Improving On Buffett And Desert Cat

[Yoshi63]

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You're correct in that the way I explained my response was bad, and probably flat out wrong.

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If $50 in cash can buy $80IV and $80IV is more valuable than $70IV, then $50 is worth more than $70IV.

It's simple economics. When you can have A or B and you choose A, you're expressing a view that A is more valuable than B.

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Still, I don't believe this is good reasoning. $50 cash is only worth more than $70IV BECAUSE you can find $80IV elsewhere. If you had no access to any markets to invest, then $50 cash would only be worth $50.

Here's an example of what you're saying: It's as if you visit a garage sale, find an antique piece worth $1000 selling for $5, and are uncertain if you should buy it. You reason with yourself that the $5 cash equals the $1000 antique, thus the $1000 antique is only worth $5 (despite being able to return much higher).

I'm not sure if I explained that well, but I think the point is that when a value exists, simple economics don't apply as you described.

[CrushinFelt]

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Perhaps I'll zoom in...

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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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Nope doesn't anwer his question or mine.

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holy [censored]

[Mark1808]

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Perhaps I'll zoom in...

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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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Nope doesn't anwer his question or mine.

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Basically you are asking yourself why a stock is priced at $40 when you think it is worth $80. The market generally does a good job of valuing companies, why are informed investors selling this stock at a price so far below what you think it is worth? Do they know something about the current or future prospects for the company that you don't? You should seek to understand why informed market participants have such a widely differant idea as to value as you do because on average they are usually very good at valuing companies.

[PairTheBoard]

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DS -
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.


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PTB -
Unnecessary for what? Unnecessary for who's goals, yours or his? You don't make your argument correct by invoking magical phrases like, "Amen", "Right on", or "It's pure logic". Let's suppose that, as you say, your theory is not true and your technique is unnecessary. Why does this imply that DC's strategy of only buying bargains at 50% discount to Instrinsic Value is by "pure logic" now obviously too conservative? You use the phrase 50% "cushion". "Cushion" is not the idea. The idea is to do research to find the best bargains possible without insisting on such rare super bargains that you can't find them often enough to put your money to work adequately.

You have to decide on some cutoff point which you think is optimal. DessertCat has settled on buying bargains at a 50% discount. There's no reason why supposing your theory is untrue should imply a change in the optimality of that cutoff point.

If buying at 40% discounts to DC's evaluation of intrinsic value amounts to pulling the cash trigger too fast and missing out on the adequately plentiful 50% discounts that a little more patience and research will uncover then supposing your theory to be untrue does not change that fact. Your Pure Logic is Pure Baloney in this case.

PairTheBoard

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CF -
The 50% number isn't an arbitrary number set by DC that is meant to say, "I want a minimum 50% return on my investments." I believe it is a cushion that is used to protect himself from variance.

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That doesn't appear to be how DessertCat sees it in his response here:
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What some arguing against David are missing, however, is the following. If Stock X is trading at $50 and you estimate its "value" to be $70. But say, your threshold for buying is such that you'd only buy X if it traded at $45. Then it's entirely disingenuous to say that you think X is worth $70, because by your own action, you'd rather have $50 than a share of X. Clearly it's not worth $70 to yourself.

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DessertCat -
No you are saying you think it offers market returns if purchased at $70. You don't buy it at $50 because you want higher returns than even $50 offers. You feel at $45 it offers such a high enough potential return and a large enough margin of safety.

The key to successful investing is having the patience to wait for situations that offer higher returns with less risk. If you lower your standards to the market's, you can't expect to do any better than it.


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That sounds much more like what I am saying. DC looks for bargains selling at a discount to Intrinsic Value as he evaluates IV, independent of market price. The term "cushion" is being used by Sklansky to bias the argument in his favor. It's not a "cushion" to protect against variance. It's a discount measuring the size of the bargain. As DC explains above, you don't want to settle for lesser bargains when you believe a little patience can uncover better ones.

My post was only addressing the particuliar argument Sklansky makes above, which he says is so obvious as to simply follow from "pure logic". If you look closely at it you should see that it's really no argument at all.


