ERICOPOLY

Well, nobody is certain that a party will take place if you drop off a keg of beer at a fraternity house on a Friday. I believe there are others who think like me out there... meaning they will sell FFH to take full advantage of the market correction when it comes. You increase your buying power of cheap equities when you sell Fairfax.

A very underrated album. Don't those lines seem especially well suited to investors? This is the kind of stuff Bill Gross would add to his newsletter for color. Intrinsic value is The Final Cut!

Intrinsic value is the number that if you were all knowing about the future, and could predict all the cash that a business would give you between now and judgement day, discounted at the proper discount rate- that number is what intrinsic value is. - Buffett speaking to UGA students Intrinsic value is the number that if you were all knowing about the future, and could predict all the cash that a crap table wager would give you between now and judgement day, discounted at the proper discount rate- that number is what intrinsic value is. +1 The key word: omniscient. Advance knowledge of all future events and risk free interest rates will produce a singular real IV. The idea that an omniscient being is going to engage in a range of potential outcomes or probabilities is ludicrous. Why do you think the omniscient being will spend any time predicting what he already knows?

The arbitrage is part of that future. It is often possible to arbitrage in the present the indeterminate future state. Financially, the present IV might be half of Schrodinger's Cat. Or about 500 live cats out of 1000 whose future state is indeterminate. :) I don't think it is possible to do anything that does not belong in the future. Once the connectors in my brains start firing time has already elapsed. Here's a commonsensical example of how IV can change. Lets work the same idea backwards. Lucky Joe has a dollar while standing at the crap table when a rare circumstance presents an even money bet. The intrinsic value of his dollar is . . . one dollar. He lays his dollar down on the even money bet. After the roll of the dice, the intrinsic value of that wager is definitely going to change. It will be worth zero or two dollars, but definitely not what it was worth before the roll of the dice. :) That entire sequence of events is Joe's cash flow. It has a singular intrinsic value that never changed. Upfront we lacked clear details on how the narrative would unfold. The passage of time may have surprised us, but Joe's cash flow was his gambling winnings. And all future gambling winnings discounted to the present has a singular real IV -- we just can't for the life of us accurately assign it a precise figure.

Yeah me too (that's why I thought of it ;D). Then I realized it was much more nuanced than I intended. When we think of a business selling at IV, wouldn't we still expect to see a profit by purchasing the company at IV? Why would you/what investor would pay the expected cash flow? You would always require a profit. Therefore, the IV needs to exclude $.50. Now, what is the right amount to pay? There is a large variance in the outcomes, so what price is appropriate to subject your capital to the variance? The Kelly Criterion comes into play here. The larger your bankroll, the closer to $.50 you should pay. The smaller your bankroll, you should pay closer to $.00. So here the value depends. I am not sure how this applies to share structures though so that's why I said we might be getting off topic. wknecht, The real IV of the coin toss is either 0 or it's $1.00. There is no other possible outcome. (hey, you asked how IV could be anything other than 50 cents ;)) You either get $0 if it's heads, or $1.00 if it's tails. There is absolutely no chance in hell that IV could be 50 cents. ironically though, estimated IV is just like you say, .50c because we have no other tool than predictive powers (and we have a lot of confidence in the equal heads/tails weightings). So we have no hope but to assign an estimate that we know for certain will not be correct in one iteration of the coin toss. In estimation efforts, we do our best. .

The arbitrage is part of that future. It is often possible to arbitrage in the present the indeterminate future state. Financially, the present IV might be half of Schrodinger's Cat. Or about 500 live cats out of 1000 whose future state is indeterminate. :) I don't think it is possible to do anything that does not belong in the future. Once the connectors in my brains start firing time has already elapsed.

I'm also planning on kicking the can (taxes on BAC) down the road for a long time, then realizing the gains as a resident of another place. Until then... I will buy this house I currently rent with cash. I will get that cash using portfolio margin borrowing power. It will be hedged with a BAC put. I will effectively have spend the pre-tax value of the BAC shares on the house. The ongoing earnings that BAC generates will effectively reimburse me for the cost of the BAC puts. This is my plan to spend the money without paying taxes. Eric, I've got to say, you're just excellent. you just gave me an idea to reduce the interest rates on my student loans, maximize the tax benefits of them, pay for my MBA and spend my investment returns to pay for my living expenses. Kudos to you, and thanks! Glad to share the idea. It's not clear to me how deductible the interest is. My understanding is margin interest is only deductible if you borrowed the money for investment purposes. Thus, if you simply withdraw $10,000 and use it to pay off your student loan the next day the tax auditor may disallow the interest on the 10,000 loan even though it's margin interest. In my own case, I'm not sure if it is tax deductible or not for my primary home which is probably not an "investment", but rather some form of personal non-business consumption.

