on, I am inclined to answer the question, "How do you think BRK will perform vs. the S&P 500 index in the future?" with, "I think it will do 1.5x better!".

Nonsense? Maybe. But it looks interesting to me. This is the danger with playing with charts.

Optionality at Low Cost
Moving on. This is not a new idea, but we can see all the cash at BRK as optionality (even though I have long said that the cash is matched pretty closely to float so wonder how much of the cash is actually immediately deployable. Some of the float might be 'fast', meaning maybe they actually can deploy a lot of that cash and run down the float if necessary).

A lot of funds held a lot of cash since the crisis and have severely underperformed the index. The worst fund managers have actually been net short since the crisis and have catastrophically posted negative returns for years on end. Sure, these guys had plenty of opportunity because they were short; if the market went down, they could profit on the decline and then use the profits to go long and make even more money! But, those guys were neither prudent nor rational, and it is unlikely they will ever be able to make up the damage as it is just too big to overcome.

And yet, here, we have BRK with all that cash and it seems like they haven't sacrificed all that much in terms of performance. That is really amazing when you think about it.

Leverage
By the way, BRK has $97 billion of cash/cash equivalents on the balance sheet just looking at the Insurance and Other segment.  This makes people say that Buffett is bearish the stock market. Well, it's true that Buffett has been having trouble finding stuff to buy, but that doesn't necessarily make him 'bearish'. There is a difference between not finding things to buy, and being bearish (and expecting a market decline).

One thing that occurred to me when thinking about this huge amount of cash and short term investments on the b/s is how small the investment in fixed maturity securities is: $18 billion.

So first of all, the amount of cash/cash equivalent sort of seems to me like more of a bearishness or unwillingness to buy bonds than stocks. There is only $18 billion worth of bonds in the insurance segment versus, what, $200 billion in stocks? That's not bearish stocks to me, that's more like, bearish bonds!

Not to mention BRK has been net purchasers of stocks; not the act of a bear.

Here's the other thing. When we look at insurance companies, we often look at investment leverage. For me, since I like risk, I look at the percent of shareholders equity invested in stocks. Markel looks at and talks about that, as it's a big source of their expected BPS growth.

So I think about BRK in the same way. Forget about cash vs. float and all that stuff for now.

Let's just look at how levered BRK equity is to 'equity'.

First of all, the portfolio (including KHC) is $219 billion at the end of 3Q 2018. That's against $379 billion in total shareholders equity (including minority interest). So the ratio of shareholders equity invested in stocks is 58%.  That's a lot higher than any other insurance company, and I think higher than MKL has been recently (maybe they are much higher now; too lazy to check now).

Of course, this is not like the old BRK, but not at all overly conservative either.

Now, keep in mind that BRK has a lot of unlisted businesses. For example, the various businesses in the railroad, utilities and energy used to be listed companies. If these were still listed, they would be included in equities. As far as growth potential is concerned, other than not having to mark to market, these businesses are basically no different than the equity portfolio (ignore the advantages of wholly owned businesses etc.).

So from the 'leverage' point of view, we can add this to the equity portfolio. The book value of this segment is $96 billion. With a similar argument for the Finance and Financial Products segment, we can add another $24 billion.

Sum that up and you get 'equity investments' of $339 billion.  That's against total shareholders equity of $379 billion. So that's already like 90% of BRK's shareholders equity invested in equity of businesses. That's really not all that bearish!

This, by the way, doesn't even include the other unlisted businesses, the Manufacturing, Service and Retailing Operations (MSR), which is the 'other' in the Insurance and Other segment. BRK doesn't disclose the balance sheet in detail for this segment, but in 2016, BRK equity in the MSR segment was $92 billion or so. Add this to the above $339 billion and you get $431 billion worth of equity investments at BRK against it's shareholders equity of $379 billion.

This is why you get equity-like returns on BRK despite BRK having so much cash/cash equivalents on the balance sheet. This is hardly the balance sheet of a bearish CEO.

Conclusion
I haven't even touched valuation here, but from all of the above, I like BRK a little more now than I have liked it in recent years.

I don't want to time the market and call a peak or anything. I have made it clear that even though we may enter a bear market or have a severe correction at any time, there doesn't seem to me to be a strong case to be made for an extended bear market in the U.S. at the moment (famous last words... I know!)

