Investing style is a religion

[gaius]

Come on, admit it, you know I'm right.

btw, here's an almost accidental discovery of mine using Buffett and Graham's approach [or rather, my understanding of it]...

...

As for Monty's formula... he overpaid by about 10%. Which as we've been discussing, kinda make sense doesn't it.

It is unclear to me if your example actually help prove you right or wrong.

If you say Monty's formula overpaid by about 10%, I could also say the seller wouldn't sell it too cheap if he uses Monty's formula.

 

[luutzu]

It is unclear to me if your example actually help prove you right or wrong.

If you say Monty's formula overpaid by about 10%, I could also say the seller wouldn't sell it too cheap if he uses Monty's formula.

People do what makes sense to them.

It just doesn't make sense that a buyer have to pay more because the investment will, in the future, be worth more from having his dividend withheld from him.

 

[gaius]

It just doesn't make sense that a buyer have to pay more because the investment will, in the future, be worth more from having his dividend withheld from him.

This is typical for growth stock. Any growing company should be able to put their money to work to earn a higher return than returning the cash to shareholders. That's the whole point of the market to drive better resource allocation for the economy.

This is text book theory anyhow, but with QE flooded the world with cheap funding, even the crappiest project is still profitable, the value of retaining cash for growth is becoming less obvious (or even becoming doubtful). Yet, the result is the same - high valuation.

 

[galumay]

I think we are bashing our heads against a brick wall here, VC. I am done.

 

[luutzu]

This is typical for growth stock. Any growing company should be able to put their money to work to earn a higher return than returning the cash to shareholders. That's the whole point of the market to drive better resource allocation for the economy.

This is text book theory anyhow, but with QE flooded the world with cheap funding, even the crappiest project is still profitable, the value of retaining cash for growth is becoming less obvious (or even becoming doubtful). Yet, the result is the same - high valuation.

I think that's the problem with adjusting a project's/investment required rate of return based on prevailing cost of capital/interests.

Gov't own infrastructure project might be the exception... where if the return is far away and below the cost, it's still acceptable as it benefit the community, create jobs, reduce the cost of doing business etc., which in turn return the cash back to the state coffer.

But yea, projects or investment made based on what interest the bank charges... while it make sense in the short term when rates are low and fixed, won't do well if interest were to rise but the return cannot be raise.

 

[luutzu]

I think we are bashing our heads against a brick wall here, VC. I am done.

Dude, Monty's approach mixes price with value.

More specifically, mixes today's price with tomorrow's value.

He's the buyer but his calculation is that of a seller.

Not sure how else to put it... so let's repeat with different emphasis.

Monty is buying WOW today, with his own cash which he will transfer over to the seller.

But for some reason, Monty figured that the price of WOW today is what it will be worth today plus the retained earnings it will earn in the future.

Yes, WOW will be worth that higher value in that future. But that future belong to him because he already paid for it today. So it's a value that is his, he should be the one selling it at that future price, not paying for it right now.

I mean, Monty would be paying for today's value, plus the value his WOW will further gain in the future.

On top of that, he's taking on the risk that Masters and other ventures didn't work out.

But alright, just put it in that I'm clueless bin.

 

[gaius]

He's the buyer but his calculation is that of a seller.

What buyer/seller calculation?? It is supposed to be the fair value! The 'objective' mid point estimate. Buyer would of course bid for lower, seller would of course ask for higher.

 

[Value Collector]

It doesn't double count to my disadvantage.

Say I reckon WOW's earning power is $10 from now into eternity. And based on that estimate I figured it's worth $100.

The fact that it kept back 30%, pays out 70% of that $10 earning shouldn't make it more or less valuable. I mean, it still earn $10.

To say that if it kept back more then it's worth more... that's mathematically true. But that's assuming I haven't already paid for and own it; that it wasn't my earning that's being kept back and being compounded.

It also assume that the dividend paid out is paid to someone else and not to me. Which doesn't make sense because it's paid to me as I own the thing.

Say I have $100M in my bank account. I call up Monty and offered it to him for $150M.
Why would he buy $100M in cash for $150M in cash?

Using his logic I tell him that if he kept all the earning and compound the $100M earning for next 5 or 10 years, it'll surely be worth $150M, at least.

That's not going to work on him, or will it?

Dude, you haven’t been paying attention at all have you?

So you understand what “return on equity” is? Do you understand why “return on equity” is important?


If you had an account with $100 million in it and it was earning 25% interest, you can bet it’s worth a lot more than $100 million in today’s market, where people are buying bonds at 2% interest.

If you had a $100 US treasury bond with a 25% interest rate, you can bet it’s going to sell for more than $100.

And a bond that earned 25%, and allowed all the earnings to be reinvested back at 25% would be selling for more than the bond that didn’t allow reinvestment.

