# How can an overvalued stock be rated a 'buy'?



## Aussiesteve (26 December 2015)

Take this for example from VectorVest (which appears to be a good free method of gaining valuations on stocks)

CAR.AX is overvalued compared to its Price of $11.35 per share, has about average safety, and is currently rated a Buy. (26/12/15)

Update: came across this post (also on ASF) "Unlike Stock Doctor's ratings which are almost entirely on fundamentals, VV also uses technical analysis so that you sometimes see buy recommenations on stocks VV rates as overvalued and sells on undervalued stocks."

Still not sure why the inclusion of technical analysis can result in this paradox?


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## systematic (26 December 2015)

You'd have to ask VectorVest about their methodolgy; but it sounds like all they mean is that a price trend might be 'good enough' to make the stock a 'buy' based on the momentum (what they call, 'T/A') aspect; despite the valuation.


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## systematic (26 December 2015)

Aussiesteve said:


> Still not sure why the inclusion of technical analysis can result in this paradox?




...because price trend and valuation travel in their own directions and if you are considering _both_ in your analysis, there is going to be tension at times.


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## luutzu (26 December 2015)

Aussiesteve said:


> Take this for example from VectorVest (which appears to be a good free method of gaining valuations on stocks)
> 
> CAR.AX is overvalued compared to its Price of $11.35 per share, has about average safety, and is currently rated a Buy. (26/12/15)
> 
> ...




It's standard operating procedure: either ignore your own rules and follow the market when it's popular; or cover both ends so you can cover your hide.

I've read a few "insights" from the likes of Motley Fools and their recommendations are all like this. That so and so company looks cheap, well managed, may have a good future ahead of it but... but don't buy it now because xyz (when the trend is down and you don't know if it's hit bottom yet).


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## Rainman (26 December 2015)

Aussiesteve said:


> ... Still not sure why the inclusion of technical analysis can result in this paradox?




Because technical analysis tells you nothing about the value of a stock.  All it does is tell you how popular (or unpopular) a stock is.


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## minwa (27 December 2015)

The rating is just an opinion of the writers. 

When the market opens, you will see quotes at specific price how many orders want to buy and sell -  this is also indicating how many market participants are rating (via their orders) the current price as a buy or sell. It changes by ever second - much like a recommendation by a company can change.

I've also heard that newsletter writers receive offers all the time from listed companies to rate their company as a buy. Bribes, and it's not illegal. If you read the fine print of newsletters, almost all of them disclose that they MAY or MAY NOT have received compensation for any recommendations made.


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## timlisten (31 December 2015)

Overvalued or buy rating are purely an opinion, nobody can really predict the stock price with 100% accuracy for the short term. People make money trading because of discipline and strategies, not because they are right every time. One analysts can say the stock is overvalue while another can say it is a strong buy. You should do your own research.


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## CanOz (31 December 2015)

Rainman said:


> Because technical analysis tells you nothing* about the value of a stock*.  All it does is tell you how popular (or unpopular) a stock is.




Is the value of the equity not the 'price'? Are you telling me Rainman, that your fundamental analysis can put a value on an equity by trusting what is published?


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## galumay (31 December 2015)

CanOz said:


> Is the value of the equity not the 'price'? Are you telling me Rainman, that your fundamental analysis can put a value on an equity by trusting what is published?




Vaue and price are definitely not the same thing!


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## CanOz (31 December 2015)

galumay said:


> Vaue and price are definitely not the same thing!




The market is valuing the equity at the current price, you might not be, but trust me the market's auction process is. 

If you go to an art auction, with a value in mind for a certain piece, you will likely not buy if you feel the price has gone above your idea of value. However, the auction continues higher because others have a different idea of value, right or wrong.


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## galumay (31 December 2015)

CanOz said:


> The market is valuing the equity at the current price, you might not be, but trust me the market's auction process is.
> 
> If you go to an art auction, with a value in mind for a certain piece, you will likely not buy if you feel the price has gone above your idea of value. However, the auction continues higher because others have a different idea of value, right or wrong.




With all due respect that is a pretty poor analogy, art has no intrinsic value, it only has price - it has no capacity to produce income. 

From a FA point of view price is specifically not used in any calculation of value.

There are many obvious examples of cases where a company's price was very different to its value, any time a company's share price reflects something much greater or less than the sum of the future cashflows, discounted back to present value this disparity exists. 

Mind you, I suspect you are just teasing and I am wasting my breath, because I am quite sure you know very well the difference between value and price! 

I suppose sometimes confusion arises because those who use TA and traders, treat shares like art - in which case I guess value is irrelevent and price is everything!

I will leave the thread here, i suspect that it will just turn into a 'religious' debate otherwise! I have taken to only posting in the stock threads, that way I avoid the extremist RWNJ's that pervade the 'off-topic' threads and also the ping pong debates about investing stratagy in these sort of threads!


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## CanOz (31 December 2015)

galumay said:


> With all due respect that is a pretty poor analogy, art has no intrinsic value, it only has price - it has no capacity to produce income.
> 
> From a FA point of view price is specifically not used in any calculation of value.
> 
> ...




Certainly not teasing anyone G. It is a FACT that the market is an auction process, its not my opinion. This is not a debate between fundies and techies. They both have their place in my view, in fact I've embraced macro fundamentals more and more in my trading with great results in providing the backdrop to the auction process.

Anyway, lets move on as you say. Happy New Year!


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## Rainman (1 January 2016)

CanOz said:


> ... If you go to an art auction, with a value in mind for a certain piece, you will likely not buy if you feel the price has gone above your idea of value. However, the auction continues higher because others have a different idea of value, right or wrong.




That is a stupid analogy.  Art does not produce value: that is, art does not produce a stream of future cash flows and/or does not itself contain assets that capable of producing a stream of future cash flows.


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## Rainman (1 January 2016)

CanOz said:


> Is the value of the equity not the 'price'?




The value of an equity may be the price if the equity's price and its value more or less coincide.  In my view, the market usually correctly values an equity's value.  But not always.  

You use the analogy that the stock market is like an auction.   That is, I think, a fair analogy when considered over the short term.  But market prices and equity values sometimes diverge and when they do you get mispricings.  Sometimes the mispricings can be very great.  However, ultimately price converges with value.  That is what Benjamin Graham meant when he said that, in the short run, the market is a voting machine but in the long run it is a weighing machine. In the short term, the market is a popularity contest but in the long run it is a marathon and it is those who are the fittest that will lead the race.  

If you do not accept this, then you are really saying that the market price always correctly reflects value and that human emotions like fear and greed can never cause value and price to diverge.  If that is what you are saying, then your logical conclusion is that a holder of a stock can never be a forced seller of that stock, i.e. someone who sells regardless of price or value.  Yet we know that that is not true.   



CanOz said:


> Are you telling me Rainman, that your fundamental analysis can put a value on an equity by trusting what is published?




I am not sure that I quite understand what you mean by this.  But you seem to be assuming again that the market and market prices perfectly, fully and at all times correctly price individual securities.  I agree that most of the time they do.  But sometimes they do not and that is when there is an opportunity to profit from the mispricing.


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## luutzu (1 January 2016)

Rainman said:


> That is a stupid analogy.  Art does not produce value: that is, art does not produce a stream of future cash flows and/or does not itself contain assets that capable of producing a stream of future cash flows.




True that value generally refer to an asset that generate cash and hence profits to the owner... BUt given the rise of the uber rich having way too much cash nowadays - breaking records at auction houses year on year for a while now - we can't just dismiss art being a good investment in the foreseeable future.

Some company might not currently produce any income, or is making a loss. That does not mean it is worthless right? Its assets, its patents have some value.. and could conceivably produce cash in the future when it's auction off or rented out or turn a profit. 

Speculative, but the future... include cash flows, are also speculative. So it depends.