But the more frothy things seem (well, less so now with the October/November corrections), the more interesting BRK becomes for the above reasons.

AND, it is possible that you won't give up much in terms of performance to buy this 'optionality', with, of course, the greatest investor of all time ready to pounce if we have any big disruption in the market. And we can't forget that BRK has a lot more levers to pull than most conventional funds or even hedge funds; they can buy private businesses too, or do add-on deals to augment the many businesses they already own.

Plus, all that cash on the balance sheet doesn't mean it's as much a drag on BRK's performance as people make it out to be.

As for a post-Buffett world, I think what we need is intense rationality and discipline not to do stupid things. We know BRK is not going to jump into Bitcoin, or buy into bubble stocks (I fear we may find AMZN in the 13-F at an entry price of $3000 some day; that may be a sell signal!), panic and sell out stocks during a crisis or anything like that. And they will not be subject to quarter-to-quarter performance pressure in fear of redemptions. Many of these (and other) advantages are enough to keep me comfortable with BRK for a long time.

Also, even though BRK is not growing the way it used to, and it doesn't look like they are outperforming as much against the index, it looks like a lot of this is due to lower returns in the market in general as the rate of outperformance has been remarkably consistent even after 1998.

By owning BRK, you sort of get paid at least market performance while you wait for the optionality to be exercised!



Thursday, November 15, 2018

BRK Corporate Governance, MSFT, Market Volatility etc.

So Buffett finally buys some JPM. He owned a bunch in his PA years ago and said it would be a conflict to own both JPM and WFC within BRK, or some such thing. I guess recent events (WFC scandals) have made him change his mind (as he may be starting to dump WFC). I've been a big fan of JPM for years, so naturally, I like this move. I wonder if Jamie Dimon would ever make it onto BRK's board; he would be a great fit there and would give the board some real, hands-on expertise in the financial industry (there is plenty of talent there, but noone with Dimon's experience/background).

This is the 13-F that was just filed (includes only positions over $1 billion):




Market Cap to GDP
Someone asked in a comment the other day what I thought about the market cap to GDP ratio, Buffett's once favorite stock market valuation indicator. This, like many other valuations measures, is really dependent on interest rates. If you believe (like I do) that interest rates drive the valuation of assets, then prices are high when rates are low and vice versa. So, of course, if interest rates are low, the market cap to GDP ratio will be high. But that tells us nothing about the valuation of asset prices as it has to be compared to interest rates. Plus, it doesn't really tell you anything about interest rates either. (A lot of bears like to point to 'overvalued' indicators, like this market cap to GDP, P/E, CAPE, EVITDA/EV, Dow-to-Gold ratio etc. But often, it's all the same thing, so it's like double counting. They all point to one thing: asset levels are high because interest rates are low. But, people still think of these above factors as separate, discrete pieces of evidence to show the market is overvalued.)

Not to mention, many U.S. companies are growing globally, so their sales and earnings from non-U.S. business will be capitalized in the U.S. stock market while the GDP will not include those new territories. If a U.S. company merges with a European company, the stock market valuation may well increase (while GDP does not). Also, when Yahoo owned Alibaba as Alibaba took off, the U.S. market cap of Yahoo (and therefore the U.S. stock market) increased (with no increase in GDP).

So in that sense, I don't think it's a relevant measure of anything these days. I still like to adjust interest rates to what we might think is a normalized rate, and then price assets off of that.

BRK Corporate Governance
Again, from the comment section, someone mentioned an analyst or author that is comparing BRK to fraudulent companies; BRK's corporate governance standard is comparable to historical frauds (ENR etc.).

Well, I am preaching to the choir here, and maybe I am just an ignorant, blind, cool-aid drinking BRK groupie, but every time I read these comments, I think it's ridiculous. It just takes a little bit of common sense to figure out the difference between BRK and the big corporate frauds in the past.

First of all, just for fun, I took a quick look at the corporate governance score of BRK on the Yahoo Finance page, and was surprised at the high score: 9 out of 10!
Corporate Governance
Berkshire Hathaway Inc.’s ISS Governance QualityScore as of November 1, 2018 is 9. The pillar scores are Audit: 1; Board: 10; Shareholder Rights: 8; Compensation: 6.
Corporate governance scores courtesy of Institutional Shareholder Services (ISS). Scores indicate decile rank relative to index or region. A decile score of 1 indicates lower governance risk, while a 10 indicates higher governance risk.
Not bad! But then, reading further, I realized that 10 means high risk, lol... Oops. So it is, in fact, the way I thought it would be. Just to be sure, I checked this at the ISS website.

