Posts tagged ‘Berkshire Hathaway’

Munger: Buffett’s Wingman & the Art of Stock Picking

Simon had Garfunkel, Batman had Robin, Hall had Oates, Dr. Evil had Mini Me, Sonny had Cher, and Malone had Stockton. In the investing world, Buffett has Munger. Charlie Munger is one of the most successful and famous wingmen of all-time –  evidenced by Berkshire Hathaway Corporation’s (BRKA/B) outperformance of the S&P 500 index by approximately +624% from 1977 – 2009, according to MarketWatch. Munger not only provides critical insights to his legendary billionaire boss, Warren Buffett, but he was also Chairman of Berkshire’s insurance subsidiary, Wesco Financial Corporation from 1984 until 2011. The magic of this dynamic duo began when they met at a dinner party 58 years ago (1959).

In an article he published in 2006, the magnificent Munger describes the “Art of Stock Picking” in a thorough review about the secrets of equity investing. We’ll now explore some of the 93-year-old’s sage advice and wisdom.

Model Building

Charlie Munger believes an individual needs a solid general education before becoming a successful investor, and in order to do that one needs to study and understand multiple “models.”

“You’ve got to have models in your head. And you’ve got to array your experience both vicarious and direct on this latticework of models. You may have noticed students who just try to remember and pound back what is remembered. Well, they fail in school and in life. You’ve got to hang experience on a latticework of models in your head.”

 

Although Munger indicates there are 80 or 90 important models, the examples he provides include mathematics, accounting, biology, physiology, psychology, and microeconomics.

Advantages of Scale

Great businesses in many cases enjoy the benefits of scale, and Munger devotes a good amount of time to this subject. Scale advantages can be realized through advertising, information, psychological “social proofing,” and structural factors.

The newspaper industry is an example of a structural scale business in which a “winner takes all” phenomenon applies. Munger aptly points out, “There’s practically no city left in the U.S., aside from a few very big ones, where there’s more than one daily newspaper.”

General Electric Co. (GE) is another example of a company that uses scale to its advantage. Jack Welch, the former General Electric CEO, learned an early lesson. If the GE division is not large enough to be a leader in a particular industry, then they should exit. Or as Welch put it, “To hell with it. We’re either going to be # 1 or #2 in every field we’re in or we’re going to be out. I don’t care how many people I have to fire and what I have to sell. We’re going to be #1 or #2 or out.”

Bigger Not Always Better

Scale comes with its advantages, but if not managed correctly, size can weigh on a company like an anchor. Munger highlights the tendency of large corporations to become “big, fat, dumb, unmotivated bureaucracies.” An implicit corruption also leads to “layers of management and associated costs that nobody needs. Then, while people are justifying all these layers, it takes forever to get anything done. They’re too slow to make decisions and nimbler people run circles around them.”

Becoming too large can also create group-think, or what Munger calls “Pavlovian Association.” Munger goes onto add, “If people tell you what you really don’t want to hear what’s unpleasant there’s an almost automatic reaction of antipathy…You can get severe malfunction in the high ranks of business. And of course, if you’re investing, it can make a lot of difference.”

Technology: Benefit or Burden?

Munger recognizes that technology lowers costs for companies, but the important question that many managers fail to ask themselves is whether the benefits from technology investments accrue to the company or to the customer? Munger summed it up here:

“There are all kinds of wonderful new inventions that give you nothing as owners except the opportunity to spend a lot more money in a business that’s still going to be lousy. The money still won’t come to you. All of the advantages from great improvements are going to flow through to the customers.”

 

Buffett and Munger realized this lesson early on when productivity improvements gained from technology investments in the textile business all went to the buyers.

Surfing the Wave

When looking for good businesses, Munger and Buffett are looking to “surf” waves or trends that will generate healthy returns for an extended period of time. “When a surfer gets up and catches the wave and just stays there, he can go a long, long time. But if he gets off the wave, he becomes mired in shallows,” states Munger. He notes that it’s the “early bird,” or company that identifies a big trend before others that enjoys the spoils. Examples Munger uses to illustrate this point are Microsoft Corp. (MSFT), Intel Corp. (INTC), and National Cash Register from the old days.

