Ask Eric!

[ERICOPOLY]

I understand so little about business, I usually don't feel comfortable investing in the majority of ideas presented on this board.  Literally, I just get so confused trying to figure them out that it's hopeless.

 

I guess that explains the concentration.  Finally I can understand something well and that's such a rare experience for me that I get carried away with the position sizing.

 

[ERICOPOLY]

Perhaps that's what Buffett refers to when he talks about 1 ft hurdles.

 

For me, my self esteem (with regards to my business knowledge) is so low that nearly everything goes into the "too hard" pile.  If it takes complexity, I'm lost.

 

It has to be a very simple proposition for me to understand it (and I guess that's what a 1 ft hurdle is, after all).

[hyten1]

eric i am really surprise by your statement about 1 ft hurdle etc.

 

i am surprise because you pick BAC as your 1 ft hurdle, can you elaborate on that? I  mean most people would think BAC is far from 1 ft hurdle due to its size and complexity and that its a bank after all.

 

hy

[Palantir]

eric i am really surprise by your statement about 1 ft hurdle etc.

 

i am surprise because you pick BAC as your 1 ft hurdle, can you elaborate on that? I  mean most people would think BAC is far from 1 ft hurdle due to its size and complexity and that its a bank after all.

 

hy

 

This.

[ERICOPOLY]

The capital levels (no serious dilution risk).

 

The years of being in a hard market (only the best credits getting a loan).

 

The scrutiny by regulators.

 

The visible underlying earnings power (once LAS runs off)

 

The business on every street corner.

 

Boring business model.  Simple.  No fancy innovation to maintain their lead over competitors (like with tech companies)

 

Trading a 2x best case normalized earnings, 5x worst case.

 

Simple proposition from how I see it. 

[BG2008]

Eric,

 

Thanks for answering these questions.  I have some detailed questions regarding position sizing, conviction, and concentration on your Call/LEAPs/Warrants. 

 

1) Is there a duration that is too short for you even if you can anticipate a catalyst?  If you know that an activist has gained control and will shake things up for a net net and the longest duration is say 9 months and you know that the activist will shake things up within 6 months.  Would you do that trade? 

 

2) Have you ever applied CALL/LEAP to spinoff strategies?  i.e. ITT spinoff into Xylem, ITT, etc Alexander and Baldwin.  Situations where sum of parts is higher than what the stock is trading at.  If you have done this in the past, does this strategy work? 

 

3) Do you buy OTM, ITM.  How much OTM, ITM?  How do you optimize between the most leverage and the least capital at risk?  Any general rules of thumbs?

 

4) Do you only buy calls/LEAPs on ideas that are high conviction?  If the risk/reward is very skewed, say 20 to 1 with the probability of 30%, would you do that trade? 

 

5) Can you share some additional "tea leaf reading" techniques?  i.e. Fairfax in 2008, Major CDS gains not reflected in the stock.  Odyseey Re buying out public subs and the SEC filing.  In 2009, I also bought some calls on BRK.B knowing that the market had rallied a good amount which will be reflected as paper gains on BRK.B earnings and the market had not priced that in.  I can share some as well, recently Baker Street Capital bought over 20% in a net-net called Xyratex.  Baker Street Capital is known for getting things done as an activist.  Within a few months, the company paid a $2 special dividend, Baker Street just got board seats, and the stock trades at $10.40 today net of the $2 dividend.  When Baker Street filed, I bought some shares at $8.25 (pre-diviend).

 

6) How do you think about being long calls/Leaps on something that's really cheap and then 08/09 comes along?  How do you size it the call/leaps?  Do you buy puts to hedge out black swan risk just in case? 

 

Thanks! 

[Yours Truly]

Can you tell us more on your first few initial ventures into the strange and wonderful world of options? and how has your understanding/strategy changed since then?

[ERICOPOLY]

I'm get the feeling that it's hard to believe somebody with little investing talent can have made extremely high returns.

 

There were a few times when it seems like a Lallapallooza moment had arrived, and I took a really big crack at it.