The arbitrage is part of that future.

I'm also planning on kicking the can (taxes on BAC) down the road for a long time, then realizing the gains as a resident of another place. Until then... I will buy this house I currently rent with cash. I will get that cash using portfolio margin borrowing power. It will be hedged with a BAC put. I will effectively have spend the pre-tax value of the BAC shares on the house. The ongoing earnings that BAC generates will effectively reimburse me for the cost of the BAC puts. This is my plan to spend the money without paying taxes.

Not always. For example, a business gets wound up. A bond matures. There are examples where you can precisely determine IV based on what is revealed by the passing of time. As you suggest, there are also times where the business still has an unknown future despite our being able to measure it's past cash flows up to this present day.

IV estimates can and do change. Unless you are all knowing about the future, you have only estimates (guesses). Surely this we can agree on. How have you witnessed the movement of IV itself? You do not have perfect enough knowledge of the future to know what IV actually is, let alone any illogical change in it's value. Going back to the coin flipping example ($1 if we win, $0 if we lose). To buy this asset (ability to participate) we would pay no more than $0.50. If it turns out that we win, we now have a $1 asset. Had we paid $0.75 before the toss, we cannot claim this was a good decision on the basis of being less than the ex-post $1 "intrinsic value" (instead of $0.50 or less). So in my view the intrinsic value changed from $0.50 before the toss to $1 after the toss. I agree with racemize. I think folks are saying the same thing, just some are looking through the rear view mirror, others the windshield. The true IV was $1 all along. This was however impossible to know upfront and the best estimate of IV before the toss was 50 cents. The true IV is "all future cash flows". Thus, it was $1. This is completely separate from expectations based on mathematical probability, however ultimately there tends to be some relationship as probability (properly assigned) is quite useful in estimating the future.

The number 7 is fixed. But how do you know that the Intrinsic value is fixed? Everybody will value cash flows differently. They will use different growth rate assumptions, different discount rates depending upon their risk calculations - always leading to a range of outcomes. Yes, different assumptions... Only time will reveal the difference between the assumptions and the one true IV. You can pull up a chart of the past risk free rates, but you cannot pull up a chart of the future risk free rates. You can create a prediction of that chart... but that's only a prediction.

The intrinsic value of future cash flows for a business is different than the intrinsic value of a woman. What's the intrinsic value of the number 7? Is it fixed in value? Or is it something you can argue doesn't exist as a single value because a woman can have multiple intrinsic values? I think there is a flaw in your logic comparing a measurement of monetary value(money) to a woman. All the cash flows that Kate Upton produces through her life... we can talk about that perhaps in the framework of this discussion. Because then it's apples to apples.

"I disagree. IV doesn't change. Your perception of IV changes along the turbulent path of discovery. You keep trying to predict the unpredictable, and blame it on the IV of the business rapidly changing. No." - Eric Doesn't Eric's comment "IV doesn't change" imply that IV couldn't have been another value? I have issue with that. IV can and does change. No, I don't think "IV doesn't change" implies that. IV is the some of all future cash flows, discounted. Those future cash flows will be certain values, and they will not be others. Putting aside my other comments, I posed another question earlier. What discount rate is the right one? If you use different discount rates, you will have different IVs. You cannot know with certainty what the proper discount rate is any more than you know what the actual cash flows will be. But there is only one past, and that past revealed the correct answer up to the present. Surely this "one past" phenomena will not change going forward. Today's future is tomorrow's past. Thus, one future. We have no hope of knowing precisely what it is, only guessing.

IV estimates can and do change. Unless you are all knowing about the future, you have only estimates (guesses). Surely this we can agree on. How have you witnessed the movement of IV itself? You do not have perfect enough knowledge of the future to know what IV actually is, let alone any illogical change in it's value.