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## luutzu (1 January 2016)

Rainman said:


> The value of an equity may be the price if the equity's price and its value more or less coincide.  In my view, the market usually correctly values an equity's value.  But not always.
> 
> You use the analogy that the stock market is like an auction.   That is, I think, a fair analogy when considered over the short term.  But market prices and equity values sometimes diverge and when they do you get mispricings.  Sometimes the mispricings can be very great.  However, ultimately price converges with value.  That is what Benjamin Graham meant when he said that, in the short run, the market is a voting machine but in the long run it is a weighing machine. In the short term, the market is a popularity contest but in the long run it is a marathon and it is those who are the fittest that will lead the race.
> 
> ...




Utimately, in the long run, price does not do anything but is what it is - it's the price investor set at each trade.

To say that in the long run, price will converge with value... while true, is misleading.

Misleading because, one... it implies that any established companies are right now priced correctly (close to its "true value"). Well, if it's been around for decades or a century.. .that's long enough for its price to merge towards intrinsic value right? So that assumption is wrong.

If by that line Graham (or his followers and value investor) mean that if we buy something now then in the future it will get to the true value. This is also misleading and wrong... The price might eventually be properly reflected in the medium to long term - but how far is that or for how long will the correct price be we cannot say. 

So value will always have to be done in the present. And in that nth future period, it will need to  be reappraised - taking into account new developments or further deterioration etc. 

We can't just buy seedlings and think that in time it'll grow into a mighty oak - it could die or be eaten by birds long before it ever see the light. 

---

Having said all that... yes, in the long term the market will reflect the asset's intrinsic value. Just that we as investor have to have some idea of what that value is to recognise it.


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## Rainman (1 January 2016)

luutzu said:


> ... To say that in the long run, price will converge with value... while true, is misleading.
> 
> Misleading because, one... it implies that any established companies are right now priced correctly (close to its "true value")...




No, it doesn't. It implies nothing of the sort.  To say that "in the long run price will converge with value" means that a stock or any other security that is currently mispriced will at some point converge with value.  It may do so only to become mispriced again because the market is dynamic, not static.  It follows therefore that prices of securities are always diverging and converging from true value and when they do converge it does not mean their prices can never again diverge from true value in the future.



luutzu said:


> ... If by that line Graham (or his followers and value investor) mean that if we buy something now then in the future it will get to the true value. This is also misleading and wrong... The price might eventually be properly reflected in the medium to long term - but how far is that or for how long will the correct price be we cannot say...




I don't understand what you're trying to say here.  Either you accept that price ultimately converges with value at some point or you do not.  If it takes 5 years for a security that you hold to double in price, that is still a 20% return annualised.  



luutzu said:


> So value will always have to be done in the present. And in that nth future period, it will need to  be reappraised - taking into account new developments or further deterioration etc...




Of course.  That is why valuation normally involves discounting the future cash flows of an asset back to a present value.  But it does not follow from that that prices cannot diverge further from value now or that events may not supervene in the interim which prevent price and value from ever converging.  Stuff happens - including to the economics of an investment.


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## Rainman (1 January 2016)

luutzu said:


> ... [W]e can't just dismiss art being a good investment in the foreseeable future...




Art is not an investment. If you buy an artwork solely in the hope of being able to off-load it onto someone else at a higher price at a point in the future, you are speculating, i.e. you are hoping that someone will pay you a higher price than you paid.   In the meantime, the artwork itself will not pay you anything.  Contrast that with an asset that steadily and regularly throws off cash to the owner of the asset: I don't need anyone to buy that asset from me at a higher price than I paid for it in order to be enriched by those cash flows and in order for those cash flows to have a reasonably clear present value.  



luutzu said:


> Some company might not currently produce any income, or is making a loss. That does not mean it is worthless right? Its assets, its patents have some value.. and could conceivably produce cash in the future when it's auction off or rented out or turn a profit...




As a generalised statement, this is true.  But if what you are saying is that an asset - say, a business that is presently losing money and will continue to lose money in the foreseeable future - is or can rationally be as valuable as a business that is presently profitable and will likely remain so, then that is less clear and may in fact be entirely speculative.


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## howardbandy (1 January 2016)

In my opinion, there are three classes -- investments, trades, and expenses.

When I buy something, if I call my lawyer and have it noted in my will, along with who gets it after I die, that is an investment.  

If I buy something anticipating selling it at some time in the future, hopefully at a profit, that is a trade.

If I buy something expecting it will have little or no value, that is an expense.

I have very few notes in my will.
Houses are trades at best, maybe expenses.  All stocks and funds are trades.
Cars, food, wine, clothes, etc are expenses.

Art, wine, etc are not investments, and are terrible trades.  The bid-ask spread is very high, liquidity is very low, scoundrels abound.  Buy wine to drink, art to enjoy.  Live as though they will never be worth more than you paid for them.  Be pleasantly surprised if someone wants them enough to buy them from you at a profit.  (In the US, an individual cannot sell wine to another individual.  There must be at least one licensed dealer involved.  Counterfeits are wide spread.  One of the first questions asked is "prove they were stored correctly.")

Best,
Howard


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## CanOz (1 January 2016)

howardbandy said:


> In my opinion, there are three classes -- investments, trades, and expenses.
> 
> When I buy something, if I call my lawyer and have it noted in my will, along with who gets it after I die, that is an investment.
> 
> ...




Well said Howard, happy new year to you!


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## luutzu (1 January 2016)

Rainman said:


> No, it doesn't. It implies nothing of the sort.  To say that "in the long run price will converge with value" means that a stock or any other security that is currently mispriced will at some point converge with value.  It may do so only to become mispriced again because the market is dynamic, not static.  It follows therefore that prices of securities are always diverging and converging from true value and when they do converge it does not mean their prices can never again diverge from true value in the future.....




What you just said there proves my point. That while at some point in the future, the market might get the price "right"; but when in the future; and what is the right price at that unknown future period?

A business is like a living organism right? It operates in a dynamic environment with declining or growing opportunities for its goods/services... So to say that in the future the price will be closer to intrinsic value - that in the long term the market is a weighing machine.. While true it's not really accurate when you apply it.

Example. Say I think company XYZ is worth at least $10 in the future. It now sells for $5. 
When that future arrives and XYZ does hit $10... could I just conclude that that $10 is then the "true price"?
It depends right?

Dynamic environment; changing circumstances; new potential markets; less competitors etc. etc. All the new and then unforeseen factors may mean $10 then is way overpriced or way under the new "true value". 

So just as we cannot say that old and established companies' share price are "true" on most days; we too cannot say that in the distant or medium future, the price will be true to its value. Therefore, we can only value a company based on current and existing information - That mean our estimate value must be referring to the value at this current point in time.

The idea of the long term the market reflects simply mean that others in the market do not agree with our assessment, but they are wrong and we are geniuses and given enough time - they too will see the light.

It does not mean that in the future, the business will grow to meet its true value.


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## luutzu (1 January 2016)

Rainman said:


> Art is not an investment. If you buy an artwork solely in the hope of being able to off-load it onto someone else at a higher price at a point in the future, you are speculating, i.e. you are hoping that someone will pay you a higher price than you paid.   In the meantime, the artwork itself will not pay you anything.  Contrast that with an asset that steadily and regularly throws off cash to the owner of the asset: I don't need anyone to buy that asset from me at a higher price than I paid for it in order to be enriched by those cash flows and in order for those cash flows to have a reasonably clear present value.




I made more of a social commentary than an argument 




Rainman said:


> As a generalised statement, this is true.  But if what you are saying is that an asset - say, a business that is presently losing money and will continue to lose money in the foreseeable future - is or can rationally be as valuable as a business that is presently profitable and will likely remain so, then that is less clear and may in fact be entirely speculative.




Could be reasoned speculation. Gotta live a little right?


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## Rainman (2 January 2016)

luutzu said:


> ... Example. Say I think company XYZ is worth at least $10 in the future. It now sells for $5.  When that future arrives and XYZ does hit $10... could I just conclude that that $10 is then the "true price"?
> It depends right?... Dynamic environment; changing circumstances; new potential markets; less competitors etc. etc. All the new and then unforeseen factors may mean $10 then is way overpriced or way under the new "true value". So just as we cannot say that old and established companies' share price are "true" on most days; we too cannot say that in the distant or medium future, the price will be true to its value. Therefore, we can only value a company based on current and existing information - That mean our estimate value must be referring to the value at this current point in time... The idea of the long term the market reflects simply mean that others in the market do not agree with our assessment, but they are wrong and we are geniuses and given enough time - they too will see the light... It does not mean that in the future, the business will grow to meet its true value




I think the claim that you are trying to make is that everything is relative: i.e. that it is impossible to say at any given point in time that the price of a security accurately reflects the security's value because in the future circumstances may exist that render the convergence of the security's price with its value inaccurate.

