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Firstly, I think calculating the (annual) yields of (potential) investments make them comparable (obviously; I mean you can translate every P/E ratio into a yield by just switiching the numerator and the denominator). And comparability (of yields) potentially plays a huge role in the capital allocation decision.
Secondly, as you mentioned, and that ties into the deluded analyst "fallacy", especially time but also the gravity of finance (aka interest rates) are the key factors for any investment decision. Buffett elaborates this in the 2000 GAM: a bird in the hand vs two in the bush (Link: https://www.youtube.com/watch?v=vo_TWaV6Xy8). It all comes back to the expected rate of return (aka yield) for the investment (and this includes an assumption on how long it will take – which can be difficult to determine - to realise the absolute return). And there you have it: you would need to have a valuation range and also make an assumption (or having some degree of conviction) about the investment's time horizon so you can calculate the yield. Only then you can compare different investments to each other (see opportunity cost). I think, the time horizon is very much linked to the investor’s assumptions about the durability of the moat as well. Because the moat protects (and ideally grows) the intrinsic value of a company, an investor might be willing to pay more now for future cash flows, clearly anticipating that he/she must hold the investment for a longer period of time to generate the same yield as a more short-term situation (e.g. workout, liquidation, etc.) would.
Again, since time is already incorporated in yields, it makes investements truly comparable.
Finally, we could argue, that the margin of safety must be bigger for long-term investment compared to shorter-term investments. Because that uncertainty is greater the further out we go on the timeline.
To this point we have not talked much about the effort (and difficulty) of analysing investments. It might require much more work to compound the absolute returns from multiple shorter-term investments than is required for one long-term investment (e.g. 1:100 type of ultrabagger). Also, one would need to be more often correct with the more short-termed investments – the eventual rate of return being the same.
Eventually, I think, it comes down to the (individual) circumstances (e.g. AuM, operational cost basis, expectations, etc.), skills and, to a certain extent, to personal preferences (i.e. temprament), in deciding if you are looking for cigar buts or great businesses at fair prices.
Your thoughts about that, Adam?
PS: Sorry for so much text – I just felt it all ties into each other.
Thanks for the comments, Alex! Re: the analyst using five years out, it's just awkward in that you need ONE frame of reference i.e. the present. And as you say, the time horizon is all-important. Buffett thinks in terms of forever and sort of equates everything using a long-term rate as a benchmark and incorporating a margin of safety.
You're spot on re: the difficulty of finding investments. Each new investment brings the potential to make a mistake. And yes, we have no choice but to incorporate our own biases and tendencies into the mix. We can't invest based on some pure theory because by definition everything has to go through us as humans, who are emotional, irrational beings to at least some degree.
Inside of a Maple Tree- Great Picture! Amazing!
Re: thinking in yields:
Firstly, I think calculating the (annual) yields of (potential) investments make them comparable (obviously; I mean you can translate every P/E ratio into a yield by just switiching the numerator and the denominator). And comparability (of yields) potentially plays a huge role in the capital allocation decision.
Secondly, as you mentioned, and that ties into the deluded analyst "fallacy", especially time but also the gravity of finance (aka interest rates) are the key factors for any investment decision. Buffett elaborates this in the 2000 GAM: a bird in the hand vs two in the bush (Link: https://www.youtube.com/watch?v=vo_TWaV6Xy8). It all comes back to the expected rate of return (aka yield) for the investment (and this includes an assumption on how long it will take – which can be difficult to determine - to realise the absolute return). And there you have it: you would need to have a valuation range and also make an assumption (or having some degree of conviction) about the investment's time horizon so you can calculate the yield. Only then you can compare different investments to each other (see opportunity cost). I think, the time horizon is very much linked to the investor’s assumptions about the durability of the moat as well. Because the moat protects (and ideally grows) the intrinsic value of a company, an investor might be willing to pay more now for future cash flows, clearly anticipating that he/she must hold the investment for a longer period of time to generate the same yield as a more short-term situation (e.g. workout, liquidation, etc.) would.
Again, since time is already incorporated in yields, it makes investements truly comparable.
Finally, we could argue, that the margin of safety must be bigger for long-term investment compared to shorter-term investments. Because that uncertainty is greater the further out we go on the timeline.
To this point we have not talked much about the effort (and difficulty) of analysing investments. It might require much more work to compound the absolute returns from multiple shorter-term investments than is required for one long-term investment (e.g. 1:100 type of ultrabagger). Also, one would need to be more often correct with the more short-termed investments – the eventual rate of return being the same.
Eventually, I think, it comes down to the (individual) circumstances (e.g. AuM, operational cost basis, expectations, etc.), skills and, to a certain extent, to personal preferences (i.e. temprament), in deciding if you are looking for cigar buts or great businesses at fair prices.
Your thoughts about that, Adam?
PS: Sorry for so much text – I just felt it all ties into each other.
Thanks for the comments, Alex! Re: the analyst using five years out, it's just awkward in that you need ONE frame of reference i.e. the present. And as you say, the time horizon is all-important. Buffett thinks in terms of forever and sort of equates everything using a long-term rate as a benchmark and incorporating a margin of safety.
You're spot on re: the difficulty of finding investments. Each new investment brings the potential to make a mistake. And yes, we have no choice but to incorporate our own biases and tendencies into the mix. We can't invest based on some pure theory because by definition everything has to go through us as humans, who are emotional, irrational beings to at least some degree.