More On The Dubious Value Of Comprehensive Knowledge- Part One

[David Sklansky]

Granted I've not studied my hypothesis when it comes to the stock market. As opposed to horses and sports. But still I would be shocked if I was way off base here.

There is no doubt that if you know all the public knowledge about a stock or option or commodity or two sports teams, your opinion of its worth, if you are not a moron, will usually be quite accurate. Certainly more accurate in the vast majority of cases than the opinion of someone without this knowledge. The problem is that this doesn't do you any good if the market is agreeing with your opinion. You only make money if you disagree with the market and you are right.

I may be great at looking at someone and estimating how many pushups they can do but if the only people who will bet me are those few who can do far more than it looks like, my expertise means nothing. Same with the fact that someone is willing to sell a stock to you for ten dollars PLUS the fact that others aren't snapping up that offer. At least some of them also have comprehensive knowledge. If the routine analysis makes the stock worth thirteen dollars and you can buy it for ten, then there is something wrong with your knowledge or your analysis. At least most of the time.

People talk about how great Warren Buffett is in evaluating the true value of a stock with public knowledge only. My guess is that he's not nearly as good as people think EXCEPT for the fact that he occasionally sees spots where he can use my Fundamental Theorem of Investing. In other words he occasionally notices a large discrepancy between his valuation and the public's valuation and ALSO has a good explanation as to why the public is erroneously disagreeing with him.

Put another way, suppose Buffet was presented with 100 randomly chosen, mid or large cap stocks, who's names were withheld from him. But not the financial and other technical information that "homework doers" use. He has to come up with his opinion of the right price for them based only on this information. The stocks that have present day prices that are more than ten percent away from Buffett's picks are checked up on in three years. Adjusting for the upward bias of stocks, who do you think will be closer in their prediction, Buffet or the market? I'd be shocked if Buffet was the favorite and even shocked if he disagreed with me.

Getting back to that pushup bet. Suppose instead of being an expert body type analyzer, I knew only two facts. The amount of pushups people will bet they can do is only slightly fewer than their true maximimum (to increase the chances someone will bet them) AND smog in this particular town they just got off the plane in as a tourist, knocks pushup levels down by 30%. If so I could be a couch potato and never have read a bodybuilding magazine but could still clean up on these bets.

More to come.

[pig4bill]

Nah, you're wrong on a number of points. First of all, a lot of people invest for the long term, so any forecast of earnings more than a few quarters out is pure guesswork, even by the company itself. So some people are guessing or hoping for higher earnings than others for the next 2 or 3 or 5 years.

Additionally, people are guessing that different earnings multiples are what a stock is "worth". One guy may think 15 times EPS is right, another 17, and yet another 20. Who's right? None of them, all of them, it doesn't matter.

Some people are playing short-term movements. A stock catches an upgrade and momentum players may jump on it, hoping to take down a quick point. They push it over some technical barrier, and now the T/A guys jump on it. Have earnings or the company's prospects changed? No, but the stock moves nonetheless.

There are probably dozens of other examples why a stock may go up or down, yet "everyone knows" all the public information.

Also, it doesn't make sense to compare what Buffet does to what investors may do. He is not an investor in stocks, he is an investor of companies. Berkshire is not a mutual fund that counts on capital gains and dividends. It is a holding company. When he buys a company, the earnings are his, whether the stock (if it was trading) goes up or not. When he doesn't fully take over a company, he often buys a very large stake that permits him to have significant influence over how they operate. That's why comparing Berkshire's returns to mutual funds is stupid. A mutual fund can't invest in a company and get them to grow their earnings.

[DesertCat]

[ QUOTE ]

Also, it doesn't make sense to compare what Buffet does to what investors may do. He is not an investor in stocks, he is an investor of companies. Berkshire is not a mutual fund that counts on capital gains and dividends. It is a holding company. When he buys a company, the earnings are his, whether the stock (if it was trading) goes up or not. When he doesn't fully take over a company, he often buys a very large stake that permits him to have significant influence over how they operate. That's why comparing Berkshire's returns to mutual funds is stupid. A mutual fund can't invest in a company and get them to grow their earnings.

[/ QUOTE ]

Buffett has been an investor for over 50 years, during the bulk of that period he was primarily an investor in stocks, rarely bought companies, and was rarely on boards. As berkshire has grown enormously his public market investing opportunities have diminished and he's done many acquisitions in the last twenty years out of necessity. But from his perspective, buying a single share of a businesss isn't much different than buying all of the shares, both are investment decisions made on the same financial analysis. I.e. buying $500k worth of stock a public company has many similarities to buying a gas station for $500k, you want to know that the earnings power of what you are buying is reasonable in relation to what you are paying.