Interestingly, you do not back up this claim with any real world examples.  Why is that?  Can't you find any?  

I suspect that you can't because your claim is contradictory.  You say or seem to say that if today I estimate the value of a particular security to be $10 per share and the security is then being offered in the market at $5 per share and if it takes 12 months for the price of the security to converge with its value of $10, the security may not really be worth $10 per share by that time because, in your words, "_changing circumstances_" have arisen over the course of that 12 months that may make the security overvalued (or undervalued as the case may be).  

But how does that prove your point that one can never "_say that in the distant or medium future the price will be true to its value_"?  In the example that you give, the "_changing circumstances_" have diminished the security's value, so of course when the price of the security finally reaches $10 per share it is overvalued.  The value of the security has changed in the meantime and if I continued to hold it I would be a fool.   

The only way that your point could be correct is if I remained ignorant of the diminution of value that these "_changing circumstances_" have had on the security's value and continued to hold onto it.  But if I have remained ignorant of these "_changing circumstances_", the fault lies with me.  How does my ignorance of factors affecting the value of my investment prove your point that one can never "_say that in the distant or medium future the price will be true to its value_"?  

I understand that you are trying to argue that it is impossible to know at any given point in time whether a security is accurately priced in relation to its value, so why not just accept in the here and now that a security's value is its price and look no further.   

But the made-up example that you give above does not prove your point and is implausible in any case.  I think that if you backed up your claim with some real world examples it would demonstrate whether there is any empirical support for your claim and help you focus on whether your claim refers to something that occurs in the real world.


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## luutzu (2 January 2016)

Rainman said:


> I think the claim that you are trying to make is that everything is relative: i.e. that it is impossible to say at any given point in time that the price of a security accurately reflects the security's value because in the future circumstances may exist that render the convergence of the security's price with its value inaccurate.
> 
> Interestingly, you do not back up this claim with any real world examples.  Why is that?  Can't you find any?
> 
> ...




No. What i'm saying is that a company's value is always at the present - that we look at its historical performance, its current state, and we estimate what its likely future performance would be. All these are done at the present.

So at this present time, we come to our estimate of its value, or range of values. 

Then looking at the market price, we'd buy if the market is undervalued relative to what we think the "true value" is most likely be.

Then the idea that in the long run etc.... that is simply the wait we would need to prepare for. That is, other people and the market are obviously not seeing the current value but in time they will. 

In other words, I find a $10 million dollar painting at a garage sale. It is worth $10M but the unlucky seller thought it's a dirty old print and selling it for what the frame might be worth. Once I buy it, put it on eBay and others will bid up to $20M. That is, I didn't buy a print and wait for it to grow in value to $10M - it's already $10M when I bought it.


Real life example... Take Mermaid Marine (MRM)... Say I estimate its value to be at least $1 per share. It's selling for 25 cents a share. When I buy at current price of 25 cents I already am ahead - just the market does not agree with me. 

When, if, the market come round to agreeing that there is value to MRM... nothing much has changed so it would still be $1 a share according to my estimate. But if the market has improved markedly and my estimate based on asset value are not so relevant and earnings and bright future is clearly happening - it just got more valuable.

So question is, how long am I willing to hold before the market may come to agree with me.


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## Smurf1976 (2 January 2016)

Price can remain out of line with underlying value for quite some time and there's potential profit to be made following the trend. Hence it may well be sensible to buy an overvalued stock if (1) there is an expectation that the price will continue to rise and (2) the intention is to sell it once that trend nears its end.

The concept that what's happening right now (price) can remain out of step with what you'd otherwise expect (fundamentals) isn't unique to the stock market and occurs in all sorts of things. Just because it was hotter than average yesterday doesn't mean it won't be even hotter today and hotter again tomorrow.


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## CanOz (2 January 2016)

Smurf1976 said:


> Price can remain out of line with underlying value for quite some time and there's potential profit to be made following the trend. Hence it may well be sensible to buy an overvalued stock if (1) there is an expectation that the price will continue to rise and (2) the intention is to sell it once that trend nears its end.
> 
> The concept that what's happening right now (price) can remain out of step with what you'd otherwise expect (fundamentals) isn't unique to the stock market and occurs in all sorts of things. Just because it was hotter than average yesterday doesn't mean it won't be even hotter today and hotter again tomorrow.




Excellent post smurf, what I've wanted to say but just couldn't find the time....


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## luutzu (2 January 2016)

Smurf1976 said:


> Price can remain out of line with underlying value for quite some time and there's potential profit to be made following the trend. Hence it may well be sensible to buy an overvalued stock if (1) there is an expectation that the price will continue to rise and (2) the intention is to sell it once that trend nears its end.
> 
> The concept that what's happening right now (price) can remain out of step with what you'd otherwise expect (fundamentals) isn't unique to the stock market and occurs in all sorts of things. Just because it was hotter than average yesterday doesn't mean it won't be even hotter today and hotter again tomorrow.




If it could be done consistently, then for sure. But thing is I don't think it's possible to consistently predict the trend, nor is it possible to get out in time.

It's like shorting stocks... we can all have some idea that a stock is way out of whack and it's just a matter of time... but to put money on when that time is. That's just too much unnecessary risk.

It's just my opinion here but I think it's best to follow an approach that suits us, that we understand, follow it in all our investment decision. 

To use one method with x variable at y value one day, then use same method with n variable at z value the next.. .or to switch between methods and approaches. That'd be like using a metric tape measure one day then next day use your thumb or hand span to measure.

I learn from my Dad to always use the same tape measure when measuring something important. Even if the tape measure is a bit off, it will be consistent and you won't stuff up (that much).

For any given stock, there are always reasons to buy or to sell or to ignore. To use a ruler that give in to one's mood is just too dangerous I think. Can't learn from mistakes or successes that way.


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## Triathlete (3 January 2016)

luutzu said:


> If it could be done consistently, then for sure. But thing is I don't think it's possible to consistently predict the trend, nor is it possible to get out in time.
> 
> 
> It's like shorting stocks... we can all have some idea that a stock is way out of whack and it's just a matter of time... but to put money on when that time is. That's just too much unnecessary risk.
> ...




I have to disagree... at least in my own trading results it is possible to consistently predict the trend if you have the right knowledge and skill level. We do not have to be 100% correct at this make money.

It will also depends on what trend you are talking about short, medium or longer term as to how you will play the stock or indices.

Again having the right knowledge and skill level when shorting stocks or indices will lower that risk level.

I agree with your last statement follow an approach that suits you and increases your profits which is easily repeated, this is one of the surest way to increase your wealth.


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## Rainman (3 January 2016)

luutzu said:


> No. What i'm saying is that a company's value is always at the present - that we look at its historical performance, its current state, and we estimate what its likely future performance would be. All these are done at the present... So at this present time, we come to our estimate of its value, or range of values.




I agree.   



luutzu said:


> Then looking at the market price, we'd buy if the market is undervalued relative to what we think the "true value" is most likely be.




Agree.  




luutzu said:


> Then the idea that in the long run etc.... that is simply the wait we would need to prepare for. That is, other people and the market are obviously not seeing the current value but in time they will.




Agree.   



luutzu said:


> In other words, I find a $10 million dollar painting at a garage sale. It is worth $10M but the unlucky seller thought it's a dirty old print and selling it for what the frame might be worth. Once I buy it, put it on eBay and others will bid up to $20M. That is, I didn't buy a print and wait for it to grow in value to $10M - it's already $10M when I bought it.