You didn’t answer my question about which bank account you would buy?

But let me ask the similar question using bonds as an example.

Which is the best value investment.

1, $100 perpetual bond @ 2% interest - selling at $100

2, $100 perpetual bond @ 25% interest - selling at $250

3, $100 perpetual bond @ 25% interest with 50% of earnings reinvested into the bond - selling at $285

Please actually answer this question.

 

[luutzu]

What buyer/seller calculation?? It is supposed to be the fair value! The 'objective' mid point estimate. Buyer would of course bid for lower, seller would of course ask for higher.

Monty is about to buy, say, a $100M bank account today. For simplicity, just say that there's $100M in cash in it right now so its price is $100M.

But in valuing that $100M ordinary, typical, no special mate's rate account at its current price of $100M.... he get creative.

He figured that if the interests (dividend) were kept back and compound... in the future that $100M will be worth, say, $150M.

Then he goes ahead and "value" that account at $150M.

I'm exxagerating the figures and it does sound silly when you put it that way. But that's essentially what he's doing when he said...

paraphrasing: If the company pays out its earnings in full, it will be worth $x. If it retain all of its earnings it will be worth $2X.

I'm saying there's no difference in price no matter the payout ratio. That yes, if more cash are kept back and wisely invested to achieve the historical ROE, it will be worth more. But that new value generated were generated from what will be my saved earnings. So why should I pay the seller for that extra value now?

 

[luutzu]

Dude, you haven’t been paying attention at all have you?

So you understand what “return on equity” is? Do you understand why “return on equity” is important?


If you had an account with $100 million in it and it was earning 25% interest, you can bet it’s worth a lot more than $100 million in today’s market, where people are buying bonds at 2% interest.

If you had a $100 US treasury bond with a 25% interest rate, you can bet it’s going to sell for more than $100.

And a bond that earned 25%, and allowed all the earnings to be reinvested back at 25% would be selling for more than the bond that didn’t allow reinvestment.

You didn’t answer my question about which bank account you would buy?

But let me ask the similar question using bonds as an example.

Which is the best value investment.

1, $100 perpetual bond @ 2% interest - selling at $100

2, $100 perpetual bond @ 25% interest - selling at $250

3, $100 perpetual bond @ 25% interest with 50% of earnings reinvested into the bond - selling at $285

Please actually answer this question.

You are missing the point.

I as buyer had come to the conclusion that WOW, at ROE of 28% etc. etc. is worth $100M, say.

That is, the reason I'm paying $100M for WOW is because of its awesomeness.

What Monty's approach is saying is that, IF the earnings from WOW were retained, it will be worth more. If that same earning were paid out completely in dividend, it will be worth less.

What I am saying is that the price should be the same $100M regardless of what I decide to do with that eventual earning once I had bought and paid for WOW.

So if I decide to retain all the earnings next year, year after that etc. Yes it will be worth more... But that new value is from my savings and investing the earnings my company earned.

 

[Value Collector]

You are missing the point.

I as buyer had come to the conclusion that WOW, at ROE of 28% etc. etc. is worth $100M, say.

That is, the reason I'm paying $100M for WOW is because of its awesomeness.

What Monty's approach is saying is that, IF the earnings from WOW were retained, it will be worth more. If that same earning were paid out completely in dividend, it will be worth less.

What I am saying is that the price should be the same $100M regardless of what I decide to do with that eventual earning once I had bought and paid for WOW.

So if I decide to retain all the earnings next year, year after that etc. Yes it will be worth more... But that new value is from my savings and investing the earnings my company earned.

Please you are really missing a key point here,

Go back to my last post, look at the 3 bond examples I gave,

Take a moment to think about it, don’t rush,

And please tell me, which of the three bonds represents the best value.

 

[gaius]

Monty is about to buy, say, a $100M bank account today. For simplicity, just say that there's $100M in cash in it right now so its price is $100M.

But in valuing that $100M ordinary, typical, no special mate's rate account at its current price of $100M.... he get creative.

He figured that if the interests (dividend) were kept back and compound... in the future that $100M will be worth, say, $150M.

Then he goes ahead and "value" that account at $150M.

I'm exxagerating the figures and it does sound silly when you put it that way. But that's essentially what he's doing when he said...

paraphrasing: If the company pays out its earnings in full, it will be worth $x. If it retain all of its earnings it will be worth $2X.

I'm saying there's no difference in price no matter the payout ratio. That yes, if more cash are kept back and wisely invested to achieve the historical ROE, it will be worth more. But that new value generated were generated from what will be my saved earnings. So why should I pay the seller for that extra value now?

Ok, let's use your example.

You value your special $100M bank account at $100M.
Monty sees your special $100M bank account worth $150M, offers you $130M for your $100M bank account.

Say $30M 'immediate profit' is a good enough for you, so deal.

