tag:blogger.com,1999:blog-5389144729834496735.post3019506709040230194..comments2024-03-17T05:15:55.634-04:00Comments on The Brooklyn Investor: Recapitalizing Berkshire HathawayUnknownnoreply@blogger.comBlogger16125tag:blogger.com,1999:blog-5389144729834496735.post-2929135585715263682012-10-11T11:09:42.489-04:002012-10-11T11:09:42.489-04:00btw the other ways to permanently impair capital a...btw the other ways to permanently impair capital are overpaying for something and debasement via inflation - pzena has some good content on this...Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-13597520654554372682012-10-11T11:08:19.310-04:002012-10-11T11:08:19.310-04:00as a consequence of this post, I got to thinking a...as a consequence of this post, I got to thinking about the idea of risk and how leverage (being one of the ways you could permanently impair capital) is a concept that should be looked at across the whole vertical of exposure (at the macro level, account level, and at the holdings (company) level). It really cleared up my thinking - thank you for insightful content!Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-75792606149449227852012-10-09T18:43:50.193-04:002012-10-09T18:43:50.193-04:00Thanks for the heads up. I did see that. Great i...Thanks for the heads up. I did see that. Great interviews! kkhttps://www.blogger.com/profile/06299974418283948333noreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-22907715693557193942012-10-09T18:35:14.595-04:002012-10-09T18:35:14.595-04:00By the way, KK,
There is an interview with Joel G...By the way, KK,<br /><br />There is an interview with Joel Greenblatt in the latest issue of Graham & Doddsville. One of the other interviews is with Loews.<br /><br />http://www.marketfolly.com/2012/10/joel-greenblatt-interview-in-latest.html<br />Tonynoreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-1851027309385323862012-10-03T20:34:40.229-04:002012-10-03T20:34:40.229-04:00Thanks all! learned more from this post and the c...Thanks all! learned more from this post and the comments than the aggregate of the past 3-6mo's of books and random articles.<br /><br />-JMCAnonymousnoreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-64856096705578385682012-10-03T18:27:16.970-04:002012-10-03T18:27:16.970-04:00One more thing, I think this is why Greenblatt sai...One more thing, I think this is why Greenblatt said you should use LEAPS to create your own leveraged recap of situations with clear catalysts. In cases with catalysts that take you out of the market's direct control, you have a much better chance of catching the right side of the leverageAnonymousnoreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-28991241786181038952012-10-03T14:57:54.354-04:002012-10-03T14:57:54.354-04:00Yes, that was the WFC example, which is the same a...Yes, that was the WFC example, which is the same as my BAC post from earlier this year. "Creating your own stub" is a different concept, but it's still a LEAPS trade so similar in that sense. kkhttps://www.blogger.com/profile/06299974418283948333noreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-3721438857432924662012-10-03T14:51:35.844-04:002012-10-03T14:51:35.844-04:00If I remember correctly, Greenblatt in the book re...If I remember correctly, Greenblatt in the book recommended LEAPS in situations where the stock already trades like an option, i.e. the downside of owning the LEAPS is not much worse than owning the stock, but the upside is much biggerfabnoreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-87558657188930649642012-10-03T13:43:28.979-04:002012-10-03T13:43:28.979-04:00OK, I said I'll mention something on my next b...OK, I said I'll mention something on my next blog post but I decided not to. What I was going to say was that if you think BRK is worth at least 1.4x book and it's trading now at 1.2x and that book is growing at 1.0x, the LEAPS can be an attractive investment, and the odds of BRK trading at say, 1.0x book at expiration is very low as BRK doesn't trade at book very often and Buffett keeps saying BRK is worth far more than book. <br /><br />Maybe this would have to become it's own post after all. I might post something if I have time later... (but maybe not)kkhttps://www.blogger.com/profile/06299974418283948333noreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-84189025673228145232012-10-03T12:36:04.014-04:002012-10-03T12:36:04.014-04:00Hi, no there is nothing wrong with your view. The...Hi, no there is nothing wrong with your view. There are surely other ways to gain leverage, of course. One can also just use futures and put up 5% margin for full 100% long exposure and then go out and pick stocks with the other 95%. That's a lot of leverage; futures is usually pretty low cost. <br /><br />You can say the BRK is so low risk people can use a little leverage. But it's more simply that those who wish that BRK would pay out cash and be a little more levered can do it themselves. For those happy with BRK should just be long BRK as is. <br /><br />For me, I bought BRK LEAPS when it was near book value; I liked the leverage and I thought the risk of the LEAPS going to zero was very small (but not zero! Tails are fat, we know!). <br /><br />So I don't think we are in disagreement. <br /><br />For me, I like to lever up by position so I don't have to think about it, plus the cost as calculated above, sounds much cheaper than the 4%-7% margin rates that seem typical for most retail investors (you can get 