Hacker News Reader

I think investors over the past year have grown so accustomed to something new and shiny and revolutionary coming every week to get excited about that they've forgotten that making money in markets successfully is about a long term focus and a LOT of boring details and unsexy businesses.

I, like a lot of people LOVE trading stocks and derivatives, and trying to beat the market -- more so as a hobby and as an opportunity to learn more about the more esoteric components of financial markets and how things operate. I've been doing it for over 15 years and I've paid my dues in terrible trades, and seen some great plays work out. The process of options pricing, managing ex-dividend dates and options, derivatives plays, trading styles like position and swing etc all are enormously fun to learn the nuances of. It's a fascinating world.

At the same time, the vast majority of the money that I save for retirement is your standard run of the mill dollar cost aversaging (DCA) into targeted funds based on my risk tolerance, age, and retirement objectives. Really boring stuff that works over 20 years, not 3 months.

Buffet is one of those guys that gets less sexy when volatility is increased, and more realistic when things are boring and people are licking their wounds.

Berkshire is going to be just fine. And they're doing just fine.

Investing and poker have some fun commonalities. One that I want to focus one in this particular case is: always play the game you know well and know how you're going to win it [nuances, 0]

In Poker: find the fish, understand why they're fish and exploit it [example, 1].

In investing: find underpriced assets, understand why they're underpriced and exploit it [examples, 2, 3].

From this perspective, Buffett doesn't understand how price movement works in tech companies.

And that's ok.

[0] You can't win everything of course, but if you're going to play a losing game by default then you're basically buying information. Once you have enough information, then it's all about execution. I daresay that Warren Buffett has enough information on a particular method of successful investing. That's all he needs, so he needs to focus on games that he knows how to win.

[1] E.g. through math/theory or math/data -- if you can get your hands on it -- (random player vs tight aggressive player)

[2] E.g. through math/theory or math/data (population will grow to 11 Billion --> economic productivity will therefore grow because bigger global work force --> world economy will grow in the long-term)

[3] Buffett's famous example is of course his own brand of value investing. The central thesis of value investing is: if a company is going to close shop, the scrap value of that company will be higher than the market cap of that company. There's a lot more to it, but that's the gist of it. One nuance, for example, is that you then try to pick the companies that are the most severely underpriced, have amazing management and a solid competitive domination strategy (e.g. crazy brand recognition or a certain asset that has a really high barrier of entry).

Obligatory Buffett paraphase: there are no called strikes in investing (ie if you choose not to swing at an opportunity, that then turns out to be good, nobody penalizes you)

As much of Berkshire's success has been based on limiting losses as pushing successes. "Buffett declines to invest in company" is a less sexy headline than "Buffett buys large stake in X" though.

Maybe Buffett's old. Maybe Berkshire is played out. Maybe they miscalled the pandemic churn. Or maybe the market is just so screwed up now that they're declining to swing.

I believe Berkshire has always been a macro-trend company? If we're looking for someone who traded in and out of pandemic dips and bubbles, that's very much not-Berkshire.

Buffett has always said he ignores the macro stuff and just focuses on acquiring great businesses.

He did dump airline stocks at the start of the pandemic on the basis that their business wasn't going to do great for a while.

Your point 3, a la Graham-Dodd, is how Buffett started. But later he realized that did not scale when you own businesses forever instead of trading them. Buying a whole dollar for 50 cents is great if you can quickly sell it for 75. Not so much if you hold it forever and it does not grow. So basically acquiring Berkshire Hathaway the textile maker on the cheap was an investment mistake that he acknowledged in his annual letters.

Price movement is not relevant if your stated goal is to hold the business and earn an income from its operations. Technology eventually becomes obsolete or commoditized.

>From this perspective, Buffett doesn't understand how price movement works in tech companies.

For someone who allegedly doesn't understand that the recent $89bn gain on Apple stock is nice going. Luck perhaps?

Incidentally he's also talked about poker as a model for investing. After telling the Mr Market story in the 1987 letter he goes on:

>But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence. Indeed, if you aren't certain that you understand and can value your business far better than Mr. Market, you don't belong in the game. As they say in poker, "If you've been in the game 30 minutes and you don't know who the patsy is, you're the patsy."

> For someone who allegedly doesn't understand that the recent $89bn gain on Apple stock is nice going. Luck perhaps

From an investor point of view, you can't categorize companies as one label. You can categorize companies as tags. This is because every perspective that allows you to give you an edge and make money in a fairly reliable manner is a valid perspective.