So, you get $130M from Monty, and think Monty is crazy.
Monty paid you $130M, uses your special $100M bank account to get $150M, so net gain of $20M.

Notice that you could have got $150M but only pocketed $130M in the end. Monty would have got nothing without the deal but now received $20M.

Also note that your $130M could not have earn enough interest to reach $150M, because it is assumed the company (your special bank account) would invest wisely at a higher earning rate.

 

[luutzu]

Please you are really missing a key point here,

Go back to my last post, look at the 3 bond examples I gave,

Take a moment to think about it, don’t rush,

And please tell me, which of the three bonds represents the best value.

How about you work it out for me?

My understanding of perpetuity can't plug the figures you gave to split out an answer.

But regardless, the point I'm making is that... Yes, if earnings are retained and reinvested, and further being reinvested at a higher rate. Then of course the bond/company will be more valuable in the future.

Just that, again, that future had already been bought and paid for by the buyer... so why is it priced today at that future value?

My brother have a habit of drawing things out. I find it annoying most of the time... maybe I should draw it out

 

[luutzu]

Ok, let's use your example.

You value your special $100M bank account at $100M.
Monty sees your special $100M bank account worth $150M, offers you $130M for your $100M bank account.

Say $30M 'immediate profit' is a good enough for you, so deal.

So, you get $130M from Monty, and think Monty is crazy.
Monty paid you $130M, uses your special $100M bank account to get $150M, so net gain of $20M.

Notice that you could have got $150M but only pocketed $130M in the end. Monty would have got nothing without the deal but now received $20M.

Also note that your $130M could not have earn enough interest to reach $150M, because it is assumed the company (your special bank account) would invest wisely at a higher earning rate.

Pretty sure I said ordinary account, nothing special about it.

You're mixing a bank account example with an ongoing business there.


If we stick to a bank account example it's this:
--------- There's $100M in cash, in the bank right now. It is worth $100M in cash because there's $100m in cash in it haha

Now, offer me $130M for it please.

You can "earn" that extra $20M all you like. All I know is that my pallett of $100M in cash just got offered $130M. So you/Monty, is taking your future earnings of $30M from on that $100M deposit and pay it to me.

True or not?

---------------
A $100M business value example....

A $100M business doesn't mean it has $100M. Not in this example.

I worked out that given its future income streams from now until eternity, discounted that back to today at my required rate... it is worth $100M.

Now, why in the world would I now, after working out that it will be worth $100M because of its probably, very likely, income streams... Why in the world will I now pay extra for it because it will reinvest those earnings back on itself?

Want to see how Buffett value the Washington Post vs how Monty values WOW?

 

[gaius]

You can "earn" that extra $20M all you like. All I know is that my pallett of $100M in cash just got offered $130M. So you/Monty, is taking your future earnings of $30M from on that $100M deposit and pay it to me.

True or not?

True, of course, didn't you notice that I used your $30M to pay you???

A $100M bank account worth more than $100M might sound silly, but in current low rate environment, if you have a $100M bank account that gives $150M in a year, it surely worth more than $100M.

 

[gaius]

You're mixing a bank account example with an ongoing business there.

...

---------------
A $100M business value example....

A $100M business doesn't mean it has $100M. Not in this example.

I worked out that given its future income streams from now until eternity, discounted that back to today at my required rate... it is worth $100M.

Now, why in the world would I now, after working out that it will be worth $100M because of its probably, very likely, income streams... Why in the world will I now pay extra for it because it will reinvest those earnings back on itself?

Want to see how Buffett value the Washington Post vs how Monty values WOW?

That bank account example was your example, but okay the same applies to your $100M business example.

You have a $100M business. The business earns some future income streams from now until eternity and you figured that with your required discount rate it worth $100M.

I see your $100M business could have earn $50M more over the next 3 years, if the business kept back some of its dividend to expand its business this year.

Since you don't believe changes in dividend payout ratio now would affect the value of the business because you believe that the dividend is yours already, you maintained your valuation of the business at $100M.

I, on the other hand, being the crazy and double counting my numbers, figured that the worth of the business should be $150M because it will worth $50M more in 3 years time. So, by mixing today's $100M and future $50M (also double counting what would have been already mine if I bought the business), I offer you $130M for the business.

Say, $30M 'immediate profit' is good enough for you, so deal.

Now, you got $130M from me, and think that I am crazy for double counting what is already mine.

I paid you $130M, uses your business to generate that additional $50M. In other words, I used your business's $50M earning to pay you $30M for your business and pocketed the remaining $20M.

Now, what price would you accept to sell your business? Is $130M good enough for you?

 

[Value Collector]

How about you work it out for me?

Ok, Well as investors it our job to put money to work where it will earn a satisfactory rate, and if we can maybe even an excellent rate, while also protecting ourselves from loss.