 

I wasn't even looking for these opportunities.  This board just tends to get very excited when these things come along -- fortunately, I understood the proposition well enough to take full advantage.  I am about the laziest and most underserving of these returns if you were to see how I spend the day.

 

Right now, such as with SD, there is a lot of excitement but I just don't have a clue -- so I'm not getting involved.  That might be the best ever investment yet, but I just don't know drilling from a hole in the ground.

 

I don't have an options strategy where I go around looking for a nail to pound.  I'm not even actively looking for nails.  I don't know when I'll have the next 20% year, let alone the next 75% year.  Maybe never on both counts. 

 

I only brought up my returns because it just so happens that it is rather interesting what a few well-timed investments can do -- and the ideas came from reading this board so I thought it worthwhile sharing.  You can think of it like one of those wax museum displays if you like -- just a rubber necking opportunity, but otherwise I'm not professing to be of any special talent.

 

 

 

[hyten1]

eric when you notice/see the next lalapallooza opportunity please let us know :)

[Kiltacular]

I'm get the feeling that it's hard to believe somebody with little investing talent can have made extremely high returns.

 

I believe it. 

 

I don't know Ericopoly.  I guess I've had one recent, non-investment related exchange with him. Other than that, just watched from the sidelines since the original board and the Fairfax days.

 

While I naturally can't vouch for the dollar amounts involved, I have every reason to believe they're entirely accurate.  But, I can pretty much vouch for the percentage returns.  The recent time he posted them isn't the first time.  There was at least one earlier post from him on this and possible one a long time ago.

 

What I also know is that, unlike a very few others I've ever seen online, he has both noted in real time what he was doing as well as the percentage of his portfolio.  Granted, I guess there has been room for fibbing but I just doubt it.  This hasn't been something where he just mentioned one day: "Oh, well, here are the trades I made the last five years." 

 

On the one hand, it isn't that big a deal.  On the other hand, it perfectly captures what Munger has said is THE way to get wealthy investing...especially when you're young and starting with a smallish dollar amount -- as Ericopoly was originally.  You can afford to lose and taking some big swings and a bit of non-recourse leverage is actually quite rational.

 

So, it has been fun -- a ton of fun -- to watch this over the years.

 

Buffett once said to Munger:  "Charlie, it isn't Greed that drives the world, it's Envy."

 

Let's stick to just being Greedy and not let Envy ruin the show. 

 

If you can just be Greedy (in the best possible sense that all human beings naturally are), you're going to go a lot further than those who never realize it is Envy that gets them into trouble.

 

Envy is THE killer.

 

My 2cents

[biaggio]

I'm get the feeling that it's hard to believe somebody with little investing talent can have made extremely high returns.

 

I believe it. 

 

I don't know Ericopoly.  I guess I've had one recent, non-investment related exchange with him. Other than that, just watched from the sidelines since the original board and the Fairfax days.

 

While I naturally can't vouch for the dollar amounts involved, I have every reason to believe they're entirely accurate.  But, I can pretty much vouch for the percentage returns.  The recent time he posted them isn't the first time.  There was at least one earlier post from him on this and possible one a long time ago.

 

What I also know is that, unlike a very few others I've ever seen online, he has both noted in real time what he was doing as well as the percentage of his portfolio.  Granted, I guess there has been room for fibbing but I just doubt it.  This hasn't been something where he just mentioned one day: "Oh, well, here are the trades I made the last five years." 

 

On the one hand, it isn't that big a deal.  On the other hand, it perfectly captures what Munger has said is THE way to get wealthy investing...especially when you're young and starting with a smallish dollar amount -- as Ericopoly was originally.  You can afford to lose and taking some big swings and a bit of non-recourse leverage is actually quite rational.

 

So, it has been fun -- a ton of fun -- to watch this over the years.

 

Buffett once said to Munger:  "Charlie, it isn't Greed that drives the world, it's Envy."

 

Let's stick to just being Greedy and not let Envy ruin the show. 

 

If you can just be Greedy (in the best possible sense that all human beings naturally are), you're going to go a lot further than those who never realize it is Envy that gets them into trouble.