Apple can be seen as a consumer/physical product company. Warren knows a lot about consumer behavior and branding. If he finds from that perspective that Apple is underpriced, then he can still make a bet while having a limited understanding of the technology by simply saying: a laptop is a laptop, it allows you to do laptop things (i.e. they're interchangeable), but Apple has an amazing brand like Coca Cola.

Of course, this isn't fully true (e.g. Windows enables different things than Apple in some cases like gaming) but combining it with superior knowledge in branding, it's good enough to make a bet.

> The central thesis of value investing is: if a company is going to close shop, the scrap value of that company will be higher than the market cap of that company. There's a lot more to it, but that's the gist of it.

There's enough "more to it", to make this statement incorrect.

You're describing Graham's style of value investing, Buffet's style is significantly different.

In fact the term "value investing" has now a very loose definition, since so many different styles are grouped under this term.

I'd say this is the most appropriate definition: "Investment is most intelligent when it is most businesslike" (straight from the Intelligent Investor).

In other terms, any type of investing that's not based on speculation is value investing.

While I'm also somewhat disappointed he doesn't discuss important topics as much as he used too, I think there are some hidden gems in this letter - especially this one:

"Investing illusions can continue for a surprisingly long time. Wall Street loves the fees that deal-making generates, and the press loves the stories that colorful promoters provide. At a point, also, the soaring price of a promoted stock can itself become the “proof” that an illusion is reality.

Eventually, of course, the party ends, and many business “emperors” are found to have no clothes. Financial history is replete with the names of famous conglomerateurs who were initially lionized as business geniuses by journalists, analysts and investment bankers, but whose creations ended up as business junkyards."

He is using the example of conglomerates, but to me, it sounds like a warning about current valuations.

Regarding his investing performance, I think we should never judge his N last years - he's definitely looking longer term (which is amazing, given his advanced age). Berkshire is sitting on a huge pile of money, waiting for the bubble to pop. It may take a year, maybe 5, maybe even 10 - nobody knows. But when it does, we can safely bet that Buffett will put this money to work - and secure exceptional returns for the following 10-20 years.

> seemingly unconditional refusal to explore technology companies

Don't forget they bought a truckload of IBM in 2015, leaving everyone scratching their heads. Probably lots of IBM'ers on here with better insight, but from the outside it appeared they were pooping where they slept: selling off hardware units, dabbling badly in cloud, offshoring key consulting operations and in general hurting their brand. Of course Berkshire sold it all in 2018 and bought more Apple.

Please tell me they didn't think IBM was a consumer company, as an alternate play to Apple in the same space as Apple? Right now it seems to be a poor services company.

Warren has addressed not investing in tech. Automobiles were a major tech advancement, but car companies always have struggled. Airplanes were also a major advancement but always struggled. A top technology company can usurped by a new company with better tech. Facebook is faddish, requires acquisitions of Instagram and Whatsapp to stay on top, but that not Warren’s idea of creating value.

Automobiles and airlines have always had slim margins and are slow to grow. It shouldn’t take a Warren Buffett to see the differences between this old technology advancement and more recent ones (from an investment perspective).

> While I'm not of these meme investors who thinks Buffett is "washed up", I confess that I've increasingly wondered if it's just sorta over. In some sense, it's not his fault.

I also think that value investing has been 'automated away' to a certain extent such that him doing it (with staff help) no longer can compete with other market players.

> Berkshire has grown so large that it has significant scale problems.

This topic has actually been studied: (mutual) fund performance of top performing funds can be based on a manager's skill, but after a certain point that skill reaches the end of the runway. The more skilled the manager, the larger the AUM they can still get returns for, but at some point it's just too much.

> For an average fund in the cross-section, we estimate a drop in alpha of 20 basis points if the fund doubles its size over one year. We also find a non-negligible impact of the size of the fund industry, although its magnitude is significantly smaller than the impact of individual fund scale. We reconcile our findings with existing empirical studies. Taken as a whole, our results lend considerable support to theoretical models that build on the premise of decreasing return to scale for active portfolio management.

* https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2872385

Discussed in the Rational Reminder podcast:

* https://rationalreminder.ca/podcast/136 (~15m30)

* https://www.youtube.com/watch?v=LhluPwDaNAQ&t=18m30s

Something to consider for anyone piling into (e.g.) ARK:

* https://awealthofcommonsense.com/2020/12/a-short-history-of-...