Now I gave you the following choices, and and I said our target rate was 10% return or better.

1, $100 perpetual bond @ 2% interest - selling at $100

This Bond is the worst investment, even though we can buy it at its face value, its not going to deliver us our 10% required return, this option would have to be selling at $20, before it would deliver us our 10%, So it is very under priced....... it expensive

2, $100 perpetual bond @ 25% interest - selling at $250

This bond is Ok, it's selling for $250 but will deliver $25 interest, so it meets our 10% required return, But if we pay over $250 for it, it won't

3, $100 perpetual bond @ 25% interest with 50% of earnings reinvested into the bond - selling at $285

This bond is the star of the group, At $285 it will deliver you a return of well over 10%, it would have to be trading at $385 before it was considered equal with bond 2. So the fact you can buy it for only $285 makes it a huge Bargain opportunity.

its ability to retain earnings and deploy them at 25%, mean that even though it's selling for $35 more than bond 2, it's returns will be significantly better, if we buy it for $285 it will have a return of well over 10%, in just 5 years the equity in the bond would have doubled and it would be earning twice the interest of bond 2.

Just that, again, that future had already been bought and paid for by the buyer... so why is it priced today at that future value?

The future value is not priced in, The full value of bond 3 is $385, but its selling today for $285 thats a big discount to its fair value, But if you are only looking skin deep and ignore its ability to retain earnings at a high return on equity, you will miss it.

Roger Wasn't saying "work out what it will be worth in the future and pay that price today", He was saying "work out what it will be worth in the future to see whether todays price represents good value and a margin of safety"

But regardless, the point I'm making is that... Yes, if earnings are retained and reinvested, and further being reinvested at a higher rate. Then of course the bond/company will be more valuable in the future.

So wouldn't you be stupid to buy an inferior bond/share just because its a looks a little cheaper based on P/E ratio or dividend today? I think so.

No, one is saying go and pay for all the future growth today, I am just saying Rogers method is one tool to help estimate future growth potential, So you can compare what the company might be worth in the future compared to todays share price, its then up to you to decide what you are willing to pay today.

 

[Value Collector]

Just so people understand how the Bond example relates to shares, Shares can be considered as "Perpetual Equity Bonds"

Where the "Equity per share" is like a bonds "Face Value",

The "Return on equity" is like a bonds "Interest rate coupon"

And just like Bonds, shares will trade in the market at market prices that may be higher or lower than the face value of the equity you are buying.

It's up to you to decide what the fair value for that "Share / equity bond" is based on its likely return on equity going forward, and what it will do with earnings, eg does it pay them out, does it retain them and invest them at a low rate or high rate, will it burn them in a bad investment etc etc.

 

[luutzu]

That bank account example was your example, but okay the same applies to your $100M business example.

You have a $100M business. The business earns some future income streams from now until eternity and you figured that with your required discount rate it worth $100M.

I see your $100M business could have earn $50M more over the next 3 years, if the business kept back some of its dividend to expand its business this year.

Since you don't believe changes in dividend payout ratio now would affect the value of the business because you believe that the dividend is yours already, you maintained your valuation of the business at $100M.

I, on the other hand, being the crazy and double counting my numbers, figured that the worth of the business should be $150M because it will worth $50M more in 3 years time. So, by mixing today's $100M and future $50M (also double counting what would have been already mine if I bought the business), I offer you $130M for the business.

Say, $30M 'immediate profit' is good enough for you, so deal.

Now, you got $130M from me, and think that I am crazy for double counting what is already mine.

I paid you $130M, uses your business to generate that additional $50M. In other words, I used your business's $50M earning to pay you $30M for your business and pocketed the remaining $20M.

Now, what price would you accept to sell your business? Is $130M good enough for you?

Where do I sign?


Put another way....

Monty goes to the car dealership. He like this Mustang that's selling for $100K.

So he try to figure out what a $100K car is worth after he bought it.

He said... it's $100K now, but wait til I reskin it with fibreglass; then gold plate that fibre. Change the rim, put in a double turbo. Some extra dark tint.

Oh boy, it's going to be worth at least $150K, easy.

Then he goes ahead and pay $130K for it after a tough negotiation.


That would be pretty silly of Monty right?


It's the same in his valuation.

So he figured that WOW earns $X. From that earning stream, it should be worth $10X, for example.

But then he figured that if he, as its new owner, were to keep back future earning streams (from himself), it is worth a lot more.

Of course it'll be worth a lot more, but that's the worth/value he own... not the owned by the current owner that's selling it to him.

 

[Value Collector]

That would be pretty silly of Monty right?

You are building a straw man.

Roger Wasn't saying "work out what it will be worth in the future and pay that price today", He was saying "work out what it will be worth in the future to see whether todays price represents good value and a margin of safety"