1-2% at some brokers, though). <br /><br />As for your question of whether there is a benefit to using LEAPS as a special situation like Greenblatt, I do believe you can. <br /><br />The binary/bimodal bet I describe in my BAC post is one special situation (also in Greenblatt's book with WFC as the example; it's the exact same trade a decade later with a different name!). <br /><br />But this synthetic stub, to me, is also another special situation type trade. Why? Because we are basing our decision on financing cost and desired leverage, not volatility. The option markets are priced using B/S (or similar) option models. To the extent that you don't use it, that you are using a different pricing mechanism can work to your benefit. <br /><br />In fact, I forgot to mention one key thing in the above post which I will make my next blog post... I was thinking about that while eating lunch just now. So check my next post which I will put up sometime this afternoon. <br />kkhttps://www.blogger.com/profile/06299974418283948333noreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-47803638297681700282012-10-03T12:18:19.835-04:002012-10-03T12:18:19.835-04:00Hi kk,
Thanks for the reply. It sounds like we a...Hi kk,<br /><br />Thanks for the reply. It sounds like we are basically in agreement, but perhaps there a slight difference in views. So, to continue my thinking...<br /><br />Regarding your scenario "instead of having 10% in BRK stock, maybe someone wants to put 5% in the 60 strike LEAPS". I would argue that anyone who wants to put 5% in 60 LEAPS could just increase their portfolio exposure to 15% BRK stock. Why not do that? Well, maybe you could argue that 95% of their portfolio in stocks that they don't want to sell. <br /><br />For arguments sake, lets assume that someone has 95% invested in the S&P 500 (SPY) and 5% cash. They could use their 5% cash to buy 60 BRK LEAPs. However, I'd argue that they could also buy LEAPS on SPY to get their leverage. Specifically, they could sell all of their SPY holdings and use 90% of the proceeds to buy LEAPS on SPY that offer some slight leverage. Now, they have about 15% cash (5% starting cash + 10% cash from the sale of SPY that wasn't used to buy the SPY LEAPS). Now, they can use this 15% cash to buy BRK stock. Overall, this seems roughly equivalent to being 95% in SPY and 5% in BRK 60 LEAPS.<br /><br />I'm guessing that we are in rough agreement on this.<br /><br />Anyway, perhaps a different way of saying what you said in your blog post is: <br />Berkshire Hathaway is such a low risk investment that anyone who has some in their portfolio can afford to use a little leverage. This leverage can be accomplished through buying BRK LEAPS, buying SPY LEAPS, or using margin. Alternatively, if you have some extra cash lying around you can just use that to purchase more BRK stock.<br /><br />I guess that I question if there is benefit to using BRK LEAPS "for people who want to run a special situations portfolio like Greenblatt did." (I do fully understand the argument that LEAPS may be mispriced for stocks with binary outcomes, but BRK does not fall into this category.)<br /><br />Let me know if I'm not thinking clearly...<br /><br />Best,<br />Tom L<br /><br />Tom Lnoreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-90697559557540380862012-10-03T12:16:52.954-04:002012-10-03T12:16:52.954-04:00Yes, thank you. I did remember the BAC post, but ...Yes, thank you. I did remember the BAC post, but I sort of look at that one as a different trade even though they are both LEAPS trades. There may not be much of a real difference, but I see this BRK trade as a self-created stub trade and the BAC trade more as a binary or bimodal bet on BAC; the LEAPS is worth either a lot more or zero. The B/S model doesn't capture those kinds of situations well at all, so it's a special situation in that sense. <br /><br />And yes, it's a good idea for tax free accounts if done carefully and with moderation. <br /><br />Thanks for commenting. kkhttps://www.blogger.com/profile/06299974418283948333noreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-27431138328070082282012-10-03T11:12:29.001-04:002012-10-03T11:12:29.001-04:00"I thought I wrote this up before but can'..."I thought I wrote this up before but can't seem to find it. I probably mentioned it within some post somewhere..."<br /><br />Yep you did, it was when you were looking at BAC and financials, I think the blog post was "Taking a LEAP on BAC". You can find it by browsing the tag BAC.<br /><br />This is a really clear explanation of LEAPS. You also explain well why it's more interesting play with a dividend-free stock than with dividends.<br /><br />It seems to me it might make sense especially for "jumpstarting" an IRA account, since the rolling over would no be subject to taxes, so you can take a small portion of the IRA and leverage it. Of course this is going to take some supervision (at least annually) for rolling over the debt, also if there is a decrease and the stock price declines catastrophically close toward the strike price (at which point you'd probably convert the LEAP back into the stock by exercising the option). So it'd take some extra attention which most people probably don't give their IRA, but under reasonable market condition you'd be able to get an extra advantage which, since these are long term positions, will tend to accumulate over time.<br /><br />And like Tom and you said, I wouldn't use it for the entire account,only for a diversified portfolio and if you want a little kicker and would like to be more aggressive (perhaps because you didn't contribute as much as you wanted to in your IRA). And if/when you've upped your position more to your liking, you can convert to the stock and let it grow and focus your attention elsewhere.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-30226667613182340412012-10-03T10:56:57.500-04:002012-10-03T10:56:57.500-04:00Hi,
