Author: mungofitch

Subject: Re: Nice article on options

Date: 8/10/2012

Recommendations: 3

I`ve been struggling with this; not so much in connection with options, but simply stock ownership. As I`ve recently indicated, there are a few companies that I`d like to think are good investments based upon comments made by others and various articles, but for which I don`t have a solid estimate of fair value. Leucadia and ABB are two examples. I`ve just about decided not to hold such firms, as I`m now feeling a bit lost when considering their prospects, and how I should relate to their current pricing. In fact, no one seems to have a handle on the value of LUK, yet many smart value investors are holding it. My thinking in that instance is that if it`s too hard for even the sophisticates to evaluate, then it may be regarded with suspicion by many institutional investors — a condition that`s likely to dampen its price movements. I believe you`ve indicated that you deal with this by adjusting your expectations based upon what might be regarded as underperformance relative to book value. Still, it all seems a bit vague to me. Youre` not alone. It`s a hard problem. But you`re ahead of a lot of folks in appreciating what problem needs solving. The good news: It doesn`t matter much what other people think. Prices will be wrong most of the time, but somehow they manage to be right once in a while. So even if everybody misunderstands a company like Berkshire or Leucadia for a few years, mere random variation will ensure that the price passes through fair value at least once every several years. Also, you don`t have to know how to value all companies. You can start with a small subset of firms and build some expertise there. It`s better to get a fair deal in an area you understand than to think you`re getting a great deal in one you don`t. I have had my head handed to me more than once in oil and gas firms, so I am gradually coming to the rather obvious conclusion that I simply don`t know how to value them so I should stay away from them even when I think they`re really cheap. A good starting place is to find out what kinds of industries have high average returns over the decades and start building a bit of valuation expertise in one or more of those! Some historically good ones are drugs, medical devices, oil, cosmetics, hotels&gaming, chemicals. You could start by building an expertise in airlines, steel, thrifts or toys, but it wouldn`t do you much good. There are other ways to skin the cat. Arguably a quant screen can be thought of as equivalent to a single company. If you have an idea of the "value" in aggregate of the things that the screen comes up with, and do about the same due diligence on the screen that you might do on a stock, you can do quite well. Jim