An easy question but perhaps not a simple answer

[anders]

I have a question regarding leverage. How much leverage would you consider to be appropriate in a portfolio?

It may be an easy answer to many, but Im quite puzzled about this and would appreciate any guidance in the field.

 

Many will simply say that they do not leverage their portfolio, but whenever you buy a stock, you will most likely be exposed to leverage since the investment itself is leveraged. If you use derivatives, you are exposed to leverage due to contract size. BRK has been using leverage through its float, I think over the years it has been 1.6-1 ratio and their subs have leverage and wells has around a 10-1 ratio. Many would argue that it is correlated to risk and asset, but look at what happened with LTCM, the smartest guys with the smartest system, telling people that 6 sigma events were impossible and still they went bust in the end due to leverage. Extremely smart people went broke using leverage, on assumptions based on history and presumed safety of asset. Less risk became coupled with high leverage, but what happens now when risk free return investments became return free risk  ???

 

Best,

 

 

[twacowfca]

I have a question regarding leverage. How much leverage would you consider to be appropriate in a portfolio?

It may be an easy answer to many, but Im quite puzzled about this and would appreciate any guidance in the field.

 

Many will simply say that they do not leverage their portfolio, but whenever you buy a stock, you will most likely be exposed to leverage since the investment itself is leveraged. If you use derivatives, you are exposed to leverage due to contract size. BRK has been using leverage through its float, I think over the years it has been 1.6-1 ratio and their subs have leverage and wells has around a 10-1 ratio. Many would argue that it is correlated to risk and asset, but look at what happened with LTCM, the smartest guys with the smartest system, telling people that 6 sigma events were impossible and still they went bust in the end due to leverage. Extremely smart people went broke using leverage, on assumptions based on history and presumed safety of asset. Less risk became coupled with high leverage, but what happens now when risk free return investments became return free risk  ???

 

Best,

 

There is good leverage (long term, non recourse, no covenants) and not so good leverage.  The leverage on BRK's BS is about as good as it gets: float at zero cost or less.  No need to pay it back for the most part. An interest free loan if their underwriting is good.  Compare that to a company that had a large amount of conventional debt with interest and principal to pay and covenants whereby the lender  could increase the interest rate or call the loan if something deteriorates.

[Olmsted]

As you hint at, there are different kinds of leverage in an investor's portfolio (laying aside for a moment portfolio companies' characteristics which twacfoa discusses). I think a key distinguisher is whether it is "callable" or not, e.g. margin at your brokerage versus one of the TARP warrants we discuss so much. Different risk profiles to each.  Margin's biggest drawback is that it can turn you into a seller at the worst times.

[Packer16]

What has helped me is to understand what makes a good high yield investment for those firms who have a good amount of debt.  The book How to Make Money in High Yield Bonds by Levin provides a nice framework.

 

Packer

[Green King]

What has helped me is to understand what makes a good high yield investment for those firms who have a good amount of debt.  The book How to Make Money in High Yield Bonds by Levin provides a nice framework.

 

Packer

 

do you mean this ? http://www.amazon.ca/How-Make-Money-Junk-Bonds/dp/007179381X

 

cuz  i can't find the other one.

[Packer16]

Yes that is it

 

Packer

[anders]

hmmm.. lets flip the question to another angle..

 

I understand the concept of good/bad leverage with different risk profiles.. insurance, hedgefund, margin account..

 

My portfolio is not leveraged. But when I buy into a company, I thereby own a part of the equity, debt and generated cash hence, I write down my share of each category so If the company has 50/50 debt-equity ratio my portfolio will have the same ratio. So when I bought ie BAC with a 10-1 ratio, my leverage in the portfolio went up quite substantially.

 

My question refers to how much leverage in the portfolio do you guys feel would be upper limit, viewed from this perspective, regardless of risk.

 

Best,

 

[MrB]

This is not a case of comparing apples with apples. Portfolio leverage is not akin to company leverage and company leverage varies depending on the business model, which is again driven by the stability of the cash flows. It explains why you can leverage a utility, bank etc much more than a crop farm.