 

Envy is THE killer.

 

My 2cents

 

Thanks for post Kilt.

 

Agree with it all.

 

Must admit that I do feel envious and I do not feel greedy at all-might be something I need to work on.

 

I think Eric is being humble saying that he has little investing talent---maybe its not investing talent (I think it is) but its some sort of talent that has worked incredibly well.

 

Has been entertaining and helpful

[meiroy]

 

Eric, (I'm assuming it's your name because the thread is titled Ask Eric and not Ask Dostoyevsky)

 

I've been reading that fantastic Charlie Munger article Art of Stock Picking where he mentions that the most important mental model in a sense is the permutations and combinations. As soon as I read it I was thinking of you and the way you express yourself as if you are going through a decision tree, passing through the combinations.  Now, I can understand the idea in general and have been using this way of thinking myself, a bit, but not too clear how it applies in other ways to investing.  Would be greatly appreciate if you (you'd probably come back and say you never heard about this article) or someone else could elaborate on it. Thanks.

 

[ERICOPOLY]

 

Eric, (I'm assuming it's your name because the thread is titled Ask Eric and not Ask Dostoyevsky)

 

I've been reading that fantastic Charlie Munger article Art of Stock Picking where he mentions that the most important mental model in a sense is the permutations and combinations. As soon as I read it I was thinking of you and the way you express yourself as if you are going through a decision tree, passing through the combinations.  Now, I can understand the idea in general and have been using this way of thinking myself, a bit, but not too clear how it applies in other ways to investing.  Would be greatly appreciate if you (you'd probably come back and say you never heard about this article) or someone else could elaborate on it. Thanks.

 

I haven't read that article, maybe I should!

 

I got a "B" in my Combinatorics class at UCLA.  So I'm familiar with it but I didn't get the top grade.

 

Chess would train your mind well though to practice thinking several moves down the road.  I like it but I'm not going to beat a serious and regular player.

 

And professionally I was a software stress tester/programmer.  You have data shared between threads, they can both be reading and writing to that data, and you have to coordinate them with locks but do so without having a thread use the lock too much (or they'll all be lined up waiting for the lock).  So doing that kind of work for 10 years might also help with this kind of thinking -- especially the bit about multiple threads off doing their own thing and making sure there aren't improper reads and writes.  Good mental exercise if nothing else.

 

Probably the software influence was the best because I did it the longest.  Multithreaded programming is hard to do correctly.  I took a Parallel Computing class at UCLA and that was even harder than multithreaded programming.

 

But my GPA was only 3.2 or 3.17 perhaps (I forget).  I didn't even get low honors.  I was out of my league and should have been studying something easier.

 

[meiroy]

Quoting from the article:

 

"First there's mathematics. Obviously, you've got to be able to handle numbers and quantities—basic arithmetic. And the great useful model, after compound interest, is the elementary math of permutations and combinations. And that was taught in my day in the sophomore year in high school. I suppose by now in great private schools, it's probably down to the eighth grade or so.

 

It's very simple algebra. It was all worked out in the course of about one year between Pascal and Fermat. They worked it out casually in a series of letters.

 

It's not that hard to learn. What is hard is to get so you use it routinely almost everyday of your life. The Fermat/Pascal system is dramatically consonant with the way that the world works. And it's fundamental truth. So you simply have to have the technique.

 

Many educational institutions—although not nearly enough—have realized this. At Harvard Business School, the great quantitative thing that bonds the first-year class together is what they call decision tree theory. All they do is take high school algebra and apply it to real life problems. And the students love it. They're amazed to find that high school algebra works in life....

 

By and large, as it works out, people can't naturally and automatically do this. If you understand elementary psychology, the reason they can't is really quite simple: The basic neural network of the brain is there through broad genetic and cultural evolution. And it's not Fermat/Pascal. It uses a very crude, shortcut-type of approximation. It's got elements of Fermat/Pascal in it. However, it's not good.