> The seemingly unconditional refusal to explore technology companies. ... The allowing of the two new managers to keep breaking Berkshire's rules

If you think they are stagnating with their current mindset, then shouldn't breaking their existing rules be a good thing?

The original comment is pretty entertaining. The commentator assumes that they better understand business than the two men with the best record in recent American history. Buffet continues to follow his general principles very well of buying great businesses for reasonable prices and holding pretty much forever. Not following BS trends and buying wildly overpriced tech stocks like Zoom, Zillow, or meme stocks like Gamestop or AMC is a huge plus in most value investors minds.

That's a fair point. Let me clarify by saying that the IPO's and airlines were two things that Buffett was repeatedly adamant and proud about over many years. These were more hard and fast rules.

The tech thing is different, that was more Buffett just admitting it was outside his area of expertise. I think it's been especially confounding since Buffett has for a long time professed a deep admiration for Bezos and Amazon, yet never really acted on it.

I think not investing in technology was a sort of inflection point for buffet. His mantra was to understand what he was investing in, and he didn't understand most tech markets. Tech markets got too big to sit out.

5 of the top 10 most profitable companies are technology companies. The rest are financial firms (BRK is actually the most profitable). Most of these tech companies' value is related to network effects, platform control and such. These are "moats" that WB doesn't understand.

So yeah... I think times overtook the man. The space he was operating in shrank. That said, BRK is still doing fine, well run, etc. They also impact the world in ways a vanguard or softbank don't.

I'd say he broke his own game of investing, rather than the game in general.

Given what he thinks he understand there's not enough opportunities to allocate this amount of capital.

I guess that's why he hired the two new managers. By the way they did come up with some of the best ideas in recent years like Apple and Snowflake.

> best ideas in recent years like Apple and Snowflake.

Are these really the best ideas. Bought apple only couple of years ago, snowflake was arguably the most hyped stock of all time. I don't see what the insight was here.

They are certainly very successful ideas in terms of outcomes. Apple went up more than 3X since he bought it in 2016.

Fair enough. But if his letters are not so insightful anymore, whose are?

In the last few years I've enjoyed reading letters (Annual Reports as they call it) written by Frank Martin of Martin Capital Management LLC.

https://www.mcmadvisors.com/newsmaterials/

It's a different kind of stuff but I find Jeremy Grantham pretty insightful. Grantham does more overall market levels rather than individual stocks, Buffett the reverse. Here's a recent one https://www.gmo.com/americas/research-library/waiting-for-th... on how things are a bit pricey now. Though he's not a perma bear - this is one he put out saying things were cheap almost exactly at the 2009 bottom https://www.gmo.com/americas/research-library/reinvesting-wh... Grantham is mostly retired but has popped up recently to comment on the current situation. He's on youtube a bit too if you google.

Well, the guy is 90. He's doing pretty well considering.

> In some sense, it's not his fault. Berkshire has grown so large that it has significant scale problems.

I hear this often that berkshire isn't what it used to be because of 'scale'. What does this even mean. At what point does it become too big. Is there a general logic that after X billion $$, investment firms become inefficient?

If you have one billion dollars and find a $100 million opportunity, you have an ROI of 10%. If you have one hundred billion dollars and find a $100 million opportunity, you have an ROI of 0.1%. He needs to search for very large opportunities to attain a good return because he has so much capital. This is why some funds return money to investors if they get too big--it's very difficult to generate returns with that much money.

> If you have one hundred billion dollars and find a $100 million opportunity

Why would they always be finding one opportunity. Can't they find 100 $100 million opportunities. Why doesn't "finding opportunists" model scale ?

Because the market is finite in size, so nothing can outperform the market forever. It's the same thing as a company not being able to grow faster than the economy forever.

>Because the market is finite in size

How though? How can the market stay a same size while berkshire size went from 1 billion to 100 billion. Where is 100 fold investment coming in if the market stays at a constant size. That doesn't compute. Why wouldn't the market also expand at like the investments.

I didn't say the same size, I said finite size.

If the market grows at a rate of 6% and your company is growing at 8%, then your company will eventually slow down to 6% or else the market will speed up to 8%, but in neither situation will you "outperform" the market forever.