 

Therefore you can probably get to an answer if you have a portfolio with two retail banks, but as soon as you have one retail bank and one investment bank it gets trickier and the makeup of your typical portfolio makes that unanswerable in my view and that is why I just stay away from leveraging the portfolio and stay away from companies with debt.

 

Also traditional metrics of leverage gives a false sense of certainty. If you see leverage of 30%, 10% etc or financial leverage ratios of 2, 5, 10 or for European banks of 30 then you think you understand what you are dealing with. However, these ratios only give you some sense of what it is really about, which is the match between fixed cash flows and varying cash flows; regular bank payments v sales and collections from selling cars for example. Once again different in the case of a utility v a crop farm. Measures of leverage never address the timing issue, the best sense you can get is that in the case of a bank financial leverage of 10 is safe and 30 you are in trouble. Leverage a crop farm 1 time and you are probably nuts.

 

So ultimately not only is the analysis imprecise, so are the tools of analysis, but because you can neatly write it down on paper, people think they understand what they are dealing with. Leverage will only get you in trouble once, but you will most likely go out of business and the majority of investors do not use leverage just once...eventually it gets them.

 

LTA: Why think about an issue that can only land you in trouble? Run with net cash, stay away from leveraged companies and move on.

[giofranchi]

The leverage on BRK's BS is about as good as it gets: float at zero cost or less.  No need to pay it back for the most part. An interest free loan if their underwriting is good.  Compare that to a company that had a large amount of conventional debt with interest and principal to pay and covenants whereby the lender could increase the interest rate or call the loan if something deteriorates.

 

I couldn't agree more. That's why, the only leveraged companies I am interested in are insurance companies. As a rule of thumb, I look for insurance companies with management whose skills are above average, and with underwriting and investment leverage that are below average. That makes me sleep soundly at night.

I am not a full time money manager. I run businesses. And I invest in companies that I like, as if their operations became my firm’s operations too. The only difference is that I don’t manage them personally. I don’t jump from one undervalued stock to the other. So, I have never thought hard enough about how good an investment in overleveraged companies at ridiculously low prices might turn out to be. I just don’t want the operations of overleveraged companies to be part of my firm’s operations. Therefore, I don’t look at them.

 

Therefore you can probably get to an answer if you have a portfolio with two retail banks, but as soon as you have one retail bank and one investment bank it gets trickier and the makeup of your typical portfolio makes that unanswerable in my view and that is why I just stay away from leveraging the portfolio and stay away from companies with debt.

 

At the portfolio level I agree with MrB. I don’t lever my firm’s portfolio. Right now I cannot remember exactly who was it, but someone once said: “A good investment is just that, leverage doesn’t make it any better or worse.” Probably, he used slightly different words, but I think the meaning is clear.

 

What has helped me is to understand what makes a good high yield investment for those firms who have a good amount of debt.  The book How to Make Money in High Yield Bonds by Levin provides a nice framework.

 

Packer

 

Packer, thank you for the suggestion: I haven’t read that book yet, but I will buy it right away!

 

giofranchi

[twacowfca]

The leverage on BRK's BS is about as good as it gets: float at zero cost or less.  No need to pay it back for the most part. An interest free loan if their underwriting is good.  Compare that to a company that had a large amount of conventional debt with interest and principal to pay and covenants whereby the lender could increase the interest rate or call the loan if something deteriorates.

 

I couldn't agree more. That's why, the only leveraged companies I am interested in are insurance companies. As a rule of thumb, I look for insurance companies with management whose skills are above average, and with underwriting and investment leverage that are below average. That makes me sleep soundly at night.

I am not a full time money manager. I run businesses. And I invest in companies that I like, as if their operations became my firm’s operations too. The only difference is that I don’t manage them personally. I don’t jump from one undervalued stock to the other. So, I have never thought hard enough about how good an investment in overleveraged companies at ridiculously low prices might turn out to be. I just don’t want the operations of overleveraged companies to be part of my firm’s operations. Therefore, I don’t look at them.

