Ray Zee, here's my question for you...

Ray,


As much as anyone, you are an advocate for buying stocks based on their P/E ratios. If 30-year bonds were trading at 5%, and the S&P 500 was trading at 5 times earnings, and earnings were growing at 10%, you would say buy, right? And Wildbill, you would say everybody should buy, right?


So, my question to Ray is how do you know how much to buy?


And my question to WildBill is, is there any price people shouldn't pay for indexes?


eLROY

so ill take a stab at a question i dont fully understand nor are qualified to answer but.--


if bonds are 5% thats the equal of a stock with a 20 to 1 p/e ratio. correct? that company is making 5% return. okay? thats why im against paying up for stocks with high p/e's.


now it doesnt matter what the s/p is trading for as its earnings are growing at 10%. so your earn over bonds is double. correct or am i off here.


so i would buy if i was willing to take the added stock risk for double the return, for more risk or volitivity(maybe just perceived).


thats why the stock market competes with fixed return things. if the yields are too low, and ratios get too high it becomes better to put your money in fixed returns.


as far as knowing how much to buy i dont know that as you may not buy any.


i use p/e to value a stocks current and its future worth. but most stocks are overpriced to their value. the proof is that when private companies are sold they sell for far less than public ones. thats also why many companies go public so that the owners can maximize their gains, as the public generally pays way too much. they do go public to raise expansion capital as well but thats another story for another day.

Ray -- when you say that private companies sell for far less than public ones, how are you making that comparison? For example, are you comparing companies with roughly the same revenues and profit margin? Doing the same kind of business? With the same prospects for survival and/or growth? ... Or if you're not, how are you making the comparison?


Also, are the guys that sell private companies for far less than public companies sell for idiots because they would make much much more by taking the company public?

yes based on the same earnings. not necessarily by size though. but alot of private companies cant take them public for alot of reasons. some is the cost, or financing, etc. many are not quite big enough to justify. and yes they may be dumb for not taking them public. but unless they are big enough they cant generate the interest in their shares or a listing other than like the pink sheets.


look at whats out there now. not many companies would really ever sell for the 30 or more times earnings that public companies trade at. as a general but lousy and approximate rule, most private businesses will sell for less than seven times earnings and most much less. i am making very general statements here.

Most obvious reason is that to be a successful public company you need to have two things. One is a "story". Why should an investor buy you? Companies have large investor relations budgets just to keep people up with this story. CFO's and CEO's tour the country and meet with investors daily for this reason. If you don't have a convincing story, you are going to pay for it with a low valuation. You can make good money, but if a competitor is perceived to have better growth rates or more dependable management, then you are going to lose the valuation game. Number two is that you need to have reliable management. This means when you tell Wall St. and the world something, you better live up to it. This has obviously gotten a lot of executives in trouble. Private companies don't have this concern, they just focus on being as profitable and successful as they want and they think they can handle. They don't make promises to anyone but themselves. However, should this company choose to go public, they have to change their thinking. Also it has negative valuation if the company is new and has unproven managers. The Street doesn't know if they will be reliable or not, they have no history. This is why spin-offs from established companies can tend to do better than IPO's that lack managers with a reputation. I read the survey about two years ago, it was about a 10% valuation difference. Problem is that this number is hard to say with certainty because you have to strip out a lot of details such as if the CFO was hired from a public company for this purpose, how much of the company's reputation is based on his performance at his other company and so forth. Bottom line, Ray is right there is a definite bias against private companies and their valuations, especially if they do eventually go public.


As for the question of paying for indexes, well its dependent on your view of future cash flow. Forget trailing EPS, that is about as useless a number that there is. Further I ignore EPS because EPS is a cooked number in far too many cases. If you read some analysts, they have gotten pretty keen on using DCF valuations for companies and that is the superior method. Estimate their net cash flow over a set period of time that you can make pretty good predictions about, say 5 years, and then assign a future growth rate past that and get a terminal valuation. That is a ton of work for indexes, certainly beyond the capability of an individual investor. Really its hard to put a specific price you should pay on a index for this reason. Still the lowering of interest rates and future inflation is crucial to increasing the value of all companies. Increasing productivity is even better for the indexes. These numbers, when they are positive, mean companies can add to their long-term growth rates fairly easily because their costs are close to flat, but their sales will increase as a function of the economy growing. From company to company, there can be fluctuations due to competition and product substitution, but over a broader index it tends to favor growth because the largest companies are generally gaining, not losing market share to smaller, non-index companies.

