Comment by valuearb | Hacker News Reader

Comment by valuearb | Hacker News Reader

Lots of investors understand how to value companies, far fewer actually apply it regularly. I'm always amused when some Wall Street advisor discusses a businesses cash flow and growth rate using terms from his valuation courses, then starts talking about market sentiment and concludes by analyzing it's chart.

It's like a physicist laying out the math perfectly for an orbital launch, but then starts analyzing launch times using Astrology.

Very, very few investors apply valuation methodologies so well they they become true value investors, the name is really a marketing label for most funds. One necessary part of being a value investor that Buffett harps on in his letters is psychology, the ability to avoid bias in order to make decisions and not undo them in a panic. He works really hard to insulate himself from irrational fears, and focus on known facts.

For example, he tries to never know what a company's stock trades at when he reads their annual reports and start making his own estimate of it's value. If it's a great company and it's trading for $100, he doesn't want to be subconsciously biased to raising his valuation estimate just to justify buying it.

There is a great story from his partnership days. His partners were told up front he'd never discuss what they were invested in, he didn't want anyone front-running his trades at hurting the partnerships results. But one day during a market tumble a partner rushes in and demands to know if Buffett had invested in certain stocks that had crumbled. Warren just buzzes his secretary, asks how much the partner's share was worth, and told her to write him a check for that amount, and told the guy you're out.

He wasn't going to panic. He wasn't going to let others try to panic him.

(disclaimer: I say this as someone who's has invested into Berkshire Hathaway)

Buffet's success is only partly his ability to value companies and buy them at good price. He is good at that, no doubt, but it's just half of the story.

The real genius is the way Buffet has structured his business to give him permanent advantage. The core of Berkshire Hathaway is the insurance business, GEICO and Berkshire Reinsurance. These companies are very profitable and generate huge cash inflow. This cash is cheaper compared to what other investors get trough financial sector. Especially when times are tough and money is tight. When other investors must sell something they own or get expensive loan, Buffet is drowning in cash and looking ways to spend it.

Someone who is just as good at valuing companies starts several percentage points behind Buffet when they scramble to finance their acquisition.

This is all true but before he structured his businesses this way, he ran a pure investment partnership for several years where his results were entirely due to his security-picking abilities (the aforementioned anecdote about returning the investor his money is from those days). He clobbered the Dow in those years too.

Buffett is an interesting case.

When he got going, people were mostly just buying what their broker told them to, which was some company the broker had heard about that morning on the elevator. There was such little information out there that his philosophy (buy and sell on fundamentals looking at various ratios) gave him a major advantage. This was Ben Graham and The Intelligent Investor, who Buffett studied under at Colombia, then worked with him.

I'd say Buffett's biggest innovation past that is realizing the role of management. He talks about it in various ways, but I think his main rule comes down to "avoid psychopaths in management; it's a fundamental people don't understand how to discount correctly." There's a lot to that, it turns out.

Then he got into insurance, as you say, to get lots of cheap cash to invest. Compare him to say, Jay Gold, who mostly got rich through stock manipulation or Michael Milken who got rich by inventing the junk bond (a "new" financial product) then went to jail.

Not many successful stock pickers out there; most rich finance people made it from commissions of some form or another, not market gains.

The world is different now though; Graham's methodologies are so beat to death at this point that there's no advantage to be had. Buffett's philosophies on the importance of the management team (not being psychopaths) still apply though.

No one follows Grahams methodologies because you can't raise money doing it. They pay lip service to it. Riches on wall street come from fees on other peoples money, something Buffett voluntarily gave up in the late 60s.

And as far as "avoid psychopaths in management" that's actually nearly opposite Buffett's real philosophy, which is "you want to own a business any fool can run, because sooner or later a fool will be running it". He looks for businesses with strong competitive barriers.

> No one follows Grahams methodologies because you can't raise money doing it.

Or because they're old and beat to death and don't work anymore? They used to work and that's where Buffett started.

> Riches on wall street come from fees on other peoples money

Yes, that's mostly true, which is what I said (I said, "most rich finance people made it from commissions of some form or another, not market gains.")

> And as far as "avoid psychopaths in management" that's actually nearly opposite Buffett's real philosophy,

No, it's really not.

> which is "you want to own a business any fool can run, because sooner or later a fool will be running it".

Didn't Peter Lynch say that? It's a good quote though; I've certainly used it. My favorite Buffett quote is "Risk comes from not knowing what you're doing."

Also "Long ago, Ben Graham taught me that 'Price is what you pay; value is what you get.' Whether we're talking about socks or stocks, I like buying quality merchandise when it is marked down"

The guy has said lots of interesting things and is worth learning more about if you're even tangentially interested in business and investing.

Relying on insurance is not without its risks as the former Lloyds names found out - all it takes is 2 or 3 black swan events and a lot of insurance companies could get wiped out

Buffett is very conservative with the insuring. He actually took over many of the problem positions of Lloyds at one point.

> then starts talking about market sentiment and concludes by analyzing it's chart

You summarise my experience of the financial industry well. If you haven't already, read "Where Are The Customer's Yachts" by Fred Schwed - very entertaining and funny, in a kind of sad way: https://www.amazon.com/Where-Are-Customers-Yachts-Street/dp/...

This is an interesting counterpoint:

http://brontecapital.blogspot.com.au/2017/01/valuation-and-i...

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