The only difference is in the latter scenario he gains control, and what does he do with that control? Almost nothing, he allows all 73 subs to run as fully independant entities identical to how they ran before. They send him monthly cash flow reports, thats the extent of his contact with most of them. HQ has 12 employees, all the subs combined have 112,000, he has very little time to spend with subs. He does dig in on the insurance business a bit, but I think that's it.

And his influence on boards has been hit or miss, he primarily provides sane capital allocation advice. I think he def. helped WPO, but KO already had rational policies in place when he got there. In fact being on the board at KO actually cost him billions, as he couldn't sell during the bubble because he was on the board, even though KO was clearly over valued. He's consistently talked about his inability to influence public companies from the board, esp. over CEO compensation issues, where it's to the point they won't put him on any compensation committee.

And BRK only gets dividends from public companies, it has to fully own it to control the excess cash flow. Buffett used to talk a lot about look through earnings, where he'd point out that he regarded the earnings per share of his public holdings as berkshires, even though the companies were reinvesting it. But he never had any control over it, and look through earnings are meaningless if the company is squandering them on ill conceived projects.

[Mr. Now]

David is actually very right. No fundamental analysis, no TA.

Just perceive some info-- an edge-- that others don't, and understand why the other guy (or the market crowd) will or will not take the other side of your bet. Empathize with them a little bit.



David, I know you greatly enjoy your lifestyle, it matches your preferences, and you have no interest in running a fund.

But you might consider advising one. That I think can be alot of fun for you and be very rewarding.

Ken Fisher manages many billions and wrote a book that is very much in agreement with your fundamental theorem. That title appears below.

Your FTI raises more topics-- such as how to correctly perceive an available edge. These edges are there, available to all, but clearly, not everyone perceives them. Such edgers are not 'insider info' per se. They are available to all who correctly perceive. That's an interesting sub topic to discuss.

The other interesting sub-topic here is the ability to know the other guy, or the crowd, well enough such that you know why they are taking the other side of your bet. The whole empathy thing.

Ken Fisher's 3 questions


"Fisher's three questions really grow out of a single central principle, and it's a principle I believe is the one and only source of investment success. It is that you aren't going to beat the market unless you possess some information that the rest of the market doesn't possess."


Article on 3 questions

[DesertCat]

[ QUOTE ]

Ken Fisher manages many billions and wrote a book that is very much in agreement with your fundamental theorem. That title appears below.

...

Ken Fisher's 3 questions


"Fisher's three questions really grow out of a single central principle, and it's a principle I believe is the one and only source of investment success. It is that you aren't going to beat the market unless you possess some information that the rest of the market doesn't possess."

Article on 3 questions

[/ QUOTE ]

[rant on]

Ken Fisher is a flaming self promoter riding on the coat-tails of a legendary father (Phillip A. Fisher) who wrote a truly great investing book ("Common Stocks and Uncommon Profits") and was the second greatest influence on Warren Buffett, just behind Ben Graham.

Ken, on the other hand, is cut from a different cloth. It's been widely reported that Ken Fisher's funds don't even beat the market. He has clients through an enormous volume of advertising to the naive. This book is just more PR to help pimp his funds. He has no credibility when discussing successful investing techniques.

[/rant off]

Sorry about that, but I just am sick and tired of getting those Ken Fisher direct mail pieces for the last decade cluttering up my mail box. I think anyone who ever subscribed to Forbes magazine is on his stupid list.

[yellowbastard]

[ QUOTE ]
In fact being on the board at KO actually cost him billions, as he couldn't sell during the bubble because he was on the board, even though KO was clearly over valued.

[/ QUOTE ]

I read that Buffett actually traded a bunch of shares of BRK in 1998 for GenRE and thus profited from Berksire's inflated stock portfolio at the time. It was a very interesting transaction. And all tax free if I remember correctly because the GenRE aquisition was treated as a merger.

[DesertCat]

[ QUOTE ]
[ QUOTE ]
In fact being on the board at KO actually cost him billions, as he couldn't sell during the bubble because he was on the board, even though KO was clearly over valued.

[/ QUOTE ]

I read that Buffett actually traded a bunch of shares of BRK in 1998 for GenRE and thus profited from Berksire's inflated stock portfolio at the time. It was a very interesting transaction. And all tax free if I remember correctly because the GenRE aquisition was treated as a merger.