 

So you have to learn in a very usable way this very elementary math and use it routinely in life—just the way if you want to become a golfer, you can't use the natural swing that broad evolution gave you. You have to learn—to have a certain grip and swing in a different way to realize your full potential as a golfer.

 

If you don't get this elementary, but mildly unnatural, mathematics of elementary probability into your repertoire, then you go through a long life like a onelegged man in an asskicking contest. You're giving a huge advantage to everybody else.

 

One of the advantages of a fellow like Buffett, whom I've worked with all these years, is that he automatically thinks in terms of decision trees and the elementary math of permutations and combinations...."

 

[ERICOPOLY]

One of the advantages of a fellow like Buffett, whom I've worked with all these years, is that he automatically thinks in terms of decision trees and the elementary math of permutations and combinations...."

 

I am much the same way but nowhere near as bright as Buffett.  One thing I have is a terrible memory and I understand that Buffett forgets very little of the numbers he reads in annual reports.  So he has eyesight and I'm practically blind.

 

This is one reason why I don't research companies the way he does -- it's very frustrating to read reams of data and to get nowhere in terms of retention.

 

But like anyone with a disability, I adapt and develop new strengths.  Such as cheating over the shoulder of people who do the research.  Then once they are convinced it's a good investment, I try to reverse engineer why it's a good investment.  If it clicks, I invest.  But that's long winded for saying I'm a dumb-ass.

[JBird]

One of the advantages of a fellow like Buffett, whom I've worked with all these years, is that he automatically thinks in terms of decision trees and the elementary math of permutations and combinations...."

 

I am much the same way but nowhere near as bright as Buffett.  One thing I have is a terrible memory and I understand that Buffett forgets very little of the numbers he reads in annual reports.  So he has eyesight and I'm practically blind.

 

This is one reason why I don't research companies the way he does -- it's very frustrating to read reams of data and to get nowhere in terms of retention.

 

But like anyone with a disability, I adapt and develop new strengths.  Such as cheating over the shoulder of people who do the research.  Then once they are convinced it's a good investment, I try to reverse engineer why it's a good investment.  If it clicks, I invest.  But that's long winded for saying I'm a dumb-ass.

 

People who are genuinely humble about their IQ can sometimes make far fewer mistakes if they do the necessary work, have a sound investment process and think in rational ways. - Charlie Munger

 

Eric's rationality is something to be admired.

[Yours Truly]

Eric's a great market timer too (see MBIA thread)

[ERICOPOLY]

He is also a good cheater -- he didn't even notice the silence over the MBI/BAC settlement.  That was somebody else's keen perceptions that pointed out the deafening silence.  He just treated that like insider information and made the purchase.

 

Meanwhile Raj rots in jail...

 

[berkshiremystery]

He is also a good cheater -- he didn't even notice the silence over the MBI/BAC settlement.  That was somebody else's keen perceptions that pointed out the deafening silence.  He just treated that like insider information and made the purchase.

 

Meanwhile Raj rots in jail...

 

I also noticed your silence in the last weeks, because you did post less frequently, thus somehow I felt you are just lazy taking some days off or your brain is working on something big. And finally yesterday was some incredible opportunistic day,... comparable with the short sale bans in financial stocks and also that special ORH opportunity.

[ERICOPOLY]

He is also a good cheater -- he didn't even notice the silence over the MBI/BAC settlement.  That was somebody else's keen perceptions that pointed out the deafening silence.  He just treated that like insider information and made the purchase.

 

Meanwhile Raj rots in jail...

 

I also noticed your silence in the last weeks, because you did post less frequently, thus somehow I felt you are just lazy taking some days off or your brain is working on something big. And finally yesterday was some incredible opportunistic day,... comparable with the short sale bans in financial stocks and also that special ORH opportunity.

 

That was partly because my wife and I divided our forces and I took one child and she took the other (visiting her mother with the one child).  Then this past weekend I took one child to my parents and she kept the other one behind.

 

I volunteered as t-ball coach assistant and had to spend time on YouTube figuring out how to organize t-ball drills.  I'm also in negotiations to get a purchase option for the home that I am renting.

 

So, a lot going on the past couple of weeks. 