Large profits will be collected by those investors that can identify and surf those rare large waves. Unfortunately, taking advantage of these rare circumstances becomes tougher and tougher for larger investors like Berkshire. If you’re an elephant trying to surf a wave, you need to find larger and larger waves, and even then, due to your size, you will be unable to surf as long as small investors.

Circle of Competence

Circle of competence is not a new subject discussed by Buffett and Munger, but it is always worth reviewing.  Here’s how Munger describes the concept:

“You have to figure out what your own aptitudes are. If you play games where other people have the aptitudes and you don’t, you’re going to lose. And that’s as close to certain as any prediction that you can make. You have to figure out where you’ve got an edge. And you’ve got to play within your own circle of competence.”

 

For Munger and Buffett, sticking to their circle of competence means staying away from high-technology companies, although more recently they have expanded this view to include International Business Machines (IBM), which they are now a large investor.

Market Efficiency or Lack Thereof

Munger acknowledges that financial markets are quite difficult to beat. Since the markets are “partly efficient and partly inefficient,” he believes there is a minority of individuals who can outperform the markets. To expand on this idea, he compares stock investing to the pari-mutuel system at the racetrack, which despite the odds stacked against the bettor (17% in fees going to the racetrack), there are a few individuals who can still make decent money.

The transactional costs are much lower for stocks, but success for an investor still requires discipline and patience. As Munger declares, “The way to win is to work, work, work, work and hope to have a few insights.”

Winning the Game – 10 Insights / 20 Punches

As the previous section implies, outperformance requires patience and a discriminating eye, which has allowed Berkshire to create the bulk of its wealth from a relatively small number of investment insights. Here’s Munger’s explanation on this matter:

“How many insights do you need? Well, I’d argue: that you don’t need many in a lifetime. If you look at Berkshire Hathaway and all of its accumulated billions, the top ten insights account for most of it….I don’t mean to say that [Warren] only had ten insights. I’m just saying, that most of the money came from ten insights.”

 

Chasing performance, trading too much, being too timid, and paying too high a price are not recipes for success. Independent thought accompanied with selective, bold decisions is the way to go. Munger’s solution to these problems is to provide investors with a Buffett 20-punch ticket:

“I could improve your ultimate financial welfare by giving you a ticket with only 20 slots in it so that you had 20 punches ‑ representing all the investments that you got to make in a lifetime. And once you’d punched through the card, you couldn’t make any more investments at all.”

 

The great thing about Munger and Buffett’s advice is that it is digestible by the masses. Like dieting, investing can be very simple to understand, but difficult to execute, and legends like these always remind us of the important investing basics. Even though Charlie Munger may be slowing down a tad at 93-years-old, Warren Buffett and investors everywhere are blessed to have this wingman around spreading his knowledge about investing and the art of stock picking.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, BRKA/B, GE, MSFT, INTC, IBM but at the time of this 3/12/17 updated publishing, SCM had no direct position in National Cash Register, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

March 12, 2017 at 7:32 pm Leave a comment

M&A Bankers Away as Elephant Hunters Play

hunter pointing rifle in blaze orange gear

With trillions in cash sitting in CEO and private equity wallets, investment bankers have been chasing mergers & acquisitions with a vengeance. Unfortunately for the bankers, investor skittishness has slowed merger activity in the boardroom. Rather than aggressively stalk corporate prey, bidders look more like deer in headlights. However, animal spirits are not completely dead. Some board members have seen the light and realize the value-destroying characteristics of idle cash in a near-zero interest rate environment, so they have decided to go elephant hunting. During a nine day period alone in the first quarter of 2013, a total of $87.7 billion in elephant deals were announced:

  • HJ Heinz Company (HNZ – $27.4 billion) – February 14, 2013 – Bidder: Berkshire Hathaway (BRKA)/ 3G Capital Partners.
  • Virgin Media Inc. (VMED – $21.9 billion) – February 6, 2013 – Bidder: Liberty Global Inc. (LBTYA).
  • Dell Inc. (DELL – $21.8 billion) – February 5, 2013 – Bidder: Silver Lake Partners LP, Michael Dell, Carl Icahn.
  • NBCUniversal Media LLC 49% Stake (GE- $17.6 billion) – February 12, 2013 – Bidder: Comcast Corp. (CMCSA).

