Loss, Profit, Method, Value, Performance

Investment Perspective – May 2018

“Neither the investing method nor the fundamentals of the business are right or wrong because the mood of the market is favourable or unfavourable toward the “stock”. That is because when you really think about it, “stocks” (shares) are all about the financials and the trading price, the share price…the cash up value. What matters more is the economics of the business” 

Peter Flannery

Berkshire Hathaway just reported a loss of $6.4 billion. 

What’s wrong!?

Nothing.

So how come making a loss is nothing to worry about?

The “bottom line” is that the $6.4 billion loss is the result of a change in accounting methodology required by listed operations in the US.  This accounting change means that Berkshire Hathaway must record market related swings in its investment portfolio within its quarterly results.  Almost all of that loss was due to the decline in the cash up value of publicly traded stocks that it owns. 

Here’s what really happened …

The insurance component earned $1.4 billion (up 121%), railroad earnings are up $1.1 billion (an increase of 37%), utilities and energy are up to $585 million (an increase of 17%) and financial products earned $374 million (up 23%). 

As you know, price and value are not the same thing for Value Investors. 

The funny thing is that those who are not Value Investors don’t recognise any difference between the trading price of a business listed on the share market and its intrinsic value.

Methodology matters

I recently read a share market trader promoting their services on the internet, claiming that averaging down is nothing more than a myth and to be avoided at all times.  The trader was saying that it was just silly putting good money after bad when the price of a listed company declines.  Better they said, to follow the trend.

Trading is all about trends and the idea being that you jump on the trend and “average up”. 

Sure, if I am following a trend then averaging up is something that works – if I’m a trader.  Of course it can also work if I am buying more of a growth business as the share price rises too.

This does not mean that when the price of a quality business declines for reasons that have little to do with the long term growth of that business that buying more of it is not a good idea.

At the risk of stating the obvious, for us as Value Investors, price and value are not the same thing. 

Buying good businesses offering long term growth is our game, especially when we can pick them up at favourable prices.  Favourable prices do not often exist when those prices are trading high and that business is highly popular.  Sure, the price can still go higher and sometimes when we delay buying we wish we hadn’t.

Good businesses continue to grow regardless of whether the market likes them or not in the short term – regardless of whether the price fluctuates in the short term.  When the price declines the value emerges and that’s just the way we like it as Value Investors.

The point here is that methodology is important.  If we say we are value investors, are adopting a specific methodology and then depart from our value discipline by investing like a trader, chances are that there is an investing problem right around the corner waiting for us.

Getting confused about what tactics to deploy is a big mistake that is often very costly for novice investors. 

Baffling to some… amusing to others

Recently Warren Buffett referred to crypto currencies as “rat poison squared”.

Charlie Munger who never says much at meetings said “Warren, I want you to know… that I dislike those crypto currencies even more than you do!”. 

Those that follow crypto currencies and like to speculate on them of course feel that Warren Buffett and Charlie Munger are just “crypto bashing old-timers who have lost touch”.  They just don’t understand …

Indeed, one commentator made the remarkable comment that he was baffled as to why Warren Buffett did not understand that crypto currencies have an intrinsic value!

Honestly …

Capital assets are totally different to commodities and currencies. 

A rental property generates rental income.  A large business listed on the share market generates profit or earnings.  The relationship between the income stream and the capital employed to generate that income creates the capital asset.

EXTRA FOR EXPERTS RIGHT HERE: The value of the asset is a function of those discounted cashflows over time.  You know, a dollar today is usually worth more than a dollar in 10 years’ time.  Therefore we discount the dollar we might get in 10 years’ time because there are risks that we can possibly foresee between now and then and there are risks that we may not foresee that could reduce the value of that dollar in the future if you see what I mean?

Gold is a great example of a commodity.  It’s “value” or intrinsic value if you like, is difficult if not  impossible to define and therefore does it actually have an intrinsic value?  What it’s worth is pretty much what someone will pay for it.  That is not intrinsic value.

Crypto currencies are similar and the story around them, whilst convincing and indeed very appealing to some, amounts to nothing short of speculation.

You will always read about the stories of those who made millions of dollars starting with very little money early and became very wealthy very quickly. 

That is because they are news. 

This is not standard operating procedure. 

It does not apply across the population.  It is not typical.  It is highly unusual – almost never happens.  When it does, it is mostly luck.  Last time I checked, luck is not a strategy.

Perhaps more importantly, there is virtually no certainty in it. 

The probability of success through speculation is limited. 

This does not mean that the exceptions to the rule cannot make significant and huge sums of money.  The reality is that it is just not that easy and not that common.

To get back to the crypto currency commentator who was baffled as to why Warren Buffett could not understand that crypto currencies did not have an intrinsic value … well what can I say? 

Crypto currencies are not capital assets.  It is not hard to work out who is baffled!

Anyway, I was amused.

“It ain’t what you don’t know that gets you into trouble.  It’s what you know for sure that just ain’t so.”

Howard Marks