 

MBI (to me) is another of those "insider trading" plays similar to ORH.  Now that there are two such home runs I'm going to call that the "insider trading" bucket.  In one case it was a settlement telegraphed, in the other it was a privatization telegraphed.  In both cases somebody else on the board divined it, and then shared the info with all of us.  Quite happy to take no credit for any of this!

 

 

 

[Aberhound]

You have enjoyed big returnsw on two of three of Berkowitz's big bets MBIA and BAC. Are you invested in Sears? How would you comment on the following points I picked up reading?

 

1. Berkowitz: The trick is to find permanent capital. Buffet did it with BRK. Lampert is doing it with Sears. I am limited to a 5% position in BAC in the mutual fund and if I could I would own a lot more. Real estate offers getting closer to full value. I like to invest in things which for half value which will rise to full value. Sears is selling and closing unprofitable stores leaving the profitable stores.

 

2. Lampert: Main points from my reading: Dramatically increasing online sales while selling loss making stores then liquidating inventory paying back debt and buying shares steadily.

 

3. ESL: Selling a big position steadily at and below current stock price.

 

4. American consumer: Middle class being squeezed but pent up demand building for many years. Eventually the fridge needs to be replaced. More people can now move because of the increase in home prices and sales allowing the step up or step down which often causes new appliances to be purchased. Numerous rentals acquired from banks many of which by funds which replace appliances all the same.

 

5. Short squeeze. Lampert intend to take it private so the run up for the last shares will create a spike if Lampert does a deal.

 

6. Possible Catalyst: There is always a possibility of a big deal unloading many similar type stores to other retailers of private equity fun expanding some successful idea followed soon afterwards by Lampert taking the company private. Private equity has good access to cheap capital and might want to acquire all the downtown properties for instance as a store of value while Lampert may want only the easy to drive to and park stores for pick up with most sales online.

 

7. Valuation: Not cheap in view of current losses but tax losses and real estate values not reflected on balance sheet. Perhaps the biggest value not in the balance sheet is mentioned by Berkowitz: Once the remaining stores are profitable and throwing off cash flow which Lampert reinvests the value rises substantially.

 

What I am really trying to do is to draw out your method of analysis in choosing or rejecting the idea. I was invested in MBIA but I was killed by the time decay on the LEAPS I held. I switched to BAC. Calonego has a good post warning about options which I should have read.

[hyten1]

eric fascinating

 

its funny, for me when i read someones speculation that something is going on due to the silence from Mbi and Bac, i for one paused a little but concluded its prob not much, however you and others thought otherwise

 

the only excuse i have is i have not been following MBI as closely and didn't think the recent silence was worth noticing (considering its earnings period)

 

obviously I was wrong :(

 

hy

 

He is also a good cheater -- he didn't even notice the silence over the MBI/BAC settlement.  That was somebody else's keen perceptions that pointed out the deafening silence.  He just treated that like insider information and made the purchase.

 

Meanwhile Raj rots in jail...

 

I also noticed your silence in the last weeks, because you did post less frequently, thus somehow I felt you are just lazy taking some days off or your brain is working on something big. And finally yesterday was some incredible opportunistic day,... comparable with the short sale bans in financial stocks and also that special ORH opportunity.

 

That was partly because my wife and I divided our forces and I took one child and she took the other (visiting her mother with the one child).  Then this past weekend I took one child to my parents and she kept the other one behind.

 

I volunteered as t-ball coach assistant and had to spend time on YouTube figuring out how to organize t-ball drills.  I'm also in negotiations to get a purchase option for the home that I am renting.

 

So, a lot going on the past couple of weeks. 

 

MBI (to me) is another of those "insider trading" plays similar to ORH.  Now that there are two such home runs I'm going to call that the "insider trading" bucket.  In one case it was a settlement telegraphed, in the other it was a privatization telegraphed.  In both cases somebody else on the board divined it, and then shared the info with all of us.  Quite happy to take no credit for any of this!