There are not multiple possible guesses at IV, but multiple possible IVs. The wave function will collapse to one particular IV when the observation is made in the future, but this does not mean that IV was destined to happen. Or in a many-worlds interpretation you might have BRK with a market cap of $1 trillion at some fixed point in the future in 60% of the universes, but BRK is bankrupt in 0.00001% of the universes. I added the bold, because I think it represents some confusion. No one is arguing that the one IV was "destined to happen", that is, it couldn't have been another value. Rather, the claim is much weaker: it will be some value X, and no other value. To me this seems to be above reproach. This is independent of wave functions or any other deliverance of the physical sciences - in fact it they have nothing to do with the question. +1

Let's try another approach. There is one universe that we live in, but we do not know everything about it. Only estimates and glimmers. Because we can only estimate it (and the estimates vary widely), you say there cannot be just one universe that we live in.

I bought FFH in mostly taxable accounts because short term capital gains tax is 52% in California where I now live, and long term tax is bad too (at least 33%). So I wanted something that wouldn't be too volatile, that would compound at a rate that would beat my cost of leverage in BAC. I wound up selling it for a small gain to buy MBI.

Plato, this is macro investing, and is very dangerous: in 2008 FFH was up 30%+, while the market was down 30%+… :) giofranchi FFH got down to roughly $210 in 2008 from over $300 in 2007 (or perhaps early 2008). (US DOLLARS). Hedged the entire time. In fact, hedges soaring while it was plumbing the 2008 lows. Everything thrown out with the bathwater. As for 2008's performance, the stock closed 2007 at $286 and finished 2008 at $313. Total of 9.4% gain (not including dividend). US Dollars.

There are multiple estimates of intrinsic value. The presence of estimates to IV does not refute the existence of a single IV. "Possible" suggests "it could be this, or it could be that, or it might be this other thing, or perhaps that other thing". There are multiple "this". There are multiple "that". There is only one "it". People are effectively arguing that if there exist multiple possible guesses at the answer (most likely none of them exactly correct), then there cannot be one unknown precisely correct answer. That's flawed logic.

Eric, I understand the comparison, but don’t agree 100%. If they were truly the same, both Mr. Buffett and Mr. Watsa wouldn’t have taken the trouble to run insurance operations, right? Instead, the difference is clear enough to me: once again I repeat that “safety” comes first. And, if you write insurance profitably, nobody can take the leverage provided by float away from you, no matter what. To paraphrase Mr. Buffett: Even the best funds, see for instance Mr. Berkowitz in 2011, don’t enjoy such a luxury and constantly risk to disappoint their clients… In insurance you are working for yourself, not for clients: apparently, it seems a small difference, in practice I think it gives a huge advantage to insurance over leveraged funds. giofranchi I view the comparison in components. You have the utility of earnings from leveraged bonds. (component #1) You have a different risk profile with a leveraged fund vs an insurer. (component #2). A risk premium. Different cost of leverage (component #3) A low rate environment brings them closer together. And there may be more components. So if you think of each (insurers and leveraged bond fund) as a sum of the value of their components, then they move directionally together by similar amount when you increase or decrease the value of the earnings from the leveraged bond component).

The trouble for me with holding FFH for long periods of time is that when equities get really cheap, I want to load up on them. I don't want to be 50% invested in them at that time. Furthermore, I want to maximize the opportunity and not sit around in JNJ. They are limited in what they can do because they are an insurer. So the very time when the market bottoms... is the time that would be most rewarding to leave them behind. Further, if you expected the collapse to come you would be best off never owning FFH in the first place (because it too will drop). I made a mistake in holding FFH and adding to it in March 2009 -- I imagined they were aggressively buying up stocks on my behalf but it didn't happen. I realize today that my expectations were unreasonable -- they are an insurer.

How does thinking in terms of ranges of potential outcomes relate to "lack of control"? I don't believe anyone asserted that they have control over which outcome is ultimately realized. That's a misunderstanding of what I was saying. As there is only one past, there will only be one future (this statement was actually denied earlier on and the poster commented that instead there is a range of potentialities). You can't probability weight all of the branches, too frustrating and your biases will lead you to assign probabilities as you see fit -- how reliable will your bias be?. The illusion of greater control of course may contain negative utility. The more complicated the tree, the more likely it won't have meaningful value to your powers of prediction as the probabilities of the entire paths across multiple decisions in the tree are multiplicative. Thus to regain a measure of control you can apply Buffett's wisdom to prune the tree of avoidable mistakes (the kinds of mistakes that are made when your biases lead you to have confidence in predicting a given technology will last 10 years without being disrupted). Work with simpler trees, put the more complicated ones in the "too hard pile" rather than spinning your wheels constructing them.

Why, with multiple futures, is there but one past?

I live in one universe. There has been one past, as there will be one future.