 

Therefore you can probably get to an answer if you have a portfolio with two retail banks, but as soon as you have one retail bank and one investment bank it gets trickier and the makeup of your typical portfolio makes that unanswerable in my view and that is why I just stay away from leveraging the portfolio and stay away from companies with debt.

 

At the portfolio level I agree with MrB. I don’t lever my firm’s portfolio. Right now I cannot remember exactly who was it, but someone once said: “A good investment is just that, leverage doesn’t make it any better or worse.” Probably, he used slightly different words, but I think the meaning is clear.

 

What has helped me is to understand what makes a good high yield investment for those firms who have a good amount of debt.  The book How to Make Money in High Yield Bonds by Levin provides a nice framework.

 

Packer

 

Packer, thank you for the suggestion: I haven’t read that book yet, but I will buy it right away!

 

giofranchi

 

Mr. B put it very well. 

 

One should look through the company to the risk characteristics of the industry, the country and the economic sphere.  If one added up all the leverage on the BS 's of the banks BRK owned, the conclusion would be that BRK's leverage is more than double what it appears to be.  However, that leverage is non recourse to BRK, and the banks it owns are mostly the very best large banks in a country where the government is a credible backstop.

 

We share your attraction to insurance companies.  A number of US insurance companies experienced a gain of more than 100 times in their market prices from the 1930's through the early 1970's as interest rates slowly rose.  Banks that survived the depression did OK, but not spectacularly.

 

Most of our assets since 2005 have been invested in various proportions of three owner operated P&C insurance companies  that have done very well through the financial turmoil with far less volatility than banks.

 

[Packer16]

Can you provide some of the 100x insurance co increase during that time?  Thx.

 

Packer

[anders]

MrB, thank you for your answer. However, I disagree with the notion that portfolio leverage is not akin to company leverage. I view my portfolio as a company and, a share is part ownership of a business, thereby exchanging the net cash for a new constellation of capital structure.

 

So why thinking about this issue, why not stay away from companies with debt? Well, a) I dont like to shrink my universe of opportunities b) using only equity for a company is an expensive form of doing business c) it is a component of RoE, used wisely it allows companies to turn over their assets at a higher rate d) even with a conservative leverage ratio in the company, it magnifies compound interest.

 

I agree that it is probably unanswerable with no universal answer and, that leverage is addictive, but that doesn't necessarily mean that one should only invest in insurance companies or stay away from companies with a debt structure.

 

Packer, thanks for recommending the book, I will make sure to read it,

 

Best,

[Green King]

MrB, thank you for your answer. However, I disagree with the notion that portfolio leverage is not akin to company leverage. I view my portfolio as a company and, a share is part ownership of a business, thereby exchanging the net cash for a new constellation of capital structure.

 

So why thinking about this issue, why not stay away from companies with debt? Well, a) I dont like to shrink my universe of opportunities b) using only equity for a company is an expensive form of doing business c) it is a component of RoE, used wisely it allows companies to turn over their assets at a higher rate d) even with a conservative leverage ratio in the company, it magnifies compound interest.

 

I agree that it is probably unanswerable with no universal answer and, that leverage is addictive, but that doesn't necessarily mean that one should only invest in insurance companies or stay away from companies with a debt structure.

 

Packer, thanks for recommending the book, I will make sure to read it,

 

Best,

 

I don't he is saying its can't be done. It just brings another level of complexity and vulnerability. If you can manage with leverage more power to you. Which might not be worth it, Sometimes the best thing to do is to do nothing at all. There is also the temptation of the devil that tempt us to far from where it is safe.

 

There is no absolute truth that apply to everything.

Question: Like what is the meaning of everything ? Answer: seven  :D

 

Just mental frame works to apply to the context of the investment problem.

direction for answer there is too.

Avoid it

or

Learn what others have done. Apply it and use the rest of your life to refine it and search for the question with no answer.

 

Sorry for rambling.

 

[giofranchi]

I agree that it is probably unanswerable with no universal answer and, that leverage is addictive, but that doesn't necessarily mean that one should only invest in insurance companies or stay away from companies with a debt structure.