I don't think it is a very instructive example to use art which is non-income generating with fractional interests of a business, i.e. shares, which are income generating.  Let's stick with real world examples using shares like your example below using MRM.   



luutzu said:


> Real life example... Take Mermaid Marine (MRM)... Say I estimate its value to be at least $1 per share. It's selling for 25 cents a share. When I buy at current price of 25 cents I already am ahead - just the market does not agree with me...




No, that does not follow.  Why are you "_already ahead_"?  Are you saying that MRM's current quoted market price undervalues MRM's net present value? 

If you are, then I am not sure that I agree with you.  MRM services the off-shore oil and gas industry.  This industry's capital expenditure is being cut back to the bone.  Meanwhile, MRM has to service debt of $442,473,000 against equity of $779,117,000 (most of which consists of equipment and boats which would not fetch much in a fire sale in the current environment).  MRM may be cheap.  But if capital spending in this sector continues to be cut back as most people are predicting that it will, MRM carries risk of the worst kind - risk of a permanent loss of capital.  



luutzu said:


> When, if, the market come round to agreeing that there is value to MRM... nothing much has changed so it would still be $1 a share according to my estimate. But if the market has improved markedly and my estimate based on asset value are not so relevant and earnings and bright future is clearly happening - it just got more valuable.




This is a non-sequitur.  I don't understand how you arrive at this conclusion from the point you make immediately above it.  If MRM's quoted market price rises to $1, I suspect a great deal will have changed - in particular, the price of oil will likely have started to rise, making a pick-up in capital spending in the oil and gas sector more likely.   



luutzu said:


> So question is, how long am I willing to hold before the market may come to agree with me.




That is a purely personal decision.  How is that relevant to your valuation of MRM or to anyone else's valuation?


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## Rainman (3 January 2016)

Triathlete said:


> I have to disagree... at least in my own trading results it is possible to consistently predict the trend if you have the right knowledge and skill level...




"_*Consistently*_" is a very relative term.  Technical traders that I know freely admit that they correctly predict trends (whether long term, short term or medium term) less 50% of the time.  In many cases, it is only around a third of the time that their predictions are correct and these guys have been trading for years.  

If a weather forecaster on the nightly news correctly predicted the weather less than 50% of the time, you'd switch channels and take you're umbrella every single day regardless of how clear the skies were outside.


----------



## Triathlete (3 January 2016)

Rainman said:


> "_*Consistently*_" is a very relative term.  Technical traders that I know freely admit that they correctly predict trends (whether long term, short term or medium term) less 50% of the time.  In many cases, it is only around a third of the time that their predictions are correct and these guys have been trading for years.




It does not matter how long you have been trading it depends on the level of knowledge and skill the trader has and how he/she approaches his/her trading.

If the technical traders that you know only get it right a third of the time then I would have to question whether it is of any use to them but I would be curious as to were they learnt there technical skills from..?

As I said before in my trading I have a far better success rate than that based on my own results...but everyone to there own.


----------



## CanOz (3 January 2016)

Rainman said:


> "_*Consistently*_" is a very relative term.
> 
> If a weather forecaster on the nightly news correctly predicted the weather less than 50% of the time, you'd switch channels and take you're umbrella every single day regardless of how clear the skies were outside.




You don't need to be right to be profitable Rainman, you only need your wins to be much greater than your losses. But you make a good point, trend following is not for everyone, as there are plenty that cannot handle the draw-downs of between 20-40% and a win rate in the low 40s to 50%. 

Also, i think most technical traders or trend followers would disagree that they are trying to predict anything. Its more of an anticipation of probability in case the historical statistics hold true. 

There are plenty of trend following traders that have been made famous and wealthy from their strategies that produced consistent profits for many years, some even decades with equity curves that even dear old dad Warren would agree were smoother than Berkshires.

Its seems our discussion has now expanded to a few threads, likely my fault there. Anyway, i've enjoyed the banter, thanks for your views and remaining civil through out.

Good luck for 2016.

CanOz


----------



## Rainman (3 January 2016)

Triathlete said:


> It does not matter how long you have been trading...




Oh, it doesn't, does it?  Are you aware of the saying that "_there are old traders and there are bold traders but there are no old bold traders_"?  I know guys who have been "trading" for more than 25 years.  These guys are almost pure "chartists" in that they pay very little attention to fundamentals.   How long have you been "trading"?



Triathlete said:


> ... It depends on the level of knowledge and skill the trader has and how he/she approaches his/her trading... As I said before in my trading I have a far better success rate than that based on my own results...but everyone to there own.




It always makes me smile when I read technical traders talk about how their knowledge of technical analysis enables them to make successful directional calls.  

Let me put this to you: if a doctor purported to base his diagnoses on a new method of diagnosis and that doctor's diagnoses of his patients' diseases were correct less than 50% of the time, would you ascribe any real predictive power to that doctor's method of diagnosis?  Would you have much faith in that doctor's diagnosis of your own medical condition?

You wouldn't.  By the same token, if, as is generally accepted, technical analysis correctly predicts stock prices accurately less than 50% of the time, does it make any sense to describe it as having any predictive power with respect to stock prices?  Or does it make any sense to claim that technical analysis furnishes you with "knowledge" and "skill" to make successful directional calls with respect to stock prices?

If a body of knowledge only allows you to be successful less than 50% of the time, it is not "knowledge" and learning it does not result in "skill".


----------



## Rainman (3 January 2016)

CanOz said:


> You don't need to be right to be profitable Rainman, you only need your wins to be much greater than your losses. But you make a good point, trend following is not for everyone, as there are plenty that cannot handle the draw-downs of between 20-40% and a win rate in the low 40s to 50%.




I have never denied that technical traders make money.  But see my earlier response to Triathlete.



CanOz said:


> Also, i think most technical traders or trend followers would disagree that they are trying to predict anything. Its more of an anticipation of probability in case the historical statistics hold true.




Isn't that just a long-winded way of saying that their trades are based on a hoped-for prediction?  You are just playing the odds.  That is gambling, pure and simple. 



CanOz said:


> There are plenty of trend following traders that have been made famous and wealthy from their strategies that produced consistent profits for many years, some even decades with equity curves that even dear old dad Warren would agree were smoother than Berkshires.




Who are they?  And where are they now?


----------



## CanOz (3 January 2016)

Rainman said:


> I have never denied that technical traders make money.  But see my earlier response to Triathlete.
> 
> 
> 
> ...




You must be just trolling, you cannot possibly be this naive, or one eyed about a subject, surely...

The most famous trend following traders were a group called The Turtles. Thier founders are still trading today as well as some of their original traders...

Here is a list of trend following funds *Trend Following Wizards – Fund performance*

I'm not a trend following trader by the way, i have nothing to gain from this debate, other than to illustrate that there is other forms of investment than 'value' investing Graham style.


----------



## Rainman (3 January 2016)

CanOz said:


> You must be just trolling, you cannot possibly be this naive, or one eyed about a subject, surely...... Here is a list of trend following funds *Trend Following Wizards – Fund performance*




You clearly have not checked the performance of the traders referred to in that link.   

You have just provided me with a list of traders who, with the exception of one of them, all have negative returns.  Are you drunk?

Not only are their returns negative for the year to date but I click on the historical performance for Abraham Trading Corporation for the last 5 years and I learn that it is 11.63% versus for the SP500 107.24%: http://abrahamtrading.com/performance. 

And you look up to these guys?  

More importantly, why would I invest with Abraham Trading for 5 years at 11.6% when I can buy an index fund and earn 107.24% over the same period?  If it weren't for the fact that we have had no inflation for the last 5 years, you would have lost money by investing with Abraham Trading.

I can't believe that you have referred me to that link in support of a claim that there are other profitable methods of investing.


----------



## Rainman (4 January 2016)

CanOz said:


> Here is a list of trend following funds *Trend Following Wizards – Fund performance*




By the way, I'd be grateful if you could show me which of them has "_produced consistent profits for many years, some even decades with equity curves that even dear old dad Warren would agree were smoother than Berkshires_" (my underlining). 

(I don't have a clue what you mean by "_equity curves that even dear old dad Warren would agree were smoother_" but perhaps when you find the trader that produces such "_curves_" and produces those "_consistent profits_" it will become clear to me).