These elephant deals helped the overall M&A deal values in the United States increase by +34% in Q1 from a year ago to $167 billion (see Mergermarket report). Unfortunately, the picture doesn’t look so good on a global basis. The overall value for global M&A deals in Q1 registered $418 billion, down -7% from the first quarter of 2012. On a transaction basis, there were a total of 2,621 deals during the first three months of the year, down -20% from 3,262 deals in the comparable period last year.

Source: Mergermarket

Source: Mergermarket

With central banks across the globe pumping liquidity into the financial system and the U.S. stock market near record highs, one would think buyers would be writing big M&A checks as they wrote poems about rainbows, puppy dogs, and flowers. This is obviously not the case, so why such the sour mood?

The biggest scapegoat right now is Europe. While the U.S. economy appears to be slowly-but-surely plodding along on its economic recovery, Europe continues to dig a deeper recessionary hole. Austerity-driven fiscal policies are hindering growth, and concerns surrounding a Cypriot contagion continue to grab headlines. Although the U.S. dollar value of deals was up substantially in Q1, the number of transactions was down significantly to 703 deals from 925 in Q1-2012 (-24%). Besides buyer nervousness, unfriendly tax policy could have accelerated deals into 2012, and stole business from 2013.

Besides lackluster global M&A volume, the record low EBITDA multiples on private equity exit prices is proof that skepticism on the sustainability of the economic recovery remains uninspired. With exit multiples at a meager level of 8.2x globally, many investors are holding onto their companies longer than they would like.

Source: Mergermarket

Source: Mergermarket

While merger activity has been a mixed bag, a bright spot in the M&A world has been the action in emerging markets. In 2012, the value of global transactions was essentially flat, yet emerging market deal values were up approximately +9% to $524 billion. This value exceeded the pre-crisis M&A activity level in 2007 by $73 billion, a feat not achieved in the other regions around the globe. Although emerging markets also pulled back in Q1, this region now account for 23% of total global M&A deal values.

Elephant buyout deals in the private equity space (skewed heavily by the Heinz & Dell deals) caused results to surge in this segment during the first quarter. Private equity related buyouts accounted for the highest share of global M&A activity (~21%) since 2007. However, like the overall U.S. M&A market, the number of Q1 transactions in the buyout space (372 transactions) declined to the lowest count in about four years.

Until skepticism turns into confidence, elephant deals will continue to distort results in the M&A sector (Echostar’s [DISH] play for Sprint [S] is further evidence). However, the existence of these giant transactions could be a leading indicator for more activity in the coming quarters. If bankers want to generate more fees, they may consider giving Warren Buffett a call. Here’s what he had to say after the announcement of the Heinz deal:

“I’m ready for another elephant. Please, if you see any walking by, just call me.”

 

Despite the weak overall M&A activity, the hunters are out there and they have plenty of ammunition (cash).

See also: Mergermarket Monthly M&A Insider Report (April 2013)

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) and CMCSA, but at the time of publishing SCM had no direct position in HNZ, BRKA, VMED, LBTYA, DELL, GE, DISH, S or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

April 21, 2013 at 6:57 pm Leave a comment

Munger: Buffett’s Wingman & the Art of Stock Picking

Simon had Garfunkel, Batman had Robin, Hall had Oates, Dr. Evil had Mini Me, Sonny had Cher, and Malone had Stockton. In the investing world, Buffett has Munger. Charlie Munger is one of the most successful and famous wingmen of all-time –  evidenced by Berkshire Hathaway Corporation’s (BRKA/B) outperformance of the S&P 500 index by approximately +624% from 1977 – 2009, according to MarketWatch. Munger not only provides critical insights to his legendary billionaire boss, Warren Buffett, but he also is Chairman of Berkshire’s insurance subsidiary, Wesco Financial Corporation. The magic of this dynamic duo began when they met at a dinner party during 1959.

In an article he published in 2006, the magnificent Munger describes the “Art of Stock Picking” in a thorough review about the secrets of equity investing. We’ll now explore some of the 88-year-old’s sage advice and wisdom.

Model Building

Charlie Munger believes an individual needs a solid general education before becoming a successful investor, and in order to do that one needs to study and understand multiple “models.”

“You’ve got to have models in your head. And you’ve got to array your experience both vicarious and direct on this latticework of models. You may have noticed students who just try to remember and pound back what is remembered. Well, they fail in school and in life. You’ve got to hang experience on a latticework of models in your head.”