Ray, I'm pretty much in agreement with you. If someone has the opportunity to build and maintain a diversified portfolio of investments in privately held companies, they will almost certainly do very well compared to someone who buys and holds a diversified portfolio of publicly traded companies, over a sufficiently long investment horizon (say 10 to 30 years).

Publicly traded companies with exposure to private companies:


The insurance conglomerate Berkshire Hathaway BRK buys 'private' companies.


There are closed end funds with large positions in private companies, MVC EQS. There are also open end mutual funds that invest in private companies, but it seems insane for an open end mutual to so that (due to redemptions). EQS is the closest thing to what you described.


There are also finance companies PMC, PCC, DOLL ... that finance small businesses.


I own BRK PMC and DOLL.

berkshire hathaway for those that dont know is warren buffets fund. it has done wonderfully over time as buffet is one of the best. BUT--- he is old and his fund is priced dearly because of his leadership, so when he goes down so does his fund. dont be in it when that happens. heed this advice.

I think Warren is an old fool.He got lucky.Someone flips a coin ten times and guesses right ,that is Warren.He hit that end of the bell curve,nothing more.

I thought he was a "value investor" How

could he not sell Coke when it was in the $80.00 range.

Gimme a break.

his specialty is findng undervalued stuff. and he has done well with it. but also he buys so much stock when he believes he is right its hard for him to sell as the price plummets when the word is out so he needs to make a private sale in one fell swoop.

perhaps its time to short his fund.

Warren never sells anything unless he thinks their business model has changed in a way he doesn't approve of. Since Coke really hasn't changed its formula over the years how can you expect him to sell? Warren's methods aren't for everyone, that is for sure, but you can't argue with success. I don't think he has been lucky at all, just savvy enough to understand business models and trends that will emerge over time. Put another way, Warren is more than willing to wait for that long run that few do as far as investing in individual names goes. The antithesis of your trading style Dr. Bill, thats all.


I do agree though, if he were to retire or pass away the stock will take some hits and may never live up to its potential. The one thing against it now is that it has gotten so valuable and big, the bets it needs to make to continue its success have gone up to the point where its hard to see it growing that much. This plays out just like what happened with Peter Lynch. A very similar type of investor, he finally got to the point where he just moved the market on his own too much and in that scenario your sells get magnified and your buys don't matter unless you take significant stakes in companies.

"I think Warren is an old fool."

He's not that old, and not that much of a fool. Also note that although Buffett is the front man, BRK is run by two individuals Warren Buffett and Charles Munger. Both are responsible for important decisions.


"Someone flips a coin ten times and guesses right ,that is Warren.He hit that end of the bell curve,nothing more."


Would you say the same thing about Stuart Unger?How many times would someone have to guess the outcome of your coin flipping experiment before you would say they were not just lucky? Separating luck from skill is a hard thing to do, Buffett has been lucky since the mid 1960's. Will he be lucky in the future?


"I thought he was a "value investor" How

could he not sell Coke when it was in the $80.00 range."


BRK owns about 15% of KO. It would not be possible for Buffett to unload that much stock, even over a long period of time. Look at Janus trying to deal with redemptions. The other issue is that the large holding in KO gives BRK control of the board, an advantage not reflected in the price of a single share. Also note that if the dollar collapses in value KO may seem like a good investment again.

I never watched Ungar in action so I would rather not comment.But Warren is different.Why do you make excuses for him.

Think about what you said,he can't sell KO because he owns too much.First off he could have sold some.Secondly does that mean he can never get out?What happens when KO no longer fits his

model(like it probably didn't at 80 bucks)?

If he can't get out why did he buy that much, didn't he know he would have a problem?

