I'm curious about what people think of Buffett's contention that American equities are cheap now, and it is a good time to buy.In other words how can you say that a stock is below its fair value when there are several ways to calculate fair value and market psychology might change in the future so that current rules for calculating fair value are meaningless. After all a fair value algorithm isn't some unbreakable natural law and If no one believes in it, it won't apply. So Buffett seems to be saying that fair value in the future will be determined like it is today and today’s fair value calculations will be applicable in the future. I don't see why this should be the case, there could be a totally different yardstick in the future, which would make todays undervalued equities look like they are fairly valued. Another question: why are stocks that don’t pay dividends worth anything at all? I guess it’s because people believe that if a company retains the money rather than pays it out it can reinvest the money in itself so that the resulting increase in the equity price offsets the loss of dividend. Maybe a large part of a non-dividend paying companies share price is the belief on behalf of investors that there will always be someone willing to buy for more because it’s seemingly always been happening that way, regardless of fundamentals? A scam based on a bubble?

As I understand it, stocks represent a portion of all the company's wealth, either tangible (machinery, natural resources) or intangible (cash, brands, intellectual property, human resources, debt=negative wealth). It is the firm's administration's duty to attempt to maximise the growth of this wealth. When the firm finds it is in excess of cash (e.g. from business revenues), it pays a dividend giving that cash back to the shareholder so that they can then reinvest it. Alternatively, the firm could decide to not issue a dividend and use the cash to buy more property for business use. In the first case, the firm's value decreases by the dividend amount because there's an outflow of property, in the second the value decreases/increases if the cash is used badly/well.One could ask: in the second case the shareholder doesn't perceive any wealth, therefore why would anyone hold a share? I imagine that the reason is that one day, a third party might decide they want to take over the company by buying all its shares in order to control its wealth. Given a share price x, the third party will do this if they consider the firm's property more valuable than Nx where N is the number of shares. On the other hand the shareholder will sell the share if they think that x >= (wealth) / N. Therefore the price at which the transaction occurs should be the best collective estimate of (wealth) / N, in other words the 'fundamental value' of a firm is relevant independent of dividends.I think this is true of a lot of investment behaviour: people invest not (only) because the investment good is useful for them, but because it will useful for other people in the future.These are just my thoughts, but I'm certainly not an expert; in fact I'd be very grateful if someone with more understanding of these issues could tell me if I'm going wrong somewhere.

QuoteOriginally posted by: ehremoAs I understand it, stocks represent a portion of all the company's wealth, either tangible (machinery, natural resources) or intangible (cash, brands, intellectual property, human resources, debt=negative wealth).Nope, it's net assets (liquidation value) plus earning power (going concern value).Edit: at least financial theory teaches that. I am personally not sure about 'plus.' I would rather consider "max(net assets, earning power)."