 

Although Munger indicates there are 80 or 90 important models, the examples he provides include mathematics, accounting, biology, physiology, psychology, and microeconomics.

Advantages of Scale

Great businesses in many cases enjoy the benefits of scale, and Munger devotes a good amount of time to this subject. Scale advantages can be realized through advertising, information, psychological “social proofing,” and structural factors.

The newspaper industry is an example of a structural scale business in which a “winner takes all” phenomenon applies. Munger aptly points out, “There’s practically no city left in the U.S., aside from a few very big ones, where there’s more than one daily newspaper.”

General Electric Co. (GE) is another example of a company that uses scale to its advantage. Jack Welch, the former General Electric CEO, learned an early lesson. If the GE division is not large enough to be a leader in a particular industry, then they should exit. Or as Welch put it, “To hell with it. We’re either going to be # 1 or #2 in every field we’re in or we’re going to be out. I don’t care how many people I have to fire and what I have to sell. We’re going to be #I or #2 or out.”

Bigger Not Always Better

Scale comes with its advantages, but if not managed correctly, size can weigh on a company like an anchor. Munger highlights the tendency of large corporations to become “big, fat, dumb, unmotivated bureaucracies.” An implicit corruption also leads to “layers of management and associated costs that nobody needs. Then, while people are justifying all these layers, it takes forever to get anything done. They’re too slow to make decisions and nimbler people run circles around them.”

Becoming too large can also create group-think, or what Munger calls “Pavlovian Association.” Munger goes onto add, “If people tell you what you really don’t want to hear what’s unpleasant there’s an almost automatic reaction of antipathy…You can get severe malfunction in the high ranks of business. And of course, if you’re investing, it can make a lot of difference.”

Technology: Benefit or Burden?

Munger recognizes that technology lowers costs for companies, but the important question that many managers fail to ask themselves is whether the benefits from technology investments accrue to the company or to the customer? Munger summed it up here:

“There are all kinds of wonderful new inventions that give you nothing as owners except the opportunity to spend a lot more money in a business that’s still going to be lousy. The money still won’t come to you. All of the advantages from great improvements are going to flow through to the customers.”

 

Buffett and Munger realized this lesson early on when productivity improvements gained from technology investments in the textile business all went to the buyers.

Surfing the Wave

When looking for good businesses, Munger and Buffett are looking to “surf” waves or trends that will generate healthy returns for an extended period of time. “When a surfer gets up and catches the wave and just stays there, he can go a long, long time. But if he gets off the wave, he becomes mired in shallows,” states Munger. He notes that it’s the “early bird,” or company that identifies a big trend before others that enjoys the spoils. Examples Munger uses to illustrate this point are Microsoft Corp. (MSFT), Intel Corp. (INTC), and National Cash Register from the old days.

Large profits will be collected by those investors that can identify and surf those rare large waves. Unfortunately, taking advantage of these rare circumstances becomes tougher and tougher for larger investors like Berkshire. If you’re an elephant trying to surf a wave, you need to find larger and larger waves, and even then, due to your size, you will be unable to surf as long as small investors.

Circle of Competence

Circle of competence is not a new subject discussed by Buffett and Munger, but it is always worth reviewing.  Here’s how Munger describes the concept:

“You have to figure out what your own aptitudes are. If you play games where other people have the aptitudes and you don’t, you’re going to lose. And that’s as close to certain as any prediction that you can make. You have to figure out where you’ve got an edge. And you’ve got to play within your own circle of competence.”

 

For Munger and Buffett, sticking to their circle of competence means staying away from high-technology companies, although more recently they have expanded this view to include International Business Machines (IBM), which they invested in late last year.

Market Efficiency or Lack Thereof

Munger acknowledges that financial markets are quite difficult to beat. Since the markets are “partly efficient and partly inefficient,” he believes there is a minority of individuals who can outperform the markets. To expand on this idea, he compares stock investing to the pari-mutuel system at the racetrack, which despite the odds stacked against the bettor (17% in fees going to the racetrack), there are a few individuals who can still make decent money.

The transactional costs are much lower for stocks, but success for an investor still requires discipline and patience. As Munger declares, “The way to win is to work, work, work, work and hope to have a few insights.”