From the ISS website:

THE METHODOLOGY BEHIND THE SCORES
Governance QualityScore uses a numeric, decile-based score that indicates a company’s governance risk relative to their index or region. A score in the 1st decile (QS:1) indicates relatively higher quality governance practices and relatively lower governance risk, and, conversely, a score in the 10th decile (QS:10) indicates relatively higher governance risk. Companies receive an overall QualityScore and a score for each of four categories: Board Structure, Compensation/ Remuneration, Shareholder Rights, and Audit & Risk Oversight.

WFC, by the way, with all it's scandals, has a QualityScore of 1.

Out of curiosity, I looked at MSFT and check this out: 
Microsoft Corporation’s ISS Governance QualityScore as of November 1, 2018 is 1. The pillar scores are Audit: 1; Board: 1; Shareholder Rights: 1; Compensation: 3.
Amazing!

MSFT
OK, and check this out from the proxy:
The vast majority of our global employees participate in an annual anonymous poll. Here is a selection of results:


LOGO


That sounds crazy too, for a large corporation. I don't know how 'real' this is, as we all know how people may be 'nudged' to fill out surveys in ways favorable to management. Well, they say it's anonymous, so OK, maybe it's legit. 

I have become in recent years a big fan of MSFT, both as a user and an investor.

My MSFT Experience
I have been tied to MSFT for most of my career as company PC networks were usually run on Microsoft and desktops were usually Windows NT or whatever. Of course, we also had Unix machines running the serious stuff, but most office work, spreadsheet work and whatnot were done on Windows machines. 

After going out on my own, I stuck to Windows, but I got increasingly frustrated at how often Windows would crash/freeze. Some days, I thought I spent more time waiting for things than actually doing any work. And then they killed XP (which I had on some of my old machines).

A programmer friend suggested I look at Linux, so I did. I installed Linux on my old laptop and eventually one of my old PC's, and I loved it. It was rock-solid and stable, like the Sun workstations (Unix) I used to work with that you never had to reboot or restart. I was seriously contemplating switching everything over to Linux and ditching MSFT altogether. 

One thing holding me back was that a lot apps written for Windows is not available in Linux (well, you can still run Windows apps with Wine, but I was a little skeptical/worried that there would be issues if there was another layer). Otherwise, I loved everything about Linux. I use GIMP now all the time for photo processing (like the Buffett photo in my last post), Libre Office is great and is getting better etc. Plus my Linux machines never just randomly go into these long updates. 

Well, one of my favorite things is how easy it is to run cron jobs in Linux versus Windows; I really hate the Windows task manager. A lot of other things are just so much easier to do off the command line in bash (although Powershell is getting pretty powerful, but it's so clumsy/clunky, I don't feel like learning how to use it properly). 

Back to Windows
But OK, I never abandoned Windows. But what sucked me back in and made me abandon the idea of switching over completely to Linux was Windows 10. I was skeptical, but upgraded all my Windows machines to Windows 10 (forgot when), and I have been very happy. Yes, if you are not careful and don't set your 'active' time, it can go into long update cycles rendering your computer unusable until the updates are done. This is forced so you can't stop it. But you can tell Windows what hours of the day you will not be using the machine, so the forced updates will happen in those inactive hours. 

OK, small problem. 

But since switching to Windows 10, I have had very, very few problems I used to have. Random crashing, random freezing etc. I have not had that occur much at all and it's been a pleasant surprise.

Also, Windows 10 comes with Ubuntu bash so if you like Linux command line stuff, you can do it all in a bash terminal right on the Windows 10 machine and in those drives/folders that Windows runs on (goodbye cygwin?!). 

The other major thing that drew me back to Windows is OneDrive. I used to do work on my home desktop and my laptop, and I used to have to email files back and forth to work on them. You can use Google Drive, Dropbox, Box etc. to sync files on your various machines, but I never got around to doing that with the above, and I didn't like how Google Drive seemed to keep altering my files (especially programs) when I uploaded them. 

But OneDrive was so easy and is basically already set up from the get-go in Windows 10. Now my most active folders are on OneDrive, I never have to worry about syncing anything; it's all done automatically.  

I think this is one of the big things that got me tied to Windows now. 