In the case of Buffet, Berkshire Hathaway has about $800 billion in assets under management. If the market size is 50 Trillion, and let's say that 10% of that consists of reliably undervalued companies then the size of the market for companies that Berkshire can buy is 5 Trillion. This market will grow at 6%, if you think Berkshire can have 8% returns, then it will own half of all undervalued companies in 63 years, 2/3 of all undervalued companies in 78 years, and all undervalued companies in 100 years. But of course Buffet can't find 100% of all undervalued companies and there are other people also trying to find them.

And of course each individual company that Buffet buys will itself stop making above average returns as it itself grows, and therefore every year, the returns on the companies in Buffet's own portfolio will go closer to the market average even as new undervalued companies are harder to find. Thus the overall return of Buffet's fund will be dragged down to the market return much sooner than the theoretical limits I outlined above.

> I didn't say the same size, I said finite size.

Not sure how you are defining "market". How is it finite size? What is the number after which it stops growing?

> If the market grows at a rate of 6% and your company is growing at 8%

Total market valuation of Dow has grown at faster pace than Berkshire portfolio size. your 6% , 8% example doesn't hold at all. Not sure where you got your your "market size" numbers from. Did you do an actual analysis of market size growth or are you just pulling these theories out of thin air.

You are assuming that there is no such thing as a "rate" of growth. Things are either growing or not. Thus if the market is "growing" at 6%, then it's OK for a member of the market to double in size every year because both are "growing" and aren't "fixed".

Numbers matter here, you cannot have one member of the market grow at a faster rate than the market forever.

Not sure what else I can do to explain this more clearly. Try using a spreadsheet or calculator to work out some examples for yourself.

> Total market valuation of Dow has grown at faster pace than Berkshire portfolio size. your 6% , 8% example doesn't hold at all.

Right because Berkshire stopped overperforming. In fact it has been underperforming the last 10 years, and Buffet was trying to explain why. https://investorplace.com/2020/10/berkshire-hathaway-stock-u...

But what what I was doing was explaining a counterfactual to show why every firm must stop outperforming. It's not just Berkshire, or 6%, 8%.

So I ran some numbers to explain to you how if A is part of B than the compound growth rare of A cannot forever be greater than the compound growth rate of B.

(Please do not reply to this comment with an argument that you are not talking about any stock called "A" and "B", just as the 6/8 seems to have tripped you up)

Berkshire is part of the market, thus it cannot outperform the market forever. In fact you expect reversion to the mean -- companies that outperform then underperform and vice versa. Why is there reversion to the mean? Because the special techniques discovered by the company are copied and disseminated, key people are poached, ideas that used to work reliably stop working, etc. So these social constraints kick in long before mathematical constraints, but even if in theory you can overcome the social constraints, you can never overcome mathematical constraints, and thus Berkshire and all other investment holding companies must eventually stop overperforming, and most only eek out a few years of net overperformance.

> Berkshire is part of the market, thus it cannot outperform the market forever. In fact you expect reversion to the mean -- companies that outperform then underperform and vice versa. Why is there reversion to the mean? Because the special techniques discovered by the company are copied and disseminated, key people are poached, ideas that used to work reliably stop working, etc. So these social constraints kick in long before mathematical constraints, but even if in theory you can overcome the social constraints, you can never overcome mathematical constraints, and thus Berkshire and all other investment holding companies must eventually stop overperforming, and most only eek out a few years of net overperformance.

Understood. Thank you!

Now I wonder why brekshire investors keep holding the stock. Shouldn't the stock crash and burn. What is their logic ? Sunk cost bias?

I can't seem to read this in any other way than you are asking something like "why is it harder to find one hundred $100 million opportunities than one?"

Finding one such opportunity is hard, finding two is harder because you have to find the first and then do more work to find the second. This pattern continues indefinitely for as many opportunities as you'd like to find.

> you have to find the first and then do more work to find the second.

Isn't this typical scaling problem though? I wasn't imagining they go one by one. I guess your Implication here is that because there only one warren buffet. I guess that makes sense if Berkshire is ultimately one man Buffet show that can only scale as much as that one man can perform. That probably explains the recent under performance, age catches up to everyone.

Everyone else is in the same boat as well. Low interest rates have made it harder and harder to hit high rates of return. Softbank ended burning a fair amount of money from its $100B Vision Fund, and a good chunk of that was the oil wealth of the Saudis.