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

[Rainman]

... 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]

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

Which of them beats Buffett?

... 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]

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]

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]

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.

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]

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:

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.

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]

"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]

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]

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.

 

[Rainman]

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.

 

[Rainman]

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]

....

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.

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.

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

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]

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.

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.

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]

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]

... 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.

... 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]

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

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

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.

In our early decades, the relationship between book value and intrinsic value was much closer than it is now. That was true because Berkshire’s assets were then largely securities whose values were continuously restated to reflect their current market prices. In Wall Street parlance, most of the assets involved in the calculation of book value were “marked to market.”

Today, our emphasis has shifted in a major way to owning and operating large businesses. Many of these are worth far more than their cost-based carrying value. But that amount is never revalued upward no matter how much the value of these companies has increased. Consequently, the gap between Berkshire’s intrinsic value and its book value has materially widened.

With that in mind, we have added a new set of data – the historical record of Berkshire’s stock price – to the performance table on the facing page. Market prices, let me stress, have their limitations in the short term.

Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. Charlie Munger, Berkshire Vice Chairman and my partner, and I believe that has been true at Berkshire: In our view, the increase in Berkshire’s per-share intrinsic value over the past 50 years is roughly equal to the 1,826,163% gain in market price of the company’s shares.

 

[howardbandy]

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

 

[howardbandy]

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

 

[Rainman]

... 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?

 

[CanOz]

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.