 

No, absolutely! You are surely right! All I was saying is what I do, to choose those companies “whose operations I like to become parts of my own firm’s operations”. I was not saying what SHOULD be done! Vice versa, I hastened to point out that I don’t have any particular insights into over-leveraged situations, that sell for ridiculously low prices. They might be excellent investment opportunities, but I just don’t venture there. When I buy a business, I want its operations to really become part of my firm’s operations for as long a time as possible. So, I run a very concentrated portfolio, because I must know everything possible about those businesses, and I concentrate on the quality of their operations. And, in my experience, high-quality businesses very seldom are over-leveraged. Therefore, as you can see, I don’t have really nothing against great investment opportunities in over-leveraged companies at wonderful prices! It is just that my goal tends to keep me away from them.

 

giofranchi

[MrB]

MrB, thank you for your answer. However, I disagree with the notion that portfolio leverage is not akin to company leverage. I view my portfolio as a company and, a share is part ownership of a business, thereby exchanging the net cash for a new constellation of capital structure.

 

So why thinking about this issue, why not stay away from companies with debt? Well, a) I dont like to shrink my universe of opportunities b) using only equity for a company is an expensive form of doing business c) it is a component of RoE, used wisely it allows companies to turn over their assets at a higher rate d) even with a conservative leverage ratio in the company, it magnifies compound interest.

 

I agree that it is probably unanswerable with no universal answer and, that leverage is addictive, but that doesn't necessarily mean that one should only invest in insurance companies or stay away from companies with a debt structure.

 

Packer, thanks for recommending the book, I will make sure to read it,

 

Best,

 

It is important to know what you are doing and to remember that there are no extra points for solving difficult puzzles with investment. For me, which does not mean its the same for you, it is a case of too complex and too difficult and I can get more out of my time by spending it elsewhere.

Leverage is not what gets you in trouble it is going to be only one check (claim on your asset) that you sent to meet the liability (interest payment or margin call) that does not clear. So it is the liability that gets you in trouble, not the leverage. Put differently; using $1m of leverage with money you borrowed from your billionaire unmarried childless uncle of whom you happen to be his blue eyed boy is a different liability when using $1m you borrowed from the local loan shark who also happened to be the local drug lord that might urgently need that money if his deal of a lifetime goes bad next Saturday night. I'm actually trying to make a serious point. Accounting and our attempts of analysis does not even try and account for that, instead we talk about leverage of 10:1 and 1.6:1 and LTCM as if it is the same thing. It is not because the liability of float, depositors and loans are vastly different.

 

For the bog standard retail bank it means taking the interest payment you received this month and passing it straight on to the depositor while clipping the coupon. With the crop farmer it is significantly more difficult, because you have to plant the crop and then it might or might not rain for several years and then only will you get paid. In the meantime you need to have checks that clear. Now having both those in your portfolio produces very erratic cash flows and now you introduce portfolio leverage into this mix.  You don't have a claim on those cash flows, you have a claim on a claim to those cash flows (say equity) and that claim (share) is priced imperfectly (share price). If you can deduce those cash flows and your portfolio liability (say margin) into the risk of permanent capital loss then you should do it. For my portfolio no thank you. For my business, absolutely and that is why I leverage it by using OPM as my main liability, but strictly on my terms.

 

Looking at it yet another way. "Value" investors, by the way I hate that term, are relatively ignorant of volatility and have investment horizons that probably average 3-5 years compared to the less than 1 year for the market. I think that most market participants will agree 100% with the thesis of say AIG on this board, but because they are in the sub 1 year and scared of volatility camp they cannot buy the stock. We can and we do and portfolio leverage reduces that advantage because with leverage you will enjoy increased upside and downside plus you increase the risk of being called out of position under 3-5 years.

 

So there you go; I just beat GK at rambling, but it should provide ideas to play around with.

 

 

[giofranchi]

Looking at it yet another way. "Value" investors, by the way I hate that term, are relatively ignorant of volatility and have investment horizons that probably average 3-5 years compared to the less than 1 year for the market. I think that most market participants will agree 100% with the thesis of say AIG on this board, but because they are in the sub 1 year and scared of volatility camp they cannot buy the stock. We can and we do and portfolio leverage reduces that advantage because with leverage you will enjoy increased upside and downside plus you increase the risk of being called out of position under 3-5 years.