Plus, I am playing with Azure now and it is very easy to create Linux instances (basically virtual machines in the cloud) so you can write bots and set them up to run as cron jobs and your tasks will be done whether your PC/laptop is on or not. Plus they have databases and many other cloud services (I use Amazon too, but mostly for fun/experimenting). 


So when you think about how all of this is integrated and everything works great with each other, you can see how excited I am about MSFT. A programmer relative told me a few years ago that MSFT sucked for most of their existence, but that with C#, Azure and other cool things, they are becoming a really incredible company. (I am also experimenting with C# but haven't created anything for actual use). Of course, at the time, I didn't really look into it or understand. 

Anyway, this is sort of relevant, right? As IBM just bought Red Hat, which is a Linux business. Anyway, I still love Linux and have a Linux box sitting next to my main Windows 10 machine. Linux will continue to grow, and behind the scenes, Linux runs everything, and will run even more going forward.

And check this out. I just recently noticed that Stanley Druckenmiller is big into MSFT: 



So he is probably seeing and hearing the same things I am talking about. Well, OK, I have no idea why Druckenmiller is long MSFT. But I would assume it has something to do with what I'm talking about.

Oh yeah, and I really enjoyed Nadella's book: Hit Refresh.

With the FANG/FAANG stocks so popular, who knows, maybe MSFT is the tortoise that surprises everyone!


Back to BRK
OK, so there is probably not much I need to say on how silly it is to criticize BRK's corporate governance. Check this out from the BRK 2018 proxy: 


This list doesn't show a group of people who really need the money. I think the average compensation for a big company director is something close to $300,000. If you wonder why so many board members seem to be yes-men to the CEO, this may be one reason why; it's good money! Don't rock the boat, keep quiet and keep cashing your checks!

It's clear from the above table that BRK directors are not there for the money. And sure, they are friends with Buffett so are they really independent? I would rather have directors that understand Buffett and BRK well, and have enough of a spine to express themselves if they see something they don't like.

There is a lot more to say on this but one of the biggest arguments in support of BRK's structure is that Buffett himself is the largest shareholder of BRK, so if this was a fraud, who is he defrauding? Himself? That's laughable. He takes a $100,000 salary but the bulk of his wealth is created by BRK's stock.

This is the opposite of most situations, where managements own token amounts of stock (and dump their stocks whenever they exercise their options) and pay themselves massive amounts of money. When you own very little stock but pay yourself huge amounts, I think that incentivises fraud more. Don't you think?

When a CEO has 99% of their wealth tied up in a stock, that is stronger than any corporate governance factor I can think of.

But corporate governance specialists, critics and academics don't seem to understand that. They would rather check the boxes on what they inflexibly think of as good corporate governance practice and that's it. I guess part of it is laziness, and part of it is just practicality.

Institutions that own a large number of companies can't possibly evaluate that many CEOs, BODs, etc. so they need some simple measure to save time. Like P/E ratios, maybe. Those that don't know how to evaluate businesses may have to depend on P/E ratios to evaluate cheapness, but if you know how to evaluate businesses, P/E ratios often don't really matter (as they don't tell the whole story, like, in the case of BRK!). 

Abdication/Transparency
I mentioned this in the comments section of another post, but the other issue is that Buffett is so hands off the businesses to the point of abdication. But this is misleading. We all know Buffett watches numbers like a hawk. He said he gets faxed sales figures every day from various businesses and he looks at them carefully every day.

What he means when he says he is hands off is that he doesn't micromanage. He doesn't insist on seeing every ad before airing. He doesn't want to interview and approve every new hire. He is not going to approve every paint job of a store, or pricing/marketing strategy of each business. He is not going to approve each detail of every budget for every line of business.

But this doesn't mean that he isn't watching every penny that goes in and out of the businesses. We all know that all of the free cash of a business is sent to Omaha, so if something is wrong, he will know right away.

For the businesses where things may get funky, like the insurance businesses, those are highly regulated, and Buffett is very closely monitoring those businesses and is very involved as he says, with big blocks of business (talks to Jain several times a day etc...).

As for transparency, I don't know. I never thought BRK lacked transparency. It could disclose more, of course, but I never thought of BRK as a complete black box or anything like that. Major business lines are presented clearly and in detail. Some of the non-insurance businesses might be opaque, but each of them are just too small to disclose separately.