Winning the Game – 10 Insights / 20 Punches

As the previous section implies, outperformance requires patience and a discriminating eye, which has allowed Berkshire to create the bulk of its wealth from a relatively small number of investment insights. Here’s Munger’s explanation on this matter:

“How many insights do you need? Well, I’d argue: that you don’t need many in a lifetime. If you look at Berkshire Hathaway and all of its accumulated billions, the top ten insights account for most of it….I don’t mean to say that [Warren] only had ten insights. I’m just saying, that most of the money came from ten insights.”

 

Chasing performance, trading too much, being too timid, and paying too high a price are not recipes for success. Independent thought accompanied with selective, bold decisions is the way to go. Munger’s solution to these problems is to provide investors with a Buffett 20-punch ticket:

“I could improve your ultimate financial welfare by giving you a ticket with only 20 slots in it so that you had 20 punches ‑ representing all the investments that you got to make in a lifetime. And once you’d punched through the card, you couldn’t make any more investments at all.”

 

The great thing about Munger and Buffett’s advice is that it is digestible by the masses. Like dieting, investing can be very simple to understand, but difficult to execute, and legends like these always remind us of the important investing basics. Even though Charlie Munger may be slowing down a tad at 88-years-old, Warren Buffett and investors everywhere are blessed to have this wingman around spreading his knowledge about investing and the art of stock picking.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in BRKA/B, GE, MSFT, INTC, National Cash Register, IBM, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

January 8, 2012 at 11:05 pm 2 comments

Buffett on Gold Fondling and Elephant Hunting

Warren Buffett is kind enough to occasionally grace investors with his perspectives on a wide range of subjects. In his recently released annual letter to shareholders he covered everything from housing and leverage to liquidity and his optimistic outlook on America (read full letter here). Taking advice from the planet’s third wealthiest person (see rankings) is not a bad idea ­– just like getting basketball pointers from Hall of Famer Michael Jordan or football tips from Pro Bowler Tom Brady isn’t a bad idea either.

Besides being charitable with billions of his dollars, the “Oracle of Omaha” was charitable with his time, spending three hours on the CNBC set (a period equal to $12 million in Charlie Sheen dollars) answering questions, all at the expense of his usual money-making practice of reading through company annual reports and 10Qs.

Buffett’s interviews are always good for a few quotable treasures and he didn’t disappoint this time either with some “gold fondling” and “elephant hunting” quotes.

Vodpod videos no longer available.
 

Buffett on Gold & Commodities

Buffett doesn’t hold back on his disdain for “fixed-dollar investments” and isn’t shy about his feelings for commodities when he says:

“The problem with commodities is that you are betting on what someone else would pay for them in six months. The commodity itself isn’t going to do anything for you….it is an entirely different game to buy a lump of something and hope that somebody else pays you more for that lump two years from now than it is to buy something that you expect to produce income for you over time.”

 

Here he equates gold demand to fear demand:

“Gold is a way of going long on fear, and it has been a pretty good way of going long on fear from time to time. But you really have to hope people become more afraid in a year or two years than they are now. And if they become more afraid you make money, if they become less afraid you lose money, but the gold itself doesn’t produce anything.”

 

Buffett goes on to say this about the giant gold cube:

“I will say this about gold. If you took all the gold in the world, it would roughly make a cube 67 feet on a side…Now for that same cube of gold, it would be worth at today’s market prices about $7 trillion dollars – that’s probably about a third of the value of all the stocks in the United States…For $7 trillion dollars…you could have all the farmland in the United States, you could have about seven Exxon Mobils (XOM), and you could have a trillion dollars of walking-around money…And if you offered me the choice of looking at some 67 foot cube of gold and looking at it all day, and you know me touching it and fondling it occasionally…Call me crazy, but I’ll take the farmland and the Exxon Mobils.”

 

Although not offered up in this particular interview, here is another classic quote by Buffett on gold:

“[Gold] gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

 

For the most part I agree with Buffett on his gold commentary, but when he says commodities “don’t do anything for you,” I draw the line there. Many commodities, outside of gold, can do a lot for you. Steel is building skyscrapers, copper is wiring cities, uranium is fueling nuclear facilities, and corn is feeding the masses. Buffett believes in buying farms, but without the commodities harvested on that farm, the land would not be producing the income he so emphatically cherishes. Gold on the other hand, while providing some limited utility, has very few applications…other than looking shiny and pretty.