Just to be clear: Buffett whom you seem to dismiss has  been investing for, I think, between 40 and 50 years and has achieved an annualised return of 20% on tens of billions of dollars.  Show me which of these "turtle traders" beats that.


----------



## CanOz (4 January 2016)

No, I don't 'look up' to them, I only posted the link as an example of a list of trend following funds. 

I'll have a look tomorrow morning for a trend following fund with a better equity curve than Berkshire's....shouldn't be hard....

Here's some better performance https://www.trendfollowing.com/performance/

Buffet owned insurance companies, he put the funds to work, how can rainman do that? How are you going to go out and buy a railway, or a heinz???


----------



## Rainman (4 January 2016)

CanOz said:


> No, I don't 'look up' to them, I only posted the link as an example of a list of trend following funds.
> 
> I'll have a look tomorrow morning for a trend following fund with a better equity curve than Berkshire's....shouldn't be hard....




You do that.  

But you didn't just post that link as "_an example of a list of trend following funds_".  What would be the point of that if almost all of those funds lose money by trend following?  

You posted it in support of your claim that there are other profitable ways to invest.  I am still waiting to see these other "profitable ways to invest".


----------



## CanOz (4 January 2016)

Rainman said:


> You do that.
> 
> But you didn't just post that link as "_an example of a list of trend following funds_".  What would be the point of that if almost all of those funds lose money by trend following?
> 
> You posted it in support of your claim that there are other profitable ways to invest.  I am still waiting to see these other "profitable ways to invest".




There are real records in that last link I posted as well, equity curves.

You been living in a cave, reading buffet and Graham?


----------



## Rainman (4 January 2016)

CanOz said:


> ... Buffet owned insurance companies, he put the funds to work, how can rainman do that? How are you going to go out and buy a railway, or a heinz???




Are you serious?  I don't have to.  All I needed to do was to have had the wisdom to invest earlier in Berkshire like these people who are now all multimillionaires: http://www.wsj.com/articles/warren-buffetts-lucky-millionaires-club-1445419800; http://www.forbes.com/sites/chloeso...families-that-warren-buffett-made-super-rich/


----------



## Rainman (4 January 2016)

CanOz said:


> There are real records in that last link I posted as well, equity curves.




Which of them beats Buffett?



CanOz said:


> ... You been living in a cave, reading buffet and Graham?




Oh, have I now? You think that I would have benefited more by reading about the stellar performance of your "turtle traders"?


----------



## CanOz (4 January 2016)

Rainman said:


> Are you serious?  I don't have to.  All I needed to do was to have had the wisdom to invest earlier in Berkshire like these people who are now all multimillionaires: http://www.wsj.com/articles/warren-buffetts-lucky-millionaires-club-1445419800; http://www.forbes.com/sites/chloeso...families-that-warren-buffett-made-super-rich/




But you can't do that now and how can you known ahead of time who is the next buffet (or Craft).

But you can research, test, walk forward and then trade a system that you develop and achieve similar results over time WITH LESS draw down....


----------



## Triathlete (4 January 2016)

Rainman said:


> I know guys who have been "trading" for more than 25 years.  These guys are almost pure "chartists" in that they pay very little attention to fundamentals.
> 
> .




Well I do pay attention to Fundamentals first then use T/A to make my calls and since I am in front at the moment that is all that counts to me and only time will tell if I stay there.

When I say my knowledge I am basing that on having studied both a Diploma and Advanced Diploma in Share trading and investments which has taken 4 years to complete and my skill is being able to put both the Fundamentals and Technicals together and make the calls to stay ahead of the game. So far so good


----------



## Rainman (4 January 2016)

CanOz said:


> But you can't do that now and how can you known ahead of time who is the next buffet (or Craft).




You really need to read more than just reports of the pathetic performance of your turtle traders.  

Do you think that Buffett's investment approach is so unique and so irreplicable that it is one that other sensible investment managers cannot employ and have  not employed with enormous success?  Well, it isn't.  Have a look at the U.S. company Markel (NYSE: MKL).  

This company is commonly referred to as a mini Berkshire Hathaway because its manager, Tom Gaynor, basically employs the same investment strategy as Buffett did in the early days of Berkshire.  Like Buffett, Gaynor uses Markel's insurance float to make investments in other stocks.  MKL's performance speaks for itself:https://www.google.com/finance?q=NYSE:MKL&ei=4HGJVoniFs7ksAHHuZSQBA 

You talk a lot about "riding the trend" but I wonder whether you'd have ridden or would continue to ride that trend.   

If you want my advice, you'll make more money investing in MKL or White Mountains Insurance (NYSE: WTM - https://www.google.com/finance?q=NYSE:WTM&ei=g3KJVqiNE9brsAGxh5nYCQ) which is another mini Berkshire than you will ever make by aping your turtle traders. 



CanOz said:


> But you can research, test, walk forward and then trade a system that you develop and achieve similar results over time WITH LESS draw down....




You keep blathering on about developing "_a system_" that generates "_consistent profits_" and then as an example of traders who have such a system you give the "turtle traders" (at the link here http://www.automated-trading-system.com/resources/trend-following-wizards-fund-performance/) whose performance as a group is embarrassing.

Show me one of your traders who for 20, 30, 40 years has earned over 21% plus annual returns like Walter Schloss did by following Ben Graham's simple strategy of buying deeply undervalued stocks: http://seekingalpha.com/article/3413816-your-essential-guide-to-walter-schloss-investing.

I *bet* you that you can't.


----------



## Rainman (4 January 2016)

Triathlete said:


> Well I do pay attention to Fundamentals first then use T/A to make my calls...




That's not what you've said previously.  The quote below is what you said on the GMA thread:



Triathlete said:


> *For me the chart is my insurance no matter how good the fundamentals look*... Technicals need to support Fundamentals ,otherwise I stay out until they do... That is my rule...this has kept me safe in the market...




"_Technicals need to support Fundamentals, otherwise I stay out until they do_": you're a technical trader.  Enough said. 



Triathlete said:


> When I say my knowledge I am basing that on having studied both a Diploma and Advanced Diploma in Share trading and investments which has taken 4 years to complete and my skill is being able to put both the Fundamentals and Technicals together and make the calls to stay ahead of the game. So far so good




To this, all I can say is that if your claim is that your "knowledge" enables you to make directional calls about the movements of stock prices and those calls are correct less than 50% of the time, it is not knowledge and you should ask for a refund on your diploma.  

As I said earlier, if your doctor's diagnosis about your physiology was accurate less than 50% of the time, would you entrust your health to him?


----------



## Triathlete (4 January 2016)

Rainman said:


> "_Technicals need to support Fundamentals, otherwise I stay out until they do_": you're a technical trader.  Enough said.




Whatever...Happy Investing and Trading everyone


----------



## CanOz (4 January 2016)

Rainman said:


> Show me one of your traders who for 20, 30, 40 years has earned over 21% plus annual returns like Walter Schloss did by following Ben Graham's simple strategy of buying deeply undervalued stocks: http://seekingalpha.com/article/3413816-your-essential-guide-to-walter-schloss-investing.
> 
> I *bet* you that you can't.




What do the historical drawdowns of these Buffet wanna be's look like? Thats peak to trough equity loss by the way...I'm guessing 40-60%?

Thats always the kicker, you say you want to buy and hold, but can everyone do that through a 2000, 2008 type drawdown?


----------



## howardbandy (4 January 2016)

Rainman said:


> Show me one of your traders who for 20, 30, 40 years has earned over 21% plus annual returns like Walter Schloss did by following Ben Graham's simple strategy of buying deeply undervalued stocks: http://seekingalpha.com/article/3413816-your-essential-guide-to-walter-schloss-investing.
> 
> I *bet* you that you can't.




David Shaw.
James Simons.


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## Rainman (4 January 2016)

howardbandy said:


> David Shaw.
> James Simons.




The original discussion concerned trend following versus stock-picking based on fundamentals.  Both David Shaw and Jim Simons are quants.  