 

Thank you MrB! Always very interesting!

When I look at some possible investment for my firm, I usually think of operations that I would like to own, and a team of managers that I would like to partner with, for the next 20 years. That would seem extreme to you… But, at the end of his career, Mr. Graham acknowledged that his gaining in GEICO had been more than all the other gains of Graham-Newman combined; similarly, Mr. Munger often said that the bulk of Berkshire’s returns might be attributable to their 10 best ideas, See’s Candies, GEICO, The Washington Post, Coca Cola, etc., all investments that Berkshire held for 20+ years.

I really look for operations that might enhance my firm’s operations, and make it a stronger and more secure organization, for as long as my firm will last.

 

giofranchi

[Kraven]

MrB, thank you for your answer. However, I disagree with the notion that portfolio leverage is not akin to company leverage. I view my portfolio as a company and, a share is part ownership of a business, thereby exchanging the net cash for a new constellation of capital structure.

 

I think that this kind of sentiment demonstrates how some value investors take certain things to the extreme.  You may view your portfolio as a company.  It is not.  It is not anything close to it.  You may view 100 shares of GM or whatever as part ownership of the car company, and yes, of course technically it is, but there is reality to deal with.  Let's think about it for a second.  So with that 100 shares would you view yourself as owing the US government your pro rata portion of the debt still outstanding?  Are you limited in the amount of salary, etc you can receive?  Is Treasury on the phone with you every day?  Of course not.  So then it must be that a true look through doesn't make complete sense.

 

Graham said it best when, and I'm paraphrasing, stock ownership is the best of both worlds.  It is both actual ownership of the company, but without the headaches of true ownership.  If you want to be an owner you can try to act like one.  If all you want is a piece of paper, well, you got that too.  But it doesn't mean you should view the debts and leverage of a stock you own as your own debts and leverage.  I suppose there is a level of ownership (well below actual control) where such a view makes sense at least on the basis of how one is affected by the economics.  But unless that's where you're at I think that taking it to this kind of extreme is more harmful than helpful.

[giofranchi]

I suppose there is a level of ownership (well below actual control) where such a view makes sense at least on the basis of how one is affected by the economics.  But unless that's where you're at I think that taking it to this kind of extreme is more harmful than helpful.

 

Kraven,

What is exactly the “level of ownership” you are referring to? And why above that level should it be safe to think of stocks as parts of a business, while below that level it is more harmful than helpful?

 

Most of you are money managers and for you it is perfectly fine to look at stocks as pieces of paper: you just can go on buying those pieces of paper that are the cheapest, waiting for their true value to be recognized, selling them, and looking for the next cheapest pieces of paper you can find. It is a perfectly sound way to become very rich!

 

But businessmen generally don’t act that way. At least, no one that I know of acts that way (and I know and work with a lot of very successful businessmen). Businessmen don’t have the time to study how to jump safely from one piece of paper to the next. Allocation of capital is a very important responsibility, probably the most important one. But it is far from being the sole responsibility of any businessman. Businessmen try to judge the future prospects of a business, the soundness of its business model, the reliability of its management, and, if they like what they see, they try to buy it at a good price. Later, they do not sell, just because the stock price has advanced 30%. They think they will get much more in the future. It was E. H. Harriman who said: “I am not looking for a 15% return, I want something that will grow.”

 

Of course, you must always recognize a very good bargain, when you see one. And at a certain price any business should be sold.

 

The control ownership you referred to is something most businessmen experience every day. I personally control two different but related businesses. Anyway, even in control ownership it is surprising how much you must rely on other people! You are a business owner if you possess a machine that creates wealth and DOESN’T DEPEND ON YOU to achieve that goal. Otherwise, you don’t have a business, you just have a job. Every businessman depend on other people and their abilities and judgment. It is true that in controlled businesses the strategy is up to you, but for the execution you must always rely on others. And strategy, without a careful and effective execution, is useless most of the time.

