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.