Buffett on Elephant Hunting

Another subject that Buffett addresses in his annual shareholder letter, and again in this interview, is his appetite to complete large “elephant” acquisitions. Since Berkshire Hathaway (BRKA/B) is so large now (total assets over $372 billion), it takes a sizeable elephant deal to be big enough to move the materiality needle for Berkshire.

“We’re looking for elephants. For one thing, there aren’t many elephants out there, and all the elephants don’t want to go in our zoo…It’s going to be rare that we are going find something selling in the tens of billions of dollars; where I understand the business; where the management wants to join up with Berkshire; where the price makes the deal feasible; but it will happen from time to time.”

 

Buffett’s target universe is actually fairly narrow, if you consider his estimate of about 50 targets that meet his true elephant definition. He has been quite open about the challenges of managing such a gigantic portfolio of assets. The ability to outperform the indexes becomes more difficult as the company swells because size becomes an impediment – “gravity always wins.”

With experience and age comes quote-ability, and Warren Buffett has no shortage in this skill department.  The fact that Buffett’s investment track record is virtually untouchable is reason enough to hang upon his every word, but his uncanny aptitude to craft stories and analogies – such as gold fondling and elephant hunting – guarantees I will continue waiting with bated breath for his next sage nuggets of wisdom.

Wade W. Slome, CFA, CFP® 

Plan. Invest. Prosper. 

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds (including commodities) and commodity related equities, but at the time of publishing SCM had no direct position in BRKA/B, XOM or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

March 8, 2011 at 1:02 am 2 comments

Buffett Sells Insurance: Weapons of ANTI-Destruction

Writing Options is the Opposite of Mass Destruction

Writing Options is the Opposite of Mass Destruction

Those same “Weapons of Mass Destruction” that Warren Buffett so ardently warned investors against are the same derivatives that catapulted Berkshire Hathaways (BRKA) Q2 earnings performance. Chris McKhann at OptionMonster summarized Buffet’s moves:

Buffett has sold a large number of puts on four major indexes starting in 2007: the S&P 500, the FTSE 100, the Euro Stoxx 50, and the Nikkei 225. He took in $4.9 billion, with a potential loss of more than $35 billion–but only if all four indexes were at zero come the expiration date (at which point we would be worrying about other things).

 

Derivatives are like a gun, if used responsibly for gaming or for self-defense, then they can be a useful tool. Unfortunately, like guns, these derivatives are used irresponsibly in many instances. This point is especially true in areas like Credit Default Swaps where there were inadequate regulations and capital requirements to prevent disastrous outcomes (e.g., AIG’s collapse). With proper transparency, capital requirements, and proper regulation, derivatives can be used to manage risk rather than create additional risk. 

Although I wouldn’t categorize myself as a value investor like Warren, I would prefer to call myself a growth investor with a value conscience. With that said, if you incorporate valuation within your investment discipline, I believe writing (selling) options is a brilliant idea. I can make this assertion because I’ve used this strategy for myself and my hedge fund. Volatility has a direct impact on the amount of premiums collected; therefore the trading levels of the CBOE Volatility Index (VIX) will have a directly correlated impact on option writing profitability. For example, if I’m selling flood insurance, I’m going to collect much higher rates in the period right after Katrina occurred.

If you are willing to accept free money from speculators betting on short-term swings in prices (Warren sold long-term, multi-year options), while being forced to sell/buy stock at price levels you like, then why not?! However, buying and selling puts and calls is a different game in my book, and one I personally do NOT excel at. I’ll keep to utilizing “Weapons of Anti-Destruction” and collect premiums up-front, like Warren, from speculators and leave the rest of the options strategies to others.

Read Seeking Alpha Article

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management and client accounts do not have direct positions in AIG or BRKA/B at the time the article was published. Sidoxia Capital Management and its clients do have long exposure to TIP shares. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

August 19, 2009 at 4:00 am 1 comment


Receive Investing Caffeine blog posts by email.

Join 1,790 other followers

Meet Wade Slome, CFA, CFP®

More on Sidoxia Services

Recognition

Top Financial Advisor Blogs And Bloggers – Rankings From Nerd’s Eye View | Kitces.com

Wade on Twitter…

Share this blog

Bookmark and Share

Subscribe to Blog RSS

Monthly Archives