Tag Archives: warren buffett

Why most people don’t understand Buffett’s style of investing

4 Jun

Buffett rarely invests in small caps, especially not micro small-caps. He did in his earlier days but has now refined his investment philosophy and seeks out businesses with incredibly wide moats. I can’t think of any small cap stocks with wide moats. Next, the reckless thinking that low P/E ratios means the business is so cheap and is a value play. I read one article by a value investor lauding how cheap Garmin was, an ardent Buffett follower. This is the problem, Garmin is not cheap, you miss the forest while you only see the trees. It is not necessarily the case that one should short Garmin, it is the fact that the fundamentals are and continue to worsen. The stock was once north of $110 a share with a market cap exceeding $20 billion.

The business fundamentals are horrible, you are essentially competing with your core offering against a free product from some of the most innovative companies in the world, Apple and Google. Revenues year-on-year have been acknowledged to decline at a worrying rate. The periphery businesses in aviation, healthcare and sports are sketchy and contribute a lower revenue mix although they currently have higher margins. They also require heavier expenditures in research and development. Advertising dollars are going to rise to attract a smaller share of the market compressing margins. It’s almost a perfect storm. There is a reason why Garmin is out-of-favour and it’s not because the business is misunderstood.

Cheap technology plays as value investments, Buffett doesn’t invest in technology-centric companies. He never has and according to what he says he never will. And to be frank he has been spot on in general. The out-of-favour argument – if you take a brief look at Buffett’s holdings they represent some of the premier franchises in the world, few, if any can be described as out-of-favour. His style is to seek out and invest in companies with a wide moat, high barriers to entry, growing positive fundamentals, simple and easy-to-understand models with long-term visibility so few stocks with that combination of characteristics are likely to be out-of-favour. And no penny stocks, please.

Buffett is a legendary investor but he is not a value investor in the purest sense. His style is a witty combination of value and growth so investors who are obsessed following his 1960s approach of cigar-butt gun-slinging investing need to reset their parameters and align themselves with Buffett’s refined methodology. This Buffett ideological misunderstanding is more endemic among the youth, they are blinded by speculative small caps that appear to be cheap by rudimentary metrics while in fact they go against everything that Buffett seeks to teach.

Buffett ain’t in the business of seeking out duds, his long-term investment performance is vastly superior in generating alpha and in comparison to other investment managers. It might look easy but seeking out companies with Buffett orientated metrics is still largely an issue of timing and great intelligence. There are many great businesses but each has a fair price. Capturing it when it is mispriced is what value investing and Buffett-style investing is about.

Delving into the Financial Crisis Inquiry Commission’s interviews

24 Apr

http://fcic.law.stanford.edu/resource/interviews

If you have not already listened to or read some of the transcripts of the Financial Crisis Inquiry Commission’s analysis into what caused the mortgage mess, take a look. Clearly some of the interviews provide a lot more utility and value than others; there are some participants that have nothing to lose and want to contribute to the exchange like the guys formerly at Deutsche Bank, Greg Lippmann and Eugene Xu. Michael Burry – have a read of The Big Short (by Michael Lewis) for further details regarding him also contributes to the inquiry. These are individuals who made a lot of money by being on the right side of the trade so their insights are imperative. Others such as Blankfein are playing a game, mixing some truths among many lies; all the investment banks were leveraged with toxic junk to the stratosphere; Blankfein has to pretend like they didn’t know as well; well they didn’t for a long period of time, but they realised just before the rest of the herd did, and were able to short change clients like the Abacus deal totally oblitering any fiduciary responsibilities they were supposed to have.

It’s an interesting collection of interviews; it is easy to comment now with such hindsight but those who were able to profit from the mess with such accuracy have every right to re-tell these generational events; to discuss cause and effect. While it has taken 18 months to culminate these findings, a few of these guys could have saved the Commission a lot of time reading ‘Learn Derivatives in 24 Hours Guaranteed!’, ‘Trading for Dummies’ etc., without having to persist with spending so much money and energy in generating findings whose future value is unlikely to be exercised. The inquiry was essentially an event in blame transfer; to ensure regulators and the government at large were not to be held accountable for their complete absence of oversight and inaction; and to mitigate any negativity they received by offsetting that with a greater public frustration at Wall Street; directly at the major firms that underpin this community. What I find most striking is the lack of prosecutions, or, at least, trials of those individuals who committed fraud; it is peculiar that Chris Dodd and Barney Frank, two of the individuals that orchestrated the crisis by proselytising the GSEs, and their federally mandated guarantees of toxic trash are now framing the new legislative works; are things upside-down or is it just me?

Derivatives as a mechanism to hedge

9 Apr


Stephenson (1967) conducted a monkey experiment aptly narrated by another blogger Safetynut:

Four monkeys were put into an observation room with one banana on the floor. The monkeys were wired so that the researchers could give each monkey a mild shock. When the first monkey approached the banana and tried to pick it up, he received a mild shock.

When the second monkey approached the banana, the first monkey became very agitated and attempted to stop the second monkey from touching the banana. Any monkey who touched the banana received a mild shock. Suffice it to say that the monkeys learned very quickly that touching the banana was an unpleasant experience.

Now for the most interesting part of the story. One of the four original monkeys was then replaced with a new monkey. As this new monkey approached the banana, the other three became extremely agitated, and succeeded in stopping the new monkey from touching the banana. A short while later, one of the remaining three original monkeys was replaced with a new monkey.

As this new monkey approached the banana, the other three monkeys, including the one who had just replaced the first monkey, became extremely agitated and stopped the new monkey from touching the banana. This replacement process continued until all of the original four monkeys had been replaced with new monkeys.

None of these new monkeys would touch the banana, and whenever a new monkey came into the observation room, he was quickly taught not to touch the banana. In effect, none of the remaining monkeys understood what would happen if they touched the banana — they just knew that they should never touch it. These monkeys were immersed in this culture and were completely unaware of the reasons for their behaviour.

This is a great real-life example of repeated behaviours that are learned / acquired without understanding cause and effect. This is very similar to the ways in which governments operate. They lack effective controls and insight; the vast majority of interest rate derivatives, credit default swaps, fixed income and equity options are not to hedge farmers output or to hedge fuel costs for airlines; they are purely an instrument for speculators. Enforcing margins of 30 or 70 basis points on deal structures is insufficient; sales are wrongly incentivised to push deal quantity including 30 year durations. Current PV’s are extrapolated into the stratosphere to determine future PV’s; it’s mostly imagination.

For those working within the investment banking community you will be well aware that the majority of the deal volume in derivative and esoteric financial products are heavily weighted towards the hedge fund community. Hedging fuel costs or agricultural produce is not the main function of derivatives; derivatives like Warren Buffet has stated are: “financial weapons of mass destruction” that could harm the whole financial and wider system.

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