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CF -
What DS is trying to say is that there needn't be such a large cushion if you can more accurately determine which of the investments is more likely to do well, which his "accounting for the other side of the market" is meant to do. The misleading thing about the title of this thread is the fact I can guarantee there's zero chance that successful FAs take this into account at least somewhat.

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I realize that's his main argument but that's not the one I was responding to above. I think DC responds to it well here:

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I think we are arguing over whether I should use price as a signal to alert me that my valuation may be incomplete, or whether I should use the market price directly in my valuation. I can't just average in the market price. I can't even adjust how I weight my risks (that's done rationally with the best information at hand). But I can review the risks of the investment to see if I missed an important risk that I didn't weight at all.


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David's main argument is really pretty simple. He says that if you apply his fundamental theorem of investing

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DS -
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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and combine it with value investing principles you should be able to reduce the discount DessertCat refers to here:

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DC -
2) You need to buy at a substantial discount to that IV estimate, your margin of safety, to protect against mistakes.


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That's Sklansky's main point. He supports that position with the futher argument that if his Theorem is not applied then the IV arrived at by DesertCat should be adjusted automatically toward the market price. That's essentially a corrollary to his theorem. This whole thread then is really just a referendum on Sklansky's Fundamental Theorem of Investing. Does it really have any merit?

Here's the thing. In order to apply Sklansky's Theorem you have to engage in a lot of guesswork. The Value Investor is trying to minimize his guesswork and apply hard analysis to the objective data that makes up his fundamental analysis of intrinsic value. Why should he change his evaluation of intrinsic value based on objective evidence according to guesswork about reasons for the market's mispricing of the stock? It's on Sklansky to make the case for doing that and I've not seen him make such a case.

His fundamental theorem is really more of an Axiom per Sklansky. Maybe it sounds good to him in theory but in practice I suspect it is close to impossible to achieve with any kind of consistency. You see the talking heads on CNBC trying to do it all the time and they are like a room full of people sitting in a circle all pointing in different directions. The reasons they give today are quickly forgotten tomorrow.

Maybe there are cases when an individual has such special insight into special circumstances where he can profitably apply Sklansky's Theorem. But I suspect such cases are so infrequent that to burden the Value Investor with that task of guesswork in the general cases where his fundamental analysis works quite well in discovering stocks selling at substantial discounts to intrinsic value for whatever the possibly unknowable reasons for the market irrationality, is in my opinion a distraction rather than an aid to the value investor's program.

PairTheBoard

[stephenNUTS]

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His fundamental theorem is really more of an Axiom per Sklansky. Maybe it sounds good to him in theory but in practice I suspect it is close to impossible to achieve with any kind of consistency. You see the talking heads on CNBC trying to do it all the time and they are like a room full of IDIOTS sitting in a circle all pointing in different directions. The reasons they give today are quickly forgotten tomorrow.


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NH sir [img]/images/graemlins/cool.gif[/img]

[Phone Booth]

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Phone Booth-
You're correct in that the way I explained my response was bad, and probably flat out wrong.

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If $50 in cash can buy $80IV and $80IV is more valuable than $70IV, then $50 is worth more than $70IV.

It's simple economics. When you can have A or B and you choose A, you're expressing a view that A is more valuable than B.

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Still, I don't believe this is good reasoning. $50 cash is only worth more than $70IV BECAUSE you can find $80IV elsewhere. If you had no access to any markets to invest, then $50 cash would only be worth $50.


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But that's always true with cash - it's only valuable to the extent that it can be used to buy tangible things.

What I'm really saying is that when a rational long-term value investor says that X is really worth $70 but I won't buy it at $50 he generally means this: if you use the general discount rate that the market requires for an investment of this type (either as sum of parts or as a whole) you end up with the present value of $70. However, since if you discount the returns using his own required return, the present value is below $50. So he thinks it should be worth $70 to other people, but it's not worth $50 to him.

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Here's an example of what you're saying: It's as if you visit a garage sale, find an antique piece worth $1000 selling for $5, and are uncertain if you should buy it. You reason with yourself that the $5 cash equals the $1000 antique, thus the $1000 antique is only worth $5 (despite being able to return much higher).


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Not sure if I follow. If you think antique > $5, then you buy. If not, you don't. It's clear that the seller doesn't think it's worth $5 to him, if that's what you mean.