Improving On Buffett And Desert Cat

[stephenNUTS]

David,

I am really trying my best to grasp/enjoy/and even understand your posts for the most part in BFI.

But in my opinion,BFI deals with real life money issues and decisions for the most part....and your theoretical/on paper/+/-EV type replies,with War and Peace length transparent responses.....dont exactly accomplish much except confuse or ignite a debate to unnecessary extremes

Does every one of "YOUR" REAL LIFE decisions have to be put through some sort of POKERSTOVE-like program as well?

I have NEVER ever before seen anyone make something basically simple...and turn it into something so complicated than it really has to be?

Unless you are just kidding here also[img]/images/graemlins/smirk.gif[/img]

Stephen [img]/images/graemlins/cool.gif[/img]

[David Sklansky]

I only delved into the theoretical to disprove a statement made by DesertCat. In actuality the point I am making is highly real life. Although it can only be used by people who have insight into why the public is making the price of a security different than you are.

[Mark1808]

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One last try. The Bellagio makes a line on football games. They are the best linemakers in the world. Their line is almost always perfect. So even a professional bettor who beats his bookie 56% of the time only picks 50.1% when he faces the Bellagio.

Joe Schmo is barely break even in his opinions. But he is better than the dart board thrower. (This is an important point.)

The Bellagio says the Yankees will win 70% of the time today. Joe Schmo thinks they will win 60%. In other words the Bellagio says that anyone holding a $100 even money bet has an equity worth $40. Joe says it is worth $20. Its TRUE worth is a tad below $40. Maybe $39.50. Change Joe Schmo to Mr Market. (And I would still love to bet that Buffett both agrees with me and doesn't think his words dispute my words)

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The information Joe Schmoe uses to form his opinion is presumably available to the Bellagio. Therefore, the Bellagio and Joe use the same information to reach their conclusions. The Bellagio tends to reach much better conclusions based on the information available. Thus, there is no reason to pay attention to Joe. Any difference between Joe's estimate and that of the Bellagio is likely the result of Joe's error.

Where Joe is correct, the Bellagio will also be correct. Joe's opinion is worthless - unless you're betting against Joe, in which case a large discrepancy between Joe and the Bellagio will indicate that you should put it all in there!

I don't know much about investing, or when to buy and sell, but I think your example here is flawed, David. It's no more likely that the actual value is $39.50 than that it's $40.50.

Very nice thread, makes me want to learn about financial analysis.

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First of all what I am saying is unquestionably correct in the real world. I will get to that in a minute. In the theoretical world I am saying that that if Jack is right about something 90% of the time and Jill is right even as little as 51%, then when they disagree, Jack's probability has gone down to 89.9% or whatever. If they are totally independent chances it easy to figure out the exact answer. You are saying Jack's probability doesn't change because they are not independent. He will get every question right that Jill will, plus more. If that was the case Jill's disagreement means nothing.

But that total lack of independence is obviously not the case in the stock market or sports betting. And once that is true, my contention MUST be true. It isn't even a contention. It is just an irrefutable math problem. If there are two differing opinions the true answer lies somewhere in between. On average. But closer to the guy who gets things right more often. As long as the other guy is better than random.

As to the real world, how can it not be obvious that I am right? Experts who use the Buffett-Graham-DesertCat technique make their play when their figures show they have some required big edge. When the smoke clears they are ahead, But obviously not to the extent that they thought they should be. Otherwise they all would be trillionaires. So the true price lays somewhere between their's and the market's.

Now why that should be the case is not clear. It is obviously sometimes because someone is illegally trading on inside information. But that is too rare to fully account for the syndrome.

When technical analysts say that the market will tell you where a stock is heading they are probably morons. But it is not moronic to say that the market is one of the best experts in telling you what a stock should BE. There are a few people who are even a little better than that. But if they are disagreeing with Mr. Market they should be very aware that the disagreement could signify that they have made at least a partial mistake.

BUT, their discomfort and trepidation should reduce if they can PINPOINT the reason why Mr. Market is disagreeing and refute his reason. When that happens they don't need to give themselves as large a margin of error.

I can't believe I'm going through all this again like I did thirty years ago in poker. You guys all need to just shut up, do what I say, and make more money.

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The problem with the example as I see it is the market price is not better than average at determing true value, because market prices on average are average. Now if you take a group of people on the other side of the trade they should tend to represent an average opinion and not a group with market beating knowledge. Where your example has some validity is if Buffett was on the opposite end of the trade of another market beating Graham disciple; in these types of trades you would not expect Buffett to do as well over a large sample size.

Table selection is very important in poker and I often observe where a respected player I know is sitting. His prescense at the table doesn't help me but I know he is very good at table selection and by going to his table I know I will be at a better table than I could pick on my own. In the same vein since company insiders have tended to outperform the market long term in their buying and selling I would like to own companies that are undervalued that are also being purchased in the open market by their own managemnet team and shy away from companies that I think are undervalued but where their corporate officers are heavy sellers. In this way I am not making trades opposite of those with market beating knowledge.

[SlowHabit]

DesertCat's realized gains > Sklansky's Theory Buxs all day.

[David Sklansky]

Firstly there is a difference between an average opinion and a random opinion. Secondly the market is not necessarily an average opinion. Do you think that the favorite on the tote board is always the horse that most people think will win?

And when you talk about avoiding acting on your opinions only if insiders are on the same side, you are actually agreeing with one aspect of my point.

[Subfallen]

Isn't the "true" value of a stock only an idealized notion useful for analysis? All that really matters is predicting Mr. Market's valuation. (Which we imagine as "going to" the true value over time.)

