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Desert Cat didn't make clear in his post whether Buffett requires of himself a stock price fully one half of his own valuation before he buys. He also didn't say whether Buffett, after coming up with his valuation (without knowing the price) adjusts that valuation AFTER seeing the price. Surely he should, even though he would still probably profit without doing that, as long as he mainly stuck to big companies.
I mean as good as Buffett it, I'd bet anything that when his valuations differ from the price by a large amount the eventual results, on average do not come close to his valuations. If they did he would be a quadrillionaire. In other words, no matter how good you are, if your opinion differs markedly from the present price, the true valuation is almost certainly somewhere between those two prices. And probably closer to the market price.
In spite of all that, if you stick to big stocks that have little chance of unknowing shenanigans, and you are good, and you don't pull the trigger unless there is a large discrepancey, you ought to make money. But I think I have a better method for the real experts. (A method closely akin to something I wrote about in GBOI regarding horse racing.)
In theory, this method takes into account not only the stuff Desert Cat talks about, but also aspects of human nature, human stupidity, and human dishonesty, that technical analysis claims to deal with. To pull it off you have to know what Desert Cat knows plus more. But if my idea is right it makes for bigger profits. Not only because your picks should have a greater edge (given equal discrepencies between your opinion and the markets). But also because you don't need as big a discrepancy to buy or sell short.
The idea is to first do as Buffett does. Come up with what you think is the right price for the security without knowing that price. But then come up with a second number. Which is your guess as to what the price actually is. When these two estimates are close you should be very wary of making a play, regardless of the actual price. If you think a stock is worth 50 and you think the market will make it 50, don't buy it a 40 or short it at 60.
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Buffett never lets the market price influence his estimate of value.
To better understand Buffett's philosophy, you must first read this.
This interview with Liz Clamen he explains how he did the PetroChina investment.
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“I sit there in my office and read an annual report, which fortunately, was in English, and it described a very good company. It told about the oil reserves, the refineries and everything else and I sat there and read it and said to myself this company’s worth about $100bn. I don’t look at the price first. I look at the business first and try to figure out what it’s worth because if I look at the price first I’ll get influenced by that
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He made a killing on PetroChina, but since he sold it, the market went crazy.
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On PetroChina:
“We sold it [all stakes], but we sold it based on price [not politics]. At the time of the annual meeting it was around $100 and since then it has more than doubled so, unfortunately, I sold it a little too soon. It was a decision based 100% on valuation.”
“If it went down a lot I’d buy it back.”
“We made about $3.5bn on a $500m investment but we still sold it too soon. I left a lot of money on the table.”
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Buffett didn't really make a mistake, but he often uses that term self-deprecatingly about investments like that. There is no way he thinks PetroChina is worth $500B or whatever it's trading for today, so there is no way for him to hold hoping the market gives him a price well over value. If you read his writings back into the 50s, it's a theme that pops up regularly, he sold too soon or bought too early, had he omniscience about market prices we (his investors) would have done much better.
Despite that, Buffett has doubled his net worth on average every three years for fifty years. It was faster when he started, and slower now due to portfolio sizes, but that's still very fast. He left the Graham Partnership in the mid-50s worth $100k, and turned that into what would be worth around $65B (if he hadn't shipped a bunch to the Gate's charity recently) now. So not a quadrillionaire, but he's done better than any other long term investor in history. If he can be the audited, certified best without being able to predict price action or market psychology, how likely is that to be a big leak? Maybe, what you propose is way too hard to offer a significant edge in practice?
It's interesting that you did this "pure thought" experiment, because it's similar to what Buffett would do (I've often thought you and he share many characteristics, besides high IQ's, being intellectual leaders in your chosen fields, maintaining an intellectual curiousity throughout your lives, and I'd bet you have a photographic memory similar to his). You should read more of his writings.
But you should also give him some credit. He's been thinking and rethinking this stuff for over 50 years and he's never espoused anything similar to what you propose. I can almost certainly say, that it's because he concedes his inability to estimate what other people will do with any measure of accuracy, especially a mass of strangers with differing financial objectives and philosophies.
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Its an indication that some rich, smart people might be agreeing with me.
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To me as an investor it is a mistake to make a decision because some smart people agree with you. Smart people make mistakes too. You can only make correct decisions if your facts, not your heroes, are in agreement with the action.
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All this of course is related to my Fundamental Theorem Of Investing. Don't invest unless you can explain why people are taking the other side. In fact using that Theorem you can theoretically beat the market without having expertise on the other end of the spectrum. The experts here hate that technique since it results in trades that ignore their abilities. So forget that for now. Combine them both.
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When you decide to make an investment, you should always have considered the risks that others have weighed so heavily to give you this bargain. In the case of my 1/3 book value investment, it is a smaller, less liquid stock, that has no analyst coverage that I'm aware of. And this little illiquid "market" thinks the company will not be able to monetize this large asset without hugely punitive taxes, and is concerned about how long it will take. They are probably also worried about it's being majority owned by a rather colorful billionaire with a "interesting" and litigious past. I see those same risks, but based on the facts it's pretty easy to see that I'm getting a great price for the potential return.
Oh, and the 50% discount is something I should look for because I run a small very liquid portfolio. Buffett has had to adjust his filter because his portfolio has grown so enormous that his investment choices have become much more limited, and the markets he can buy in are much more liquid and hence efficient. My guess is he'd be really happy with a 30% discount right now, and probably is forced to take some 25% discounts. Discount of course isn't the exact right way to think about it, it's really expected rate of return which depends on holding periods, but discount is a nice short cut rule of thumb. I buy lots of stuff at 20% discounts if I think my holding period will be 3 or 4 months.
And lastly, It's DesertCat, not Desert Cat. I don't go around calling you Sk lanksy, do I [img]/images/graemlins/smirk.gif[/img]?