Jim Simons' performance in particular at Renaissance Technologies is outstanding.  I think it is one of the best in the hedge fund industry.  But is the method which Renaissance Technologies uses to allocate capital replicable by a small private investor like those on this forum?  No.  It would be like holding up NASA to a model plane enthusiast as something to aspire to.   

The same goes for David Shaw's performance (although Shaw's performance is nothing compared to Jim Simons').

The focus is really on what are realistic strategies that small private investors can adopt to achieve annualised returns of 15% plus.  I would argue that sophisticated quant strategies like those used by Renaissance Technologies and David Shaw are not realistically available to small investors.  I don't think that that claim can seriously be denied.


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## Rainman (4 January 2016)

CanOz said:


> What do the historical drawdowns of these Buffet wanna be's look like? Thats peak to trough equity loss by the way...I'm guessing 40-60%?
> 
> Thats always the kicker, you say you want to buy and hold, but can everyone do that through a 2000, 2008 type drawdown?




Has it ever occurred to you that with your focus on the occasional drawdowns which are part and parcel of investing in common stocks you are missing the wood for the trees?  

Isn't the only statistic that matters the annualised performance over the long term, so that compounding returns can work their magic?  

From what you are saying, it seems that you would prefer smooth annualised 10% returns over lumpy 20% annualised returns.  If that is the case, your thinking and strategy will ultimately yield only a subpar performance.


----------



## luutzu (4 January 2016)

Rainman said:


> ....
> 
> If you are, then I am not sure that I agree with you.  MRM services the off-shore oil and gas industry.  This industry's capital expenditure is being cut back to the bone.  Meanwhile, MRM has to service debt of $442,473,000 against equity of $779,117,000 (most of which consists of equipment and boats which would not fetch much in a fire sale in the current environment).  MRM may be cheap.  But if capital spending in this sector continues to be cut back as most people are predicting that it will, MRM carries risk of the worst kind - risk of a permanent loss of capital.
> 
> ...




You don't mince words do you? Sweet. I like people with no social skills.

How do you figured anyone could lose money on MRM at current prices?

I am somewhat aware of the oil price crash; also have some idea of big capex cuts by the oil majors; and things will definitely be worst in FY 16 than it was FY15.

But hoping it will get much better in FY17. By which I might double my money - hoping for more but let's not be greedy and upset the gods.

I bought some at 45cents; a big chunk at 40, some at 35 and sold a flower for this weed at 22... so average around 30 cents. Meaning currently losing if we mark performance to market.

But let's look at the number... at 30 cents with 375M shares (the options aren't going to be granted or vested for sure, but let's assume the diulted figure)... that mean I bought MRM for $112.5M.

It has $125M in cash. [am I not already ahead?]

Total of $1.8 Billion has been invested in MRM since inception - depreciation, write downs, wear and tear and the non-cash impairment mean net asset of $779M (after the $392M debt due next 4 years, and with $125M cash).

This mean it's a big company (quick look at some listed ones around the world show MRM might be top 6 or 10 operator)... and that $779M net assets... I'm paying $112.5M for them.

Fire sale so won't be worth much? No utilisation?

Firstly, the vessels alone have a book value of $790M after the $100M non-cash impairment (something created for the taxman). So MRM has already taken into account the "fire sale" factor of their worth. But let's be conservative and say that's not far enough and ought to be halved further - to $400M.

At that price, I'm still buying $1 for around 25 cents. 

----

Debt and bankruptcy...

Don' think so.

MRM actually made a profit last year. Net operating cash is strong at some $185M. And while a quick and rash look at its FCF would suggest negative cash to the firm etc., that would be wrong since its maintenance capex are much less and the reported figure includes its PPE on the new builds.

It's still wining contracts, the construction on some major LNG/offshore are still going; those in production still need logistical supports. 

But it's safe to assume FY16 will see further impairment and much lower revenue. FY17 will see INPEX and a few other major Australian projects in the NW shelf really kicking in. With any luck the Saudi and OPEC might find it wise to not pump so much oil out and bring the price back up...

With $20M worth of vessel sold and others they're rationalising; with dry docking those they don't need and soon an end to new builts. It will survive the downturn.

BUt let say things get really bad for a lot longer... raise equity to get through or be taken over by competitors wanting to expand into SEAsia and AUS. 

---
Something we might miss is that MRM is not merely an oil and gas service company. It's also an offshore logistic company with marine engineering and services on offer as well as the oil/gas exploration and construction support.

So it's not all about oil exploration and capex. Also operating expenses to maintenance and service completed platforms and vessels.

Also, being a pretty big player, the clients will pressure it and it in turn will pressure its contractors and suppliers for lower rates - cuts roll downhill too.

That and given the political tensions in the world, ME and soon Asia Pacific, particularly China's claims... other countries might need to stake a claim on their ocean somewhere and that might mean some extra opportunities

Anyway... we'll see how wrong I'd be in a couple years.


----------



## Rainman (5 January 2016)

luutzu said:


> How do you figured anyone could lose money on MRM at current prices?




That is a different question from whether MRM is presently correctly valued by the market.  That was the original question that we were considering.  

I didn't say one would lose money on MRM.  My point was that a close look at MRM's debt load and its assets suggests that, when balanced against the risk involved and the lack of earnings visibility, MRM is not necessarily a screaming buy.  I say this as someone who was and still is considering taking a position in MRM.   



luutzu said:


> But let's look at the number... at 30 cents with 375M shares (the options aren't going to be granted or vested for sure, but let's assume the diulted figure)... that mean I bought MRM for $112.5M.
> 
> It has $125M in cash. [am I not already ahead?]
> 
> ...




I agree with most of what you say above.  MRM will likely take further write-downs on its fixed assets this year.  I am probably less sanguine than you about its future prospects.


----------



## howardbandy (5 January 2016)

Rainman said:


> The original discussion concerned trend following versus stock-picking based on fundamentals.




A large part of the success of trend following has been the expansion of developed economies following world war two.  Using the US as an example, the population is 5% of the world's population, while resource usage has been 25%.  That is unlikely to continue as the economies that did not participate in the 1945 to 2000 expansion compete for resources and funds.  If the resource use levels out, reducing the US' 25%, the US economy will contract.  Buying assets anticipating long term growth will be riskier with less profit.  

Another large part of trend following, ala Turtles, has already been arbitraged away.  Turtle-esk trend following of buying breakouts to higher prices anticipating yet higher prices worked:
when few other people were aware of the tactic.
before widely available historical price data.
before low cost powerful desktop computers.
before low commission. 
before analytic software.
Plotting the equity from Turtle-esk trend following shows strong profit in the 1980s to mid-90s, then flat.  And primarily for commodities.  It has never worked well for equities.

Not to say that Buffett is not talented.  But there is a strong survivorship bias among money managers.  Many people try, some succeed, some fail and disappear, some fail and reemerge to try again.  A few are very successful.  Just as tossing 100 coins will produce 80 heads in a small portion of the experiments.  Daniel Kahneman, "Thinking, Fast and Slow," gives great insight into our biases.

Drawdown increases in proportion to the square root of the length of the holding period.  Buffett, among others, regularly experience drawdowns much higher than most individuals can tolerate.  51% in 2009.  Down 11% for 2015 in a market that is net flat.  When normalized for risk, and in accord with the risk tolerance of most individuals and small trading organizations, the profit potential of holding long periods is lower than of algorithmic trading.

To be profitable via long term holding of equity index instruments depends on an upward sloping economy.  To add value through use of individual companies requires insider information.  All information outside the boardroom has already been priced into the market.  Add the difficulties of periodicity of reporting periods (quarterly), revisions, agenda of the agency reporting, etc, and the problem reverts to one of estimating the future of a broad economy. 

Thanks for listening,
Howard


----------



## Rainman (5 January 2016)

howardbandy said:


> ... Drawdown increases in proportion to the square root of the length of the holding period...




However true that this may be as a mathematical proposition, it is meaningless if the assumption behind it is that the remedy is shorter holding periods and attempts to time the market.   



howardbandy said:


> ... Buffett, among others, regularly experience drawdowns much higher than most individuals can tolerate...