But if the "true" value of a stock is Mr. Market's valuation at the limit, so to speak...then clearly DS is correct, as long as Mr. Market's valuation changes in a discernibly continuous fashion.

This is probably of little practical value, but theoretically it seems obvious.

[Mark1808]

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Firstly there is a difference between an average opinion and a random opinion. Secondly the market is not necessarily an average opinion. Do you think that the favorite on the tote board is always the horse that most people think will win?

And when you talk about avoiding acting on your opinions only if insiders are on the same side, you are actually agreeing with one aspect of my point.

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I definately agree that if those on the opposite side of your trade are better than average then your expected return, even if the best, will be less.


I believe the favorite on the tote board has the most money on him to win, his price, or odds, is the collective wisdom of bettors who on average should do no better or worse in predicting than the odds given. Now if I was the best handicapper in the business and I saw a trainer with a great betting record taking another horse than mine, I might still have the best pick but the EV would not be as great.

I am just having a tough time seeing how the market price of a stock is a better predictor of its value than the average of all investors who in fact set that market price through their actions.

But I will say knowing the motivations and record of those on the opposite side of your trade can only enhance your EV.

[ahnuld]

subfallen, it doesnt really matter if mr market gets it right or wrong ever, as we own a part of the company and are entitled to dividens/a share of the profit. So as long as we can forecast accurate cash flows and we pay a low price for those cash flows we dont care what the market does after it has given us the opportunity to buy those cash flows cheaply.

[DesertCat]

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First of all what I am saying is unquestionably correct in the real world. I will get to that in a minute. In the theoretical world I am saying that that if Jack is right about something 90% of the time and Jill is right even as little as 51%, then when they disagree, Jack's probability has gone down to 89.9% or whatever. If they are totally independent chances it easy to figure out the exact answer. You are saying Jack's probability doesn't change because they are not independent. He will get every question right that Jill will, plus more. If that was the case Jill's disagreement means nothing.

But that total lack of independence is obviously not the case in the stock market or sports betting. And once that is true, my contention MUST be true. It isn't even a contention. It is just an irrefutable math problem. If there are two differing opinions the true answer lies somewhere in between. On average. But closer to the guy who gets things right more often. As long as the other guy is better than random.

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I think I understand what you are saying, and it's mathematically sound. If Jack can guess right 90% of the time, and Jill can guess right 51%, you make perfect sense. If they were guessing a random event, like a coin flip. Assume Jack has a sixth sense that gives him 90% accuracy, Jill has a weaker version that only makes her 75% accurate, and their predictions are independant, i.e. when she is right he is sometimes wrong. If he is getting paid 9-8 on every right guess he should first ask Jill what her guess is, and if it's different than his, pass on the bet knowing his edge has disappeared.

But FA isn't guess-work, and I don't think your example applies. It's a logical, rational, framework for valuing an investment. The goal of a value investor is to find market inefficiencies, in a market that is usually efficient. In this case, Mr. Market isn't even being 50% accurate. So using an inaccurate "guess" can't make your rational evaluation more accurate.

This morning I thought you got here because sports betting involves lots of non-public information, and I think that makes a big difference. In sports betting it's important to take the line into effect when you do your own handicapping. You can never know if there is an unreported injury, or even a fix, that other betters are aware of, and averaging your results with the current line helps protect you from being cheated.

But in the stock market, there are many valuations you can do that don't involve any non-public information. And non-public information is much less prevalent and valuable than in sports betting. Public companies have disclosure rules, insider selling is controlled and reported, and the stock market is legal in every state with fraud is investigated by the SEC, state attorney generals and private lawyers. A company like Coke can be valued pretty confidently because it's value has little to do with any individual quarterly or annual report, it's value is based primarily on it's long term international and domestic growth rates. Value investors avoid companies where non-public information can radically change company valuations. Value investors seek out predictable, easy to value, stocks.

Imclone (the martha stewart) is one of the most well known examples of insider trading of recent years. But the CEO sold all his stock basically in a single day. If you valued ImClone fairly, and bought it at any time in the months before at big discounts to that valuation, you weren't cheated at all, there was no non-public information affecting the stock's valuation. You were only cheated if you bought on the same day the CEO sold. So even in this case it was a rarity.

And ImClone wasn't a stock a value investor would buy. It's value had no predictability, because it was all linked to a specific study and FDA authorization that was high risk. Even if you could handicap it well, it incorporated secondary risks such as fraud do to the importance of the test results. This is the exact reason why value investors try to avoid "fulcrum stocks" whose value changes dramatically based on a single event.

Your technique actually may be valuable for fulcrum stocks, but that means it can only be used rarely, esp. by value investors.

[David Sklansky]

I will try to rephrase things differently. If there are stocks where my theory isn't true and my technique is unnecessary, then it is also unnecesary to have anywhere near the 50% cushion you require, when investing in these stocks, as long as you have any sort of reasonable value assigning skills.

The above is pure logic. You don't even need to know what a stock IS for it to be true.

Obviously fulcrum stocks are the most suceptible to my techniques. But the other stocks are not immune to them and when you say that you need a 50% cushion you have implicitly agreed. Your error is the PURE LOGIC error of not seeing how your insistence on conservatism MEANS you agree with me.

But enough with the theory. Let's get back to Buffett. Forget one example. He has presumably made thousands of trades where he rated the eventual worth of a security a lot different than the market did at the time of his trade. Assuming he honestly told you his original ratings then it could be checked five or ten years later. Your contention is that if that they were done one would find that the prices averaged out to his ratings. My contention is that that isn't even close. Yes they moved toward his ratings and away from the markets. But I bet they didn't even move halfway toward them. In fact if he used anywhere near the same criteria you use (think the real value is double before investing) the proof of that is one line.