If he owns a lot because the stock split he could have sold some as his stake grew.

Sorry..I may be wrong but I think the old coot just got lucky.It should only happen to us!!!


And one last thing,maybe it was his partner who made the right moves.

Ok Dr. Bill, so you are saying Warren should have sold just about everything when the market was at its top? Warren is doing just fine, he keeps his shareholders happy. Don't forget that, he isn't an investor as much as he is the leader of a publicly traded company. That must not be forgotten. He has people buying his stock because they want him invested in the market and making the types of picks he makes. Those investors are comfortable with his style and he obliges them. He is not there to trade his portfolio like you are for that is not his job. It is easy to forget this because people call him the best investor and all that, but Warren is not one to forget who is employing him and what their mandate is to him.

All of what you say may be true..but it doesn't anwer my question.If Warren had NO position in KO

would he have bought it when it was trading at 80 bucks? Of course not,he is a value investor and the P/E was thru the roof.And yet he did not sell.

You refer to Warrens style and the fact that he must appease his investors.KO at 80 ain't his style.

Should he have sold stocks at the top..of course not, just the ones that were ridiculously priced

like KO.He is not a "value investor".He is lucky.

Buffet a fool? The guy is basically the greatest investor ever. His track record is unmatched.


I don't think your analogy with the coin flip applies here. His return vs. the market is statistically significant. He may have missed the tech boom but if he were 30 years younger I would bet on him again. As said though...he's too old now for someone to invest comfortably and his stock is overpriced because of his legend.


Since when does not selling one stock in a huge portfolio at the top make you stupid? He's never really been just a "value" investor. Plenty of his insurance plays were based on growth. The guy was just good.

The greatest investor ever? Not even close.Sir,

I have worked with people who are so superior

to Buffet you just can't imagine.I will give you one example.I worked for a ML in Chicago doing

currency arbitrage.ML was an incredible spreader

in the currency market and interest rate markets.

Of the 100s of positions he took over the 4 years I worked with him there was not one loser.I know you won't believe it but I don't care.NOT ONE LOSER.In addition during the late 70's he called me upstairs from the trading floor and said Get on the phones we have reached the peak in interest rates and I am going long bonds by buying AAA Tax Free.I said "ML How do you know we have peaked"He showed me some formula he had worked out that involved Eurodollars and other instruments.He was salivating..going this is it,

this is the top.I won't have to pay taxes on these

babies!!!He picked the top to the day!!!!

Believe it or not,he had two brothers who were as good or better traders then him.

Please don't tell me about Buffet.The number of decisions he has made have no statistical value.

A coin toss for sure.And by the way he should have dumped Coke!!

... If Buffett lives his current expected lifespan, he will reach 12 figures.

He didnt make that type of money.Don't you mean the value of his holdings or stocks.Big deal,go buy Berkshire if you think he is so smart.Pay a ridiculous premium because Mr.Lucky was involved.

He was too lazy to even research the internet when

it became important.

"He is not a "value investor".He is lucky."


Lucky describes people who go into a casino with $500 and come out of it with $5000. Buffett started with close to nothing and became a billionaire. Perhaps really extremely consistantly lucky?


As to the value investor part maybe you are right, perhaps the correct word is capitalist? Actually BRK is not an investment vehicle, it is an insurance company. Buffett describes his own activities as allocating capital.


As to KO one question is whether the value of a holding increases faster or slower than it's size.


For example:

BRK owns 200 millon shares of KO. Is that more valuable than, equal to, or less valuale than 200 million times owning one share of KO.


Another question was buying KO a good idea at the time. Compare KO to the S&P:


http://finance.yahoo.com/q?d=c&c=&k=c1&t=my&s=ko&a=v&p=s&l=on&z=m&q=l&x=on


Also note that KO paid more dividends than the S&P. BRK also has a significant unrealized cap gain on which taxes would be due if BRK sold any KO. A disadvantage of the buy and hold strategy is that your tax basis gets very low.