"_Than most investors can tolerate_...": That is why most investors lose money in the market or, if they don't lose money, they significantly underperform the index.  Studies consistently show this: http://www.umass.edu/preferen/You Must Read This/Barber-Odean 2011.pdf; http://www.marketwatch.com/story/individual-investors-are-destroying-their-wealth-2012-10-19

Just to be clear: I don't consider the returns of Berkshire Hathaway in its present form as worthy of emulation.  You are not going to make serious money investing in a company with an enterprise value of $340 billion.  But there are companies today that resemble Berkshire when it was much smaller and was producing 20% plus returns. Companies like Markel and White Mountains Insurance offer attractive long-term investment potential through their ability to compound insurance float sustainably for years to come (although both Markel and White Mountains are presently a little pricey).  

I suspect that the market returns of most of the trend-followers, adrenalin-charged daytraders and ardent market-timers on this forum would show a similar picture over 3, 5 and 10 year periods.  Their performance would show net losses or would be unlikely to show consistent outperformance of the major market indices.


----------



## craft (5 January 2016)

howardbandy said:


> Not to say that Buffett is not talented.  But there is a strong survivorship bias among money managers.  Many people try, some succeed, some fail and disappear, some fail and reemerge to try again.  A few are very successful.  Just as tossing 100 coins will produce 80 heads in a small portion of the experiments.




Buffett himself has addressed this on the 50th anniversary of 'Security Analysis'.

http://www.tilsonfunds.com/superinvestors.html 




howardbandy said:


> Drawdown increases in proportion to the square root of the length of the holding period.  Buffett, among others, regularly experience drawdowns much higher than most individuals can tolerate.  51% in 2009.  Down 11% for 2015 in a market that is net flat.  When normalized for risk, and in accord with the risk tolerance of most individuals and small trading organizations, the profit potential of holding long periods is lower than of algorithmic trading.
> 
> To be profitable via long term holding of equity index instruments depends on an upward sloping economy.  To add value through use of individual companies requires insider information.  All information outside the boardroom has already been priced into the market.  Add the difficulties of periodicity of reporting periods (quarterly), revisions, agenda of the agency reporting, etc, and the problem reverts to one of estimating the future of a broad economy.
> 
> ...




I’m not so sure that ‘tolerance’ is the key to understanding drawdown resilience but rather perspective. If your price focused then its logical to measure your drawdown in price but if you are business focussed then it logical to monitor your exposure in relation to business performance.  

In Buffets last letter he tables both market price and book equity yoy change. He refers to book value as 







> a crude, but useful, tracking device for the number that really counts: intrinsic business value.







You can see that business performance as defined by book value is far less volatile than market price. (and in my interpretation of IV it is even less volatile than book value)

In this volatility mismatch between market price and business value lays the opportunity for business focused investment and the proof that your last paragraph cannot be correct.

What Buffett has freely demonstrated in his actions and words is as relevant today as ever. Luckily most are not listening. 



> Berkshire’s gain in net worth during 2014 was $18.3 billion, which increased the per-share book value of both our Class A and Class B stock by 8.3%. Over the last 50 years (that is, since present management took over), per-share book value has grown from $19 to $146,186, a rate of 19.4% compounded annually.*
> 
> During our tenure, we have consistently compared the yearly performance of the S&P 500 to the change in Berkshire’s per-share book value. We’ve done that because book value has been a crude, but useful, tracking device for the number that really counts: intrinsic business value.
> 
> ...


----------



## howardbandy (5 January 2016)

Greetings --

Drawdown being proportional to the square root of holding period is more than theoretical.  The markets actually do exhibit this behavior.  See the charts on page 303 of my Quantitative Trading Systems book.  The plot of the semi-log relationship -- drawdown versus square root of holding period -- is straight.  The only way to avoid increase in drawdown is to reduce the holding period -- to exit before the serious drawdown.    

No doubt there are ebbs and flows in equity.  Trading or investing techniques eventually fail to recover from a drawdown -- perhaps permanently, perhaps only over a period of time longer than the person can hold the positions but exceeding limits over that period.  Permanent failure could be because the inefficiency the methods have identified is arbitraged out, or because some underlying reason they previously worked has changed.  All permanent failures begin with temporary failures -- small drawdowns.  It is not possible to determine whether there will be recovery or not.  Continuing to trade or invest when in a drawdown is an act of faith, not of reason.  The money management scheme that buys into drawdowns is a Martingale.  Martingales eventually go broke -- which is one of the reasons that gambling companies can afford fancy casinos.

Even before a technique is applied to determine when to buy and when to sell, each trade-able / invest-able issue has an inherent risk.  Chapter 2 -- pages 39 through 76 -- of my Quantitative Technical Analysis (QTA) book discusses that topic and gives methods for measuring it.  We each have our own risk tolerance -- the point in an equity sequence associated with a technique where we admit that the technique is not working as anticipated and it should be taken offline.  Mine is about 20%.  Most of the money managers I talk with prefer to keep it under 10%.  Position size can be, and should be, adjusted taking recent performance into account.  When the drawdown reaches the person's limit, the position size will already have been considerably reduced.  At the limit, take the system offline and just observe its shadow performance until it recovers.  

Drawdown also increases as accuracy of buying and selling decreases.  Trading or investing involves a combination of 1) characteristics of the issue, 2) accuracy of positions, 3) holding period.  Many issues can only be traded at reduced fraction of the trading account because of the inherent risk in the series -- some of the funds must be held in risk-free notes to act as a buffer when the funds traded experience a drawdown.  There is a loose relationship between safety of the issue and profit potential, with very safe issues providing very little profit potential.  Even those safe enough to trade while still providing enough profit potential to be worth trading are limited by accuracy of the technique and holding period.  

Pick your own drawdown tolerance.  But it is nearly impossible to trade (an issue that offers reasonable profit potential) accurately enough to hold drawdowns to less than 20% if the holding period is longer than 10 days.  See the discussion in chapter 5 and the chart on page 130 of the QTA book.  Fully disclosed computer code is provided so readers can replicate my results and apply their own variations.

There are parallels with quantum physics uncertainty principle.  We can fix -- that is set specific values -- for some of the variables, but not all.  Fixing some in ranges with the conservative limits we desire causes others -- complimentary variables -- to exceed our desired ranges.  No matter how much we wish it were otherwise.

Best regards,
Howard


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## howardbandy (5 January 2016)

Rainman said:


> Isn't the only statistic that matters the annualised performance over the long term, so that compounding returns can work their magic?
> 
> From what you are saying, it seems that you would prefer smooth annualised 10% returns over lumpy 20% annualised returns.  If that is the case, your thinking and strategy will ultimately yield only a subpar performance.




Hi Rainman, and all --

1.  In my opinion the meaningful metric is not compound annual rate of return, but rather risk-normalized compound annual rate of return.

2.  Yes, take the smoother equity curve with the lower drawdown every time.  Apply dynamic positions sizing -- adjusting position size upward when the performance is good and downward when it is poor -- to both systems.  Given a set of trades that represent each, you can do the math.  (My entire Modeling book is devoted to explaining and providing tools for measurement.)  

All systems must have a positive mathematical expectation in order to be profitable over an extended number of positions.  Given that, the most important single thing that can be done to improve risk-normalized profit is avoid large individual losing trades and large numbers of small losing trades.  It is preferable to lose the opportunity for profit on some trades that would have been profitable in order to avoid large losing trades.  (For the nerds listening -- the cost of Type I and Type II errors is highly unsymmetric.)

Almost always the distribution of final equity for the smoother system will be higher -- often dramatically higher -- five or ten times higher.

Best regards,
Howard


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## Rainman (5 January 2016)

howardbandy said:


> ... In my opinion the meaningful metric is not compound annual rate of return, but rather risk-normalized compound annual rate of return...




Well, if the price that you are paying for "smoother returns" is ultimately a lower annualised return and if the risk that you are talking about is mere beta risk, then this metric is really just a recipe for sub-optimal performance.

What kind of returns have you gotten from using your quantitative system and over how long a period have you gotten them?