[/ QUOTE ]

The main tax benefit of using stock for an acquisition (tax deferral) accrues to the seller, not the buyer, so I don't think taxes were a consideration for Buffett in this deal. But you are likely right that he was happy to trade what he regarded as overvalued (BRK) for something he thought was undervalued (GenRe). Note that he almost always pays cash in acquisitions because he usually regards BRK as undervalued or fairly valued and doesn't want dilution. But with GenRe he did his biggest deal ever and took on huge dilution to do it when he could have used cash, so it's pretty clear he thought BRK stock was overpriced.

But of course Gen Re was nothing but problems for years after the deal, and a big part of his weak performance since the deal. He always insists on keeping management in place,so he's been very good about sizing up potential managers and avoiding deals with bad ones. In this case he blew it as he was forced to make major changes with GenRe in pretty short order. If he had a do over, I doubt he'd do this deal again.

[Objectothis]

Ken Fisher does go way overboard on the marketing. Does that necessarily mean he's a poor investor?

I know his book Super Stocks was one of the first stock market books I read and it made a big impression on me.

These guys independently and consistently rate him as one of the best forecasters they follow:

"He has been clear and consistent with his guidance. His speculations about the magnitude and/or direction of future changes in the overall market are right about 72% of the time, a very good track record."
http://www.cxoadvisory.com/gurus/fisher/default.asp

[DesertCat]

[ QUOTE ]
Ken Fisher does go way overboard on the marketing. Does that necessarily mean he's a poor investor?

[/ QUOTE ]

No, the fact that his funds trail the market makes him a bad investor.


[ QUOTE ]

I know his book Super Stocks was one of the first stock market books I read and it made a big impression on me.


[/ QUOTE ]

Never read it, but I've read many investing books that had a big impression on me when I didn't know anything about investing. Now I realize most of them were worthless, or plain wrong. Can't tell you if his book is in or out of those categories.


[ QUOTE ]

These guys independently and consistently rate him as one of the best forecasters they follow:

"He has been clear and consistent with his guidance. His speculations about the magnitude and/or direction of future changes in the overall market are right about 72% of the time, a very good track record."
http://www.cxoadvisory.com/gurus/fisher/default.asp

[/ QUOTE ]

Nobody has a good track record forecasting the market over long periods. Not publicly, at least. The analysis you point to is short term (only 6 years) and can be very easily biased, or cheated. But most importantly, if his calls are so prescient, how come his funds aren't killing the market?

[Objectothis]

He could be a poor bottom-up investor and a good market timer. Or he could be good at both or horrible at both. It’s not easy to tease it out of the data.
A large % of the $40 billion+ of accounts that Fisher is running are with a balanced mandate. How does one say a balanced portfolio is outperforming or underperforming really? If the market goes up it will more than likely underperform and if the market goes down it will more than likely outperform. He used to claim (still does?) that in the long run he beats the market(I’d love to see the data he uses because if the long run is long enough, then it would be almost impossible to beat the market headsup with a balanced approach). But I'm sure the data can be massaged to make him look like a genius or an idiot.
I would disagree with the statement that no one has a good track record forecasting the market over long periods. But it’s almost impossible to prove. Most investors have their market timing exposure commingled with their investment picking exposure. So one that is considered a great investor may just be a great market timer via cash exposure, beta-tilting the portfolio etc and vice-versa.
And six years can be a lifetime if the sample size is high enough or nothing if it’s not. More than one hedge fund has computer algorithms that many times a day can certainly forecast where markets are going in the next few seconds and have been able to do that for many many years. Warren Buffet correctly sold everything 1970ish and bought everything 1974ish. Everyone goes on about how great his market timing was and that’s only two trades in a 5 year period. A casual look at the history of the Fisher comments shows he was bearish in early 2000, nailed the bottom in 2002 and has been bullish since then. So one could say it was very much Buffett-like. [img]/images/graemlins/smile.gif[/img] And if, adjusted for market exposures, he still underperformed the market then he could well be an extremely bad stock picker as his timing was spot on for that period at least.
So from all of the above I agree that it can’t really be proved that he’s a great timer. But it can’t really be proved he’s horrible either. And by one popular guru measure he’s done ok at it.
The only reason I’m defending him is that he has always been willing to public views that are often actually contrarian to the popular view makes him one of the few pundits I’ll at least check in on every several months.

Good point on the book. I do think it was a good book when it came out 25 years ago but it’s subpar now. Similar to my view on the Seth Klarman book “Margin of Safety” that goes for $1,000 on Ebay.

Sorry for the ramble.