I am not here to say that control ownership and stocks ownership are not different. They surely are. But also in control ownership you must judge people every day, you must rely on them, and the ultimate success is much less dependent only on yourself than you might like to think.

 

giofranchi

[scorpioncapital]

I don't think calleability of leverage is particularly that important. The central issue is the success or failure of the investment. Whether my loan can be called and I lose part of my shares or investment seems to mean very little even if that loan can't be called and it has dropped to such an extent to make my return very low. If my house is worth half of what I paid for it and I have to wait 10 years to get to break-even, the penalty is in the rate of return, not that I didn't lose my house. I could very well lose my house, and use whatever cash is left over and make another investment. As a sidenote, a major study was done showing that even with margin calls, young people would still have a higher overall return if using leverage than just cash. The conventional wisdom is that recklessness doesn't pay off, perhaps this is only a half-truth.

 

The truth is that recklessness in investment selection is far more damaging than recklessness in financing that investment.

[MrB]

 

The control ownership you referred to is something most businessmen experience every day. I personally control two different but related businesses. Anyway, even in control ownership it is surprising how much you must rely on other people! You are a business owner if you possess a machine that creates wealth and DOESN’T DEPEND ON YOU to achieve that goal. Otherwise, you don’t have a business, you just have a job. Every businessman depend on other people and their abilities and judgment. It is true that in controlled businesses the strategy is up to you, but for the execution you must always rely on others. And strategy, without a careful and effective execution, is useless most of the time.

giofranchi

 

LOL! That is a classic line.

[giofranchi]

Yes! Right now I don’t remember exactly where I first read that judgment, but it rang true as soon as I did! And it stayed with me ever since! Many times you just experience something and then someone else writes about it and you click on it immediately!

Imho, it is true and I live it every day.

 

giofranchi

[Kraven]

I suppose there is a level of ownership (well below actual control) where such a view makes sense at least on the basis of how one is affected by the economics.  But unless that's where you're at I think that taking it to this kind of extreme is more harmful than helpful.

 

Kraven,

What is exactly the “level of ownership” you are referring to? And why above that level should it be safe to think of stocks as parts of a business, while below that level it is more harmful than helpful?

 

 

Giofranchi - I am chuckling a bit.  I think you took my post in directions all your own.  I will admit, I kind of just skimmed your post as I don't have that much time, but it seems as if you wrote about how business owners think of their business.  Yes?  That's all fine.  I think you missed my point.  I don't think I disagree with what you said, but it's different from what I said.

 

Remember I was responding to a post by someone who said that they view their portfolio as a company and that they attribute the underlying portfolio company's leverage, etc as being essentially part and parcel of the portfolio as a whole.  My point was simply that while one can view their portfolio as a "company" with the pro rata attributes of the underlying companies, that would be at best incredibly misleading and at worst, just completely wrong.  I believe I further said that if this was true, then if one owned some shares in GM, as and example, or say a bank with TARP outstanding should that person view themselves as having obligations under TARP?  Are they restricted on the salary they can receive?  Do they need to check in with Treasury constantly?

 

This is where things get fuzzy. Clearly ownership of a share of stock is partial ownership of the company.  But in some respects that's just a technicality.  It's almost a fiction we create for ourselves.  We own, but do we really own?  To be or not to be?  If I own shares of McDonald's can I walk in and get a free shake?  I mean you refer to "actual" business owners.  If I own a local diner, I sure can walk in and grab something without paying (since I already have paid).

 

So while we need to think like owners in terms of when to buy, sell, etc., taking advantage of our rights, and such, I think it can be taken to an extreme.  It's kind of like Buffett's 20 punches.  Does he literally mean that one should own 20 stocks?  Well, maybe, in some kind of utopian stock world.  But if so, he hit his 20 punches about a million years ago.  It's a way of thinking that I don't think is intended to be taken literally. 

 

Hope I made some sense.