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## CanOz (5 January 2016)

How can one realize optimal returns if one does not have the intestinal fortitude to stomach the draw-down? We are human, we have individual tolerances for risk, usually dependent on many factors, including age. What might work for you might not work for someone else...

What do your returns Rainman, look like and have you held through a major draw-down, maybe share that with us?

I will say that we bailed after a draw-down greater than 30% on a systematic portfolio of trading systems a couple of years ago. I was ok with the Draw-down, just, but the wife was not.


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## Rainman (5 January 2016)

CanOz said:


> How can one realize optimal returns if one does not have the intestinal fortitude to stomach the draw-down?...




Well, to that all I can do is quote Peter Lynch: "The organ that determines success in the equity market is not the head.  It's the stomach".


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## Rainman (5 January 2016)

CanOz said:


> ... What do your returns Rainman, look like and have you held through a major draw-down, maybe share that with us?
> 
> I will say that we bailed after a draw-down greater than 30% on a systematic portfolio of trading systems a couple of years ago. I was ok with the Draw-down, just, but the wife was not.




I have been down 30% on an individual stock many a time.  But if the business continues to perform or is not deteriorating I hold.  The only risk that I am concerned with is the risk of total capital loss.  Beta risk doesn't worry me in the slightest.


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## CanOz (5 January 2016)

Rainman said:


> Well, to that all I can do is quote Peter Lynch: "The organ that determines success in the equity market is not the head.  It's the stomach".




Totally agree with this and it doesn't matter what it is, equities, futures, real estate. Everyone has thier vomit point. At least with quantitative strategies you have some idea of historical draw downs. You would think, that investing in good companies, they'll become more attractive to many investors as your portfolio draws down, giving you some faith that common sense and logic will prevail over senseless irrational behavior...but the question is always when? Another quote and perhaps one of the more famous, "the markets can stay irrational longer than you may stay solvent"


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## Rainman (5 January 2016)

CanOz said:


> Totally agree with this and it doesn't matter what it is, equities, futures, real estate. Everyone has thier vomit point. At least with quantitative strategies you have some idea of historical draw downs. You would think, that investing in good companies, they'll become more attractive to many investors as your portfolio draws down, giving you some faith that common sense and logic will prevail over senseless irrational behavior...but the question is always when? Another quote and perhaps one of the more famous, "the markets can stay irrational longer than you may stay solvent"




Yes, but the risk of insolvency only arises if you use leverage.


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## craft (5 January 2016)

Interesting debate guys.



CanOz said:


> Totally agree with this and it doesn't matter what it is, equities, futures, real estate. Everyone has thier vomit point. At least with quantitative strategies you have some idea of historical draw downs. You would think, that investing in good companies, they'll become more attractive to many investors as your portfolio draws down, giving you some faith that common sense and logic will prevail over senseless irrational behavior...but the question is always when? Another quote and perhaps one of the more famous, "the markets can stay irrational longer than you may stay solvent"




good points.




Rainman said:


> I have been down 30% on an individual stock many a time.  But if the business continues to perform or is not deteriorating I hold.  The only risk that I am concerned with is the risk of total capital loss.  Beta risk doesn't worry me in the slightest.




Rainman. you and I probably come from similar camps where our perceptions of the business value are more important than the price.....    BUT  have you really mastered indifference to price? I reckon I have a bit of experience under my belt but there are still days(bad days)  when the mark to market value that I'm theoretically indifferent too uncontrollably crystallises in my conscious into how many wages or house or toys or whatever I have just seen wiped from my account and things get tough for a while (not worried in the slightest is not how I would describe these testing times) and I don't think I have seen the last time I sit there at the ultimate buying discount thinking what in the FCUK does everybody else know that I don't - The market price can't possibly be that far out - only to find out later it was.  If you have truly mastered your emotions to the level you say I am in awe - But if you are talking theory better get ready for some real life schooling at some stage.


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## luutzu (5 January 2016)

craft said:


> ...
> 
> Rainman. you and I probably come from similar camps where our perceptions of the business value are more important than the price.....    BUT  have you really mastered indifference to price? I reckon I have a bit of experience under my belt but there are still days(bad days)  when the mark to market value that I'm theoretically indifferent too uncontrollably crystallises in my conscious into how many wages or house or toys or whatever I have just seen wiped from my account and things get tough for a while (not worried in the slightest is not how I would describe these testing times) and I don't think I have seen the last time I sit there at the ultimate buying discount thinking what in the FCUK does everybody else know that I don't - The market price can't possibly be that far out - only to find out later it was.  If you have truly mastered your emotions to the level you say I am in awe - But if you are talking theory better get ready for some real life schooling at some stage.




True that.

There's a lot of red on my account at the moment and while the dividend meant I have actually made a reasonable return last couple years, it's not pretty and some day I wonder what the heck. 

But nothing a couple beers or a few bad jokes can't help, for now 

Lucky I don't borrow money to invest and have a reasonable margin for expenses.


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## luutzu (5 January 2016)

Rainman said:


> Well, to that all I can do is quote Peter Lynch: "The organ that determines success in the equity market is not the head.  It's the stomach".




True.

I find investing the method and theory to be quite simple. It's the commitment to it on some purchases that's hard. I mean, to see value when many others do not; to buy and see it halved... 

Just have to have a big ego and do a lot of homework and hope you aren't the sucker being screwed.


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## Rainman (6 January 2016)

craft said:


> If you have truly mastered your emotions to the level you say I am in awe...




I hope I don't give that impression. 

When my portfolios are down, it depresses me.  No doubt.  But if a stock's business and its prospects are unimpaired, I usually buy more.  

I run two portfolios.  One contains stocks trading below net current asset value.  I call this the NCAV portfolio.  I am not really concerned about the quality of the businesses that I buy for this portfolio.  The selection process is almost purely quantitative.  As long as the stock is growing net current asset value (or, if not growing it, it is not rapidly eroding it), the stock is a possible candidate.  Also, the bigger the discount from NCAV, the better, in my view.   Last year, for example, ONC (which now trades as TFL) traded for months around 20% below net cash.  It ended up distributing a lot of the cash to shareholders.  The beauty of it was that even when ONC told the market that it was going to distribute this ton of cash to its shareholders the stock barely moved.  I bought a chunk of it.  

The NCAV portfolio did well towards the end of last financial year up to the beginning of this financial year.  It ended up over 50%.  The big winners were ONC, RIS and BAU.  UOS which is not a NCAV stock but which is very cheap on an asset basis also made a decent contribution.  The losers in that portfolio were TGZ, CHN, MGX and MPO.  With an NCAV you always have losers.  That is why you must diversify: it is the portfolio as a whole which gives you your outperformance.  I have since sold down most of my positions in the NCAV portfolio after huge rises by ONC/TFL and RIS in particular.  ONC/TFL almost tripled at one point in a matter of months but I was out of it by then.  RIS is no longer trading below net current asset value and I am out of it as well.   

My other portfolio contains stocks which I consider have a decent business but which are fairly to cheaply priced.  This portfolio is quite concentrated and is currently down around 4% for the half year.  The biggest loser has been IMF.  It has had a setback with the bank fees case(although it's been granted leave to appeal that case to the High Court).  Still, it has kept going down on sentiment alone, it seems.  It dropped another 7% yesterday for no apparent reason.  I am now down over 22% on it.  But I will keep buying.  The fundamental story has not changed.  But its performance has left me scratching my head, to put it mildly.


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## Rainman (6 January 2016)

By the way, for anyone interested in the sort of outperformance that you can get from adopting a NCAV strategy, I recommend reading: 


_Deep Value_ by Toby Carlisle (an Aussie); 


_The Rediscovered Benjamin Graham: Selected Writings of the Wall Street Legend_;


_How the Small Investor Can Beat the Market: By Buying Stocks That Are Selling Below Their Liquidation Value_, an early article by Joel Greenblatt (the article is summarised here:http://www.valuewalk.com/2015/04/original-magic-formula/).
The first and third of these publications contain studies on just how effective Ben Graham's original net-net strategy has proven to be over time and in spite of (or perhaps precisely because of) the emergence of ever more sophisticated quantitative computer programs.


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