You are exactly right. Buffett/Munger would...Hi, <br /><br />You are exactly right. Buffett/Munger would agree with you 100%. You seem to understand the situation and you conclude that you wouldn't need the leverage. <br /><br />And yes, LEAPS are risky so you don't want to put too much into it as like you said, it can go to zero, particularly the higher strike. If BRK is down 30% at expiration, a $60 strike call is worthless. <br /><br />And yes, you are at the mercy of Mr. Market unlike and outright long. <br /><br />I think this applies more to people who run a diversified portfolio and wants a little kicker, even if it adds some risk. <br /><br />So for example, instead of having 10% in BRK stock, maybe someone wants to put 5% in the 60 strike LEAPS (then you have 15% notional exposure to BRK instead of 10% with only 5 down. But then of course you have the odds of zero). <br /><br />Or others may want to put 10% into the lower strike calls with the view that a 55% decline in the stock price only happens a couple of times every few decades so doesn't worry about it too much (but still, you don't want your entire net worth in it!). <br /><br />Anyway, for most long term investors, something like this is not a good idea. <br /><br />I think it's more for people who want to run a special situations portfolio like Greenblatt did. This has to be a part of portfolio, not a replacement for a long term investor with a lot of net worth in BRK... <br /><br />So anyway, there is nothing wrong with your thinking.kkhttps://www.blogger.com/profile/06299974418283948333noreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-18648089475000274352012-10-03T10:43:20.901-04:002012-10-03T10:43:20.901-04:00First, I really enjoy your blog and liked this pos...First, I really enjoy your blog and liked this post. I've thought about this idea before, and concluded that there isn't much of an opportunity, but it requires a bit of explanation...<br /><br />My different point of view comes from looking at investing from a portfolio level. Suppose I that I have invested 20% of my net worth in BRK stock, and I don't want any more exposure for diversification purposes. The question is: Can I benefit by using LEAPS? My answer is not really. I could sell my BRK stock, and then buy LEAPS that offer 2x leverage to BRK with 10% of my net worth. On a portfolio level, this would leave my exposure to BRK at 20% of my net worth. But, I don't really get anything by doing this.<br /><br />Now, in reality I'm comfortable holding 100% of my net worth in BRK (at least money that I don't need for 5 years). I realize that this seems a bit extreme to most people, but I'm comfortable with this. Now, the question is: Does it make sense for me to buy BRK LEAPS, since they can offer a higher exposure to BRK? Well, again if I invested half of my net worth in BRK LEAPS (that offer 2x leverage) and kept half of my net worth in cash, then I don't really benefit. While my LEAPS have twice the expected return (lets say 20%, instead of 10% on BRK stock), I don't benefit. My total expected portfolio return is still just 10% per year.<br /><br />Now, that brings up the real question: Does it make sense for me to leverage my portfolio? <br /><br />Lets say that I decide that 100% exposure to BRK stock is not enough, so I put 100% of my portfolio into BRK LEAPS (2x leverage). Is this a good idea? Well, my expected portfolio return is about 20% instead of 10%, so that is good. But, what happens if by Jan 2014 BRK stock has dropped by 30%? If I own the LEAPS, then at their expiration I will end up with 40% of my original cash (assuming that I opt for cash settlement). Now, I may think that BRK is wildly undervalued at that point and decide to put that cash from the LEAPS into BRK stock. At that point I will end up owning less shares of BRK stock in Jan 2014 than if I had just purchased BRK stock to begin with. So, my loss will be real. Of course if BRK stock goes up by Jan 2014, I settle the LEAPS for cash, and convert that cash to BRK shares, then I will end up with more shares of BRK in 2014. <br /><br />If I put 100% of my net worth into BRK stock, I really don't care what the market does. I can just ignore the market - after all, I don't need to sell. HOWEVER, if I put 100% of my net worth into BRK LEAPS, I really do care about Mr. Market. After all, if Mr. Market marks down BRK stock by 50% in 2014 then I will lose everything. Buying BRK LEAPS makes me a slave to Mr. Market and can cause my to lose everything (even if I'm right about BRK's intrinsic value). If I owned BRK stock and it goes down 50%, I am allowed to ignore Mr. Market and just wait for Warren to repurchase shares or pay me a dividend.<br /><br />Sorry for the long reply. I don't pretend that I have all the answers, so I'd be curious to hear pushback.<br /><br />Best,<br />Tom L<br /><br />Tom Lnoreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-16528484743793066112012-10-03T07:48:19.986-04:002012-10-03T07:48:19.986-04:00awesome!!awesome!!Anonymousnoreply@blogger.com