Ironic Expert

When I first read Van Den Berg's 2004 lecture. He mentioned so many potential problems that could exist in US economy after a bubble bust in 2000-2003. I almost fully agree with him because a big bubble does need more time to heal.

But close to the end of his lecture, he said his best indicator of overall market is Value Line median P/E. I started to find this guy isn't clear on the basics. P/E for a year is not really a good indicator for a general market position for long term investments. In economic cycles, P/E tends to have wild swings, but long term investment need to take these cycles into consideration, and generally take average profitability of 10 years as a indicator of evaluation. For example, the median P/E in 2008 actually is higher than 2007 because corporate earning reduced a lot in recession , but can we say stocks in 2008, after 33% drop is still more expensive than 2007?

Now after reading his 2006 lecture, it becomes even more funny.

In 2006's lecture to his clients, he suddenly turns from extremely bearish in 2004 to extremely bullish (or at least "appears" to be so), and told his clients that this is an extraordinary opportunity in every 15-20 years to buy big blue-chip companies because their yield is same as treasury bond, and they got earning potential in additional to the yield. He also said the big companies' stocks are extremely cheap.

This is really ridiculous. First, he "forgot" all the potential problems he mentioned himself in 2004. Second, he only sees that big companies have growth potential in additional to earnings yield, but bond doesn't have growth potential, but he forgot big companies' earning is also not fixed, and could go to negative at recession, but treasury bond's return doesn't change. Normally, if big companies' return is same as treasury during a recession, that may be a good value, but if those two are the same at the peak of bull market (or well into the bull market), that is not really cheap (especially if the treasury yield is very low because of low inflation), since the corporate earning has a large room to go down in down turns.

I would say the Dow at mid-2006 is not very expensive, but it is not really cheap either. I guess Buffett felt the same since he didn't buy a lot of stocks in 2006 and didn't say the stocks became cheap then.

This guy is either missing the basics, or try to fool his clients. I think he has both. But no matter what, he and his century management are on my black-list now :)

You can see a so-called expert with a fairly good track record in 30 years and listed as a guru in gurufocus.com could be such a silly person, what about the analysts on the street...

Here is what Berkowitz said on how to choose a money manager (and I totally agree):

1.You want to find someone who has had a good paper trail of investing, a record, you know, of someone who's done very well.
2.you want to make sure that whoever you're going to entrust has a proven level of honesty and integrity so you don't have to worry.
3.you have to make sure that you have to have a basic comprehension of the strategy the person's using so that when times get tough, as they
inevitably do, you're not gonna get shaken loose at the worst possible time.
4.you have to assure yourself that there's a level playing field. Everyone has to be on the same side of the fence so to speak. Everyone should
do well together. (This means the manager should have a good percentage of personal wealth invested in the same fund, so he gets punished if the fund has bad performance).

Evaluation of Berkshire Hathaway

I looked at the 2Q report of Berkshire Hathaway again, on surface, the book value is 118.8B, translating this to per share of BRK-B, it is $2555. Its stock investment may increased 5B value now since 06/30/2009, that is a $107 increase. That gives a $2662.

There are also two items not reflected in book value:

1. Long term put options on stock index has a liability of 8.2B. This kind of put option is european option, which has maturity in 15-20 years later. Roughly, if 15 years later, the US and european stock index is higher than what it was in 2007, BRK has no obligation to pay anything. To me, this is very likely to be the case. So I like to remove this liability from the book(a little optimistic, but I think it makes sense), after tax, it gives a $114 increase on per share book value.

2. The investment on convertible notes/preferred shares in many deals:a. GS: this one is worth 2.5B capital gains now if converted.b. Swiss Re: this one is worth 2.4B capital gain if converted.These two add together gives $70 after-tax book value. In this calculation, you can see the effective book value for now is $2846.Tax consideration is very important, both for individual investors and corporate investors. Buffett invested on 8.5% bond/preferred stock early this year for Dow company, maybe partially because of the tax considerations: for dividend income, corporate only needs to pay about 10% tax, for capital gains, they need to pay 35% tax. Another reason he likes bond more is because of the safety, I guess.He also likes to own a company as subsidiary, instead of buying a company's stock maybe partially due to tax reason (another reason is better control on management, I guess).

Besides the book value analysis, from P/E, its look through earning is about 14B per year, with P/E of 15, it gives a fair value of at least $4500.

Since Buffett only invests on companies with good management and durable competitive advantages, his collection of companies are among the best ones. Given this rare collection of companies and his cautious investment style, plus his ability to get good deals and find good investment opportunities, I think the current price ($3260) is still a bargain.

From safety side, it may not be as diversified as SP 500, but because it is a good collection, it is better than SP 500 average. Still, it is not as diversified, that is a fact to consider. The maximum on insurance loss would not affect the parent company though, since the insurance are issued by its three major subsidiaries and these are not guarranteed by parent company. The only loan guarranteed by parent company is about 10+ Billion.

So I could argue the downside risk is less than S&P 500 index.