I wasn't trying to say Buffett was better than your acquaintance ML, so let me rephrase. First of all, I'm definitely astonished by ML's success rate that you've reported, no matter what asset level he was trading. So I'm very interested to know how high he's been able to scale that edge. I mentioned the figures on Buffett because I'd be especially impressed if ML's scaled up to that territory. It seems like most traders reach a plateau at 10 figures or below.

I just ask why didn't he? Were his 100s of trades yielding a couple bucks a pop? If you hit 100 trades in a row, you should be playing with a seriously fat BR. I don't care what you trade and how much you start with, futures trading is so heavily leveraged that you have to make a lot of money if you even pick 80% winners and put stops in place. Maybe ML was so obsessed with winning trades that he took unnecessary risks? Who knows, all I know is that it is true, if you hit that kind of percentage you should be calling up Bill Gates for computer advice and talking to George Soros about where to donate your charity this year.

Regarding ML win rate.First you need to understand the times.Late 70s and early 80s.ML

was ahead of his time.He understood spreads in currencies better than the banks.We did currency arbitrage on the floor of the IMM.We had over a billion dollars in credit lines with various banks.ML would examine say the Swiss

Franc 2 month forward vs the 5 month forward.He would then buy or sell that spread in big numbers.

He was never wrong.When then Peso was devalued in the 70s one of the big banks asked him to come to trade out of the banks losing position.

The man was incredible.I can't tell you what type of income ML generated long term because I left the firm after a few years.(the arbitrage generated 35M my last year)But he and his brothers were incredible.We use to have a poker

game in the office Wednesday nights.

One night we went into one of the other brothers

"book".He was a local in the pork bellies.

On average he made 10k a day with one losing session every 10 days of about 3 or 4 k tops.

This book covered over a nine month period.

Anyway,I don't mean to belittle Buffet but I think

the number of decisions he has made are subject

to the "coin toss" analogy.I know that is not true of ML and family.

Buffett has been lucky in some ways, but I think there is certainly talent there. You have to give him credit for the incredibly smart idea of getting into Berkshire in the first place just as the best structure for an investment vehicle. Then you have to give him credit for being able to move such huge sums of money without pricing himself out. Also remember that its tough investing when you become a significant, if not controlling owner of the company. Its one thing to like management and its model, but its another to suddenly be the one choosing management and its model. Of course Warren stays out of that almost all the time, but its still something not many could do. That is akin to you or I going out and buying say a local store that is struggling and not quite living up to its potential. Almost every time we would go in there and clean house, get new management in or at least tell them to try new things. Instead Warren just tells them keep doing what you are doing and just send me your financials when you are done. And if you want my advice or help of our experts, here is my number. Not too many people have that kind of self-control but to Warren its second nature.

So he made 2.5MM a year trading huge volumes. Listen, I'm not trying to downplay how good this guy was. But just because "your buddy" was a good trader doesn't make him a better investor than Buffet. The proof is in his net worth...despite the fact that his stock has a valuation premium. The guy is still just plain good. I think him staying out of the Internet stocks ended up a solid play by the way.

The 2.5MM you refer too was not ML but one of the brothers(the weakest trader).It is an amazing feat to win 10 out of 11 sessions,month after month.

ML made considerably more.One man,no research assisitants etc.We traded with the biggest banks in the world.ML "picked them off" all the time.

They had teams of players and analysts and all the trappings.

Sorry no comparison between ML and Buffet.

Well...Buffett is still much richer. Even without his "guru" premium. A great trader is not a great investor in my book.


We'll have to agree to disagree.

I agree.But ML was an investor as well .I know he

bought triple A tax free bonds at the height of the interest rate peak(1979?)and those made a fortune.I also know he loaded up on stocks back then also but which ones I couldn't say.But I would make the following bet.I have not been in touch since I left Chicago in about 1982.But I spoke to his brother when the S&P was about 650.

I asked what he thought and he said he expected to

see it over 1000 and perhaps double.I think this was in about 1997.I thought he was nuts.

I am telling you this group was blessed.

Almost like the Producers.They bought some race horses for tax purposes.I don't need to tell you what happened.Win,Win!!I know they bought part of a major league baseball team and it made it to the playoffs.

They invested as well as traded.

pffs that year.