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I thought the answer to the Berkshire question was a little strange as in it Pabrai revealed an opinion that he expects weak stock markets until 2016 and then a bull market afterward through 2033. Seeing that he has some sort of belief in a repeating 17-year bull then bear market cycles was surprising to me as it isn’t what I would expect from a value investor. It actually seems rather silly to me as I have no belief that such patterns exist. I’m quite certain Mr. Buffett doesn’t either.
Here are the questions and answers:
Question: Based on your experience, let’s say you have two investment options: one a net company which doesn’t have too much in terms of competitive advantage but has a huge margin of safety, and the other a very strong company with a huge substantial moat but not available with the same amount of margin of safety but has a very satisfactory earnings yield. Which decision would you chose? I’m over generalizing here but I just want to know if you have a clear preference.
A: One of the things I have found about net-nets and companies which are trading close to net asset values or have a lot of cash is that there’s a seductive element to them that can lead you astray.
Let me give you an example. Let’s say I have a company that has a $100 million market cap and let’s say it has $95 million in cash. And let’s say it has a business that generates a million dollars a year.
Well that type of investment is of zero interest to me because the cash is an anchor. The million is going to happen for sure year in and year out in a business like that without cash. Maybe it’s worth somewhere between $10 and $15 million. Let’s say $15 million. So that business has a value of $110 million. And you’re paying a $100 million for it and that’s just not interesting. So I would not have an interest.
In fact you could go to the other end and say it has $110 million of cash and the market cap is $100 million and it’s still not of interest. Even if it’s generating a million a year because now it’s worth $125 million and you’re paying $100 million or so. It’s not that interesting.
Now of course it has a lot of downside protection elements, which is fine. But you can find those types of businesses a dime a dozen in Japan today, for example. I’m more interested in a business where everything is there. Where there is downside protection and there’s an upside pop.
One of the problems you have with net nets is that you have only one side of it. You have downside protection. You don’t have the upside. I really try to look for ones where I can get both. And it’s few and far between but that’s what we try to do.
Q: I have a question on the cash. Berkshire says that they hold a lot of cash on their books. But they also sell a lot of long term S&P puts, 20 year and 30 years out. So is it really cash or if the market collapsed will they use up all their cash and more?
A: This is probably a question best directed to Warren but if you look at the 20 year puts that they have, look at the strike prices and all of that, the odds that they have any payout on those is so close to zero that it approaches zero. Those are European style options which means they can only be exercised on one date when it ends. There’s no exercise possible until the end. And my personal view is that after 2015 or 2016 is when you start making hay in the stock market.
So we have these perfect symmetry events where 1982 to 1999 the market ran a lot. And from 1999 to 2016 let’s say it does nothing or did nothing. So all we have to do is get to 2016 with a pot of cash and then we climb again until 2033. So when those puts expire, which is way after 2016, my view is that Berkshire will be just fine. They will have no pay out on those. But if you’re concerned you should ask Warren at the annual meeting and maybe he’ll give a better answer.
About the author:
http://valueinvestorcanada.blogspot.com/
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