[rkbabang]

eric fascinating

 

its funny, for me when i read someones speculation that something is going on due to the silence from Mbi and Bac, i for one paused a little but concluded its prob not much, however you and others thought otherwise

 

the only excuse i have is i have not been following MBI as closely and didn't think the recent silence was worth noticing (considering its earnings period)

 

obviously I was wrong :(

 

I paused a little and thought that there may be something to it, but it wasn't until Eric's post that I gave it a considerable amount of thought.  I've been reading the MBI board for over a year, because of my large position in BAC which is probably why I agreed with everyone there that the silence was something new and must mean something.    Even though I didn't have Eric's confidence to go in with a large position.  I went in with a 5% position, and to show you how little confidence I had, my position was in 2015 $10 calls.    I thought that even if I'm wrong I won't lose it all and have plenty of time to get back out.  I definitely don't have the guts to go all in when I have an idea like Eric does.  I've had so many situations where I've made tremendous returns on small investments over the years that had I gone all in on even one of them it would have been life changing.  I don't think I will ever be able to do something like that though, it just isn't my style.  I had a 50% BAC position and I've been trimming it down to keep it at 50% as its grown.  While no one ever went broke taking profits, maybe it can prevent you from getting rich.

 

 

[ERICOPOLY]

You have enjoyed big returnsw on two of three of Berkowitz's big bets MBIA and BAC. Are you invested in Sears? How would you comment on the following points I picked up reading?

 

1. Berkowitz: The trick is to find permanent capital. Buffet did it with BRK. Lampert is doing it with Sears. I am limited to a 5% position in BAC in the mutual fund and if I could I would own a lot more. Real estate offers getting closer to full value. I like to invest in things which for half value which will rise to full value. Sears is selling and closing unprofitable stores leaving the profitable stores.

 

2. Lampert: Main points from my reading: Dramatically increasing online sales while selling loss making stores then liquidating inventory paying back debt and buying shares steadily.

 

3. ESL: Selling a big position steadily at and below current stock price.

 

4. American consumer: Middle class being squeezed but pent up demand building for many years. Eventually the fridge needs to be replaced. More people can now move because of the increase in home prices and sales allowing the step up or step down which often causes new appliances to be purchased. Numerous rentals acquired from banks many of which by funds which replace appliances all the same.

 

5. Short squeeze. Lampert intend to take it private so the run up for the last shares will create a spike if Lampert does a deal.

 

6. Possible Catalyst: There is always a possibility of a big deal unloading many similar type stores to other retailers of private equity fun expanding some successful idea followed soon afterwards by Lampert taking the company private. Private equity has good access to cheap capital and might want to acquire all the downtown properties for instance as a store of value while Lampert may want only the easy to drive to and park stores for pick up with most sales online.

 

7. Valuation: Not cheap in view of current losses but tax losses and real estate values not reflected on balance sheet. Perhaps the biggest value not in the balance sheet is mentioned by Berkowitz: Once the remaining stores are profitable and throwing off cash flow which Lampert reinvests the value rises substantially.

 

What I am really trying to do is to draw out your method of analysis in choosing or rejecting the idea. I was invested in MBIA but I was killed by the time decay on the LEAPS I held. I switched to BAC. Calonego has a good post warning about options which I should have read.

 

I haven't thought enough about Sears to comment.  I've been partial to BAC because there is a money maker if they just cut expenses -- and that looks to be on track.  I think MBI is the same (except not needing to cut).  But I feel like Sears is more of a mystery because I've been to  a couple of their stores.  And more recently I used their SearsPartsDirect website -- yikes!  I had to call their customer service and the woman on the phone couldn't even tell me what manufacturer made a given part number.  I mean, talk about incompetence.  But perhaps I extrapolate too much from that anecdote.

 

 

[Yours Truly]

What I am really trying to do is to draw out your method of analysis in choosing or rejecting the idea. I was invested in MBIA but I was killed by the time decay on the LEAPS I held. I switched to BAC. Calonego has a good post warning about options which I should have read.

 

Can you point me out to this post?

 

Eric -> Have you had any large losses to date? or just simple small losses on rolling over options?