[LC]

 

This is where things get fuzzy. Clearly ownership of a share of stock is partial ownership of the company.  But in some respects that's just a technicality.  It's almost a fiction we create for ourselves.  We own, but do we really own?  To be or not to be?  If I own shares of McDonald's can I walk in and get a free shake?  I mean you refer to "actual" business owners.  If I own a local diner, I sure can walk in and grab something without paying (since I already have paid).

 

 

I'll disagree....slightly. Because I don't agree with your example.

 

Visibility is the issue your example illustrates, not control. Can the store manager of a random McDonalds get free burgers? Surely. If a portfolio manager whose fund owns 8% of the company walks into that same McDonalds, will he get a free burger? Probably not because nobody working there knows who he is.

 

[Kraven]

 

This is where things get fuzzy. Clearly ownership of a share of stock is partial ownership of the company.  But in some respects that's just a technicality.  It's almost a fiction we create for ourselves.  We own, but do we really own?  To be or not to be?  If I own shares of McDonald's can I walk in and get a free shake?  I mean you refer to "actual" business owners.  If I own a local diner, I sure can walk in and grab something without paying (since I already have paid).

 

 

I'll disagree....slightly. Because I don't agree with your example.

 

Visibility is the issue your example illustrates, not control. Can the store manager of a random McDonalds get free burgers? Surely. If the portfolio manager whose fund owns 8% of the company walks into that same McDonalds, will he get a free burger? Probably not because nobody working there knows who he is.

 

Sorry, I never answered the question about control.  I don't disagree with you at all and my example wasn't related to control at all, only ownership.  So Berkshire owns 10% of Coke or whatever percentage  it is.  Obviously Buffett can't stroll into the distributor and grab a 6 pack.  When I was a kid my best friend's dad owned a Mobil gas station.  We used to just walk in and grab a soda and a pack of gum.  It's different obviously.

 

My point about control was simply one of perception and degree.  That is, if I own 100 shares of Coke do I really envision myself as having a pro rata portion of their debt?  That's what the prior poster said (not about Coke, just generally).  So Coke has 30 some odd billion in debt.  So with my 100 shares do I have .000000001% of that debt (I am sure my math is wrong)?  The stock goes up, it goes down.  Whether to buy it, sell it or hold it is a multi faceted analysis of which debt levels is obviously a part.  When one thinks "like an owner" I believe this means that one envisions themself as if they owned the company.  What would they pay?  That kind of thing.  There is an amount of ownership (control wasn't the right word, I intended to mean level of ownership) where I think that one moves on the spectrum from a creative fiction to a reality.  Just my 2 cents (and a few more).

[anders]

MrB,

Accounting and our attempts of analysis does not even try and account for that,

Excellent point, I agree and you gave great feedback for me to play around with.

If I interpret what you are saying correctly then; just as you can't compensate for risk or create MoS by simply increasing the discount rate, you cant define risk of debt in absolute terms since it comes in different forms and variations.

 

giofranchi, many thanks for input and putting value on the table.

 

Kraven

When one thinks "like an owner" I believe this means that one envisions themself as if they owned the company.  What would they pay?  That kind of thing.  There is an amount of ownership (control wasn't the right word, I intended to mean level of ownership) where I think that one moves on the spectrum from a creative fiction to a reality.

 

You provide very good arguments and I thank you for it. It is a pleasure to get inputs from other angles. That said, you know when Graham said that "investing is most intelligent when it is most businesslike" and then later Buffet said that "these are the nine most important words ever written about investing." Maybe I take this to the extreme but hear me out. I have a company that has cash as an asset (portfolio) and, if I use that asset to buy 100% of a company, it would be natural for both investors and accountants to consolidate that new capital structure into the company. So is it then not logical to think that buying 1% would should create the same pattern, even if accounting states it differently? When I invest, I write down how much my shares generate, ie I own 1/100 and the company earns 100 dollars, my shares generated 1 dollar, regardless of fluctuations in market price and where the price will be year end. I also sum up how much equity in x amount to see how much that is covered from company failure, it would be illogical to leave out the debt since all three financial statements are integrated. I might be wrong, but it helps me to view things as a businessman.

 

Best,