Some fuss is made about the Sokol incident, but those things will happen every now and then to any company. Goldman Sachs has a lot of legal and compliance infrastructure, is highly regulated and constantly audited, and yet we now have the 1MDB scandal. So I don't know that the Sokol incident proves anything about BRK either way. You have to look at the big picture and see the kinds of problems they've had over the years, and the record is pretty good. Will another scandal happen? Yes. These things will happen. It's how management deals with it that will determine the fate of BRK, and I have faith that they will deal with any issues in the future promptly.

As Munger says, it's all about incentives, and I think BRK people are properly incentivized.

Remember what Buffett said after the crisis. He said that there was a regulator who had one job, and that was to regulate FNM and FRE, I think. And they failed. So just because you have someone watching and regulating, if the incentives are not correct, you are going to have problems. 


Market Volatility
So, I was a little irked when the market was down 600 points the other day when I was on my way out of the house. I know I don't really care, but still, at the back of my mind, I think, is this it? Is this the end of capitalism? Are we going to go down 90% like we did in 1929-1932? OK, I wasn't that worried, actually.

But it made me curious. Why are we so scared of big market moves like this? 600 points is a little more than 2%. Back in the late 1980s and early 1990s, a 2% move would have been a 50 point move. 600 points is psychologically shocking because Black Monday was a 500 point drop. So it feels like Black Monday again (that was before my time!).

I tend to buy into narratives I don't really care about. The HFT/quants are making the markets more volatile. ETFs, especially leveraged ETFs are making the markets more volatile. More regulation in the markets and the resulting decrease in liquidity (thinner bid/ask from market-makers/specialists) are making the markets more volatile etc...

I go, hmm... OK. Probably true. But whatever. Doesn't matter to me.

But sometimes, I suddenly think, wait a minute. Is all of this true?!

Let's take a look!

First of all, let's just take a look at the market's volatility on a rolling 100-day basis. This is what derivatives traders would call the 100-day historical volatility. I looked at this going back to 1950. All of the following charts include data up to this past Monday (11/12/2018).




So, looks pretty normal. Even with the big moves in the past few weeks, nothing out of the ordinary here. In fact, I would have guessed things were pretty wild since Trump was elected, but if you look back to even 2012, 100-day vols have been in a normal range. It certainly doesn't feel that way.

OK, so maybe vols don't tell the whole story. Let's look at some other things.

We've had a few days where the market was down more than 2% recently. Or it feels like it happens a lot. So, I looked to see how often the market went down more than 2% on the day. To make it a readable chart, I just summed up how many times the market declined by more than 2% in the past 200 days.

Here's that chart:




So yes, it's a little elevated, but nothing really out of the ordinary. Look at the period during the crisis! Also, look at the mid to late 1990s, even before the bubble collapsed.

What about those days the market opens down 800 points and closes up 300, or some such crazy thing? It seems like that sort of thing happens a lot these days. If I had to guess, I would tell you that that happens more often these days than in the past.

To measure that, I just subtracted the day's high from the day's low and divided it by the day's close, and then took a 100-day average of that.

Here is that chart going back to 1962 (hi-lo data only goes back to 62):




...and surprisingly, this too is in a very normal range, and far below the levels of even the mid-90s (I guess the day traders used to make this really wide). Nothing out of the ordinary here.

And let's look at the number of days in the past 100 days that the day's range exceeded 2%. 



Totally normal range. Nothing out of the ordinary.

Conclusion
JPM is now a BRK stock. Get Jamie on the board! He would be the person I trust most next to Buffett.

BRK scores low on corporate governance, but so what? Look at the incentive structure, which is more important than committees, bureaucracies like compliance/legal departments etc.

People who write to complain about BRK are people who just don't understand, or just use BRK to grandstand and gain attention by making astounding claims against consensus (this is why people like to say "the market is going to crash 50%!", or "the market will get to 500,000!"). So ignore those people.

Microsoft is pretty awesome. I never made a post about it as an investment; I should have when I started to get interested, but oh well. Maybe eventually, but I don't really have anything to add to MSFT in terms of financial analysis/valuation.

And, the markets seem like they are crazy and more volatile than ever, but the above charts don't bear that out. People, the press, keep freaking out over 2% moves as if they are 10% moves. The markets, despite all the things that should make markets more volatile than ever, are just as volatile as they ever were and no more.  So relax!