36: Munger's Ancestors; A Bankers' Duty; Portfolio Management; Thoughts On Cost Basis

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Banking Credo

Thanks to RL for sending me this link as a reminder of Mugner’s ancestor’s past. That reminded me of a great quote from Alex Pollock in his book “Boom and Bust”:

"It is the professional duty of the bankers and debt investors to be skeptical, not optimistic."

I actually printed that out and put it in my office when I was working in credit. It can be easy to forget when you're loaning someone else's money and being incented to make deals, all the while the customer is shopping his/her deal around. 

It’s also a quote worth extending to all investors, debt and equity alike. Especially today.

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Pondering High Stock Prices

One part of my job is managing portfolios of companies. It can be hard when stock prices rise and valuations stretch. Do you sell because of valuation? Hold? What if you’re wrong?

Buffett has long counseled a hold approach. Back around 2000, he held onto shares of Coke even though they were trading at nosebleed levels. Great businesses are rare, and if you have ownership in one it’s probably best to just hang onto it.

I got to thinking, what role do taxes play in marginal decisions, and does this effectively mean every holder “sees” a different quoted price?

What I mean is, say you bought BRKA shares last year at $330,000.¹ Shares today trade at $430,000, so you have a $100,000 long-term capital gain. Great.

Your marginal tax rate is 25% (keeping it simple), which means you’d pay $25,000 in taxes if you sold. So is the current price really $405,000 (current quoted price minus taxes) for you?

Think about an even more extreme example. Warren Buffett first purchased shares around $7.50, which means his cost basis is effectively zero. For Buffett shares at $430,000 really means $322,500 (assuming a 25% tax rate). That’s a full 20 percentage points less than you!

What am I trying to say here? Everyone looks at the quoted market price of a stock and has some opinion on it—too low, too high, just right, whatever. But market participants are diverse. Not only do they have different opinions, but they also have different cost bases influencing their behavior.

Stay rational! —Adam

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1. I’m using Berkshire as an example because it’s a well-known company and because of Buffett’s cost basis. I’m not expressing or implying any opinion on valuation.