Berkshire Hathaway seems cheap !from THOMSON DATASTREAMQuoteInvestors are wondering if Warren Buffett has lost his gift for the markets.They are bailing out of Berkshire Hathaway Inc. stock and have lost some confidence that the insurance and investment company, run by one of the world's most admired investors since 1965, can pay its debts.Berkshire stock has lost close to half its value since hitting a record high last December, as the company struggles with lower returns at its insurance businesses, the declining value of its stock holdings and paper losses on derivative contracts.Meanwhile, the cost of protecting Berkshire's triple-A-rated debt has soared to a level more befitting a triple-B or even a junk-rated company.Berkshire class A shares fell as low as $74,100 a share yesterday, their lowest level since August, 2003, before rebounding slightly. That's down 51 per cent from their record $151,650 set last Dec. 11 and down 34 per cent since Berkshire said on Nov. 7 that lower insurance returns as well as investment losses led to a 77-per-cent drop in third-quarter profit, the fourth successive quarterly decline. Operating profit was down 18 per cent. Berkshire ended September with $33.37-billion in cash.Whitney Tilson, managing partner at T2 Partners LLC, a hedge fund firm:"Investors are looking at the derivative exposure, seeing Berkshire marking losses, and it reminds them of AIG and other companies whose derivative exposures got them into trouble. They are coming to the insane conclusion that Berkshire faces similar risks." The cost of protecting $10-million of Berkshire debt against default for five years rose to $490,000 annually yesterday from $294,000 a week ago and $31,000 at the start of 2008, according to financial information services company Markit.Berkshire could have to pay as much as $37.04-billion between 2019 and 2027 under some derivative contracts if the Standard & Poor's 500 index and three other stock indexes are lower than when Berkshire entered the contracts. It obtained about $4.85-billion of premiums upfront.As of Sept. 30, Berkshire had written down $6.73-billion on the contracts, and losses have almost certainly mounted since then. In October alone, Berkshire shareholder equity fell $9-billion or 7.5 per cent.Mr. Buffett has said he expects the contracts to be profitable, distinguishing them from the "financial weapons of mass destruction" that he labelled other derivatives.Berkshire also ended September with $10.78-billion in potential liabilities tied to various credit events, such as junk bond defaults, up from $4.66-billion at year-end 2007.Moody's Investors Service said the global junk bond default rate could rise to 10.4 per cent by the end of 2009 from 2.8 per cent in October. With a typical junk bond yielding more than 20 per cent, new financing is essentially non-existent."Based on his 50-year track record selling insurance, I have a great deal of confidence he is selling these at the right price," Mr. Tilson said. "The critical thing is he does not have to post cash collateral until there are actual defaults."A credit rating downgrade would likely not be material. Berkshire would have to post "nominal" additional collateral on derivatives of "far below 1 per cent of assets" if Berkshire lost its triple-A ratings, according to Jackie Wilson, Mr. Buffett's assistant. It was posting no such collateral as of Sept 30, when Berkshire assets totalled $281.7-billion.Berkshire has other exposures to falling markets.It ended September with $76-billion in stock investments, including multibillion-dollar stakes in American Express Co., Coca-Cola Co., ConocoPhillips Co., Procter & Gamble Co. and Wells Fargo & Co. Shares in all have fallen this quarter.And investors have shrugged off Berkshire's investment of $8-billion in General Electric Co. and Goldman Sachs Group Inc. preferred shares, with their 10-per-cent dividend yields. Shares of both have fallen, rendering Mr. Buffett's warrants to buy common shares worthless for the time being.

QuoteOriginally posted by: albertmillsI'm curious about what people think of Buffett's contention that American equities are cheap now, and it is a good time to buy.He is more or less saying and thinking that when it's good to buy stocks for him it is good to buy stocks for anyone. In the past Buffett has bought way too early, which is fine if you are a good stockpicker. I don't for what reason he seems to believe that everyone is capable of doing of what he has done. Perhaps it's the same logic by which a nuclear physicist would assume that everyone can understand nuclear physics.QuoteOriginally posted by: albertmillsAnother question: why are stocks that don’t pay dividends worth anything at all? Note that companies can also buy back shares instead of paying dividends.Here the top5 flop5 dividend payouts by industry.QuoteTobacco 100,00%Life Insurance 97,96%Gas, Water & Multiutilities 96,25%Industrial Transportation 93,41%Industrial Engineering 92,13%============================Pharmaceuticals & Biotechnology 65,36%Alternative Energy 58,82%Technology Hardware & Equipment 53,88%Health Care Equipment & Services 52,46%Software & Computer Services 50,37%

QuoteIn other words how can you say that a stock is below its fair value when there are several ways to calculate fair value and market psychology might change in the future so that current rules for calculating fair value are meaningless. I think the answer to this question is that he just doesn't care about market value of shares, except when he's about to buy. Reportedly, he only checks the price of stocks he own once a year.His philosophy on stock picking is based on certainty. Will the company make more profit in ten years time than it does right now? That's why he wants to buy companies he understands and which are not likely to change in the near future - if they change their business, how can he be sure they'll earn more in the new business? That's also why he emphasizes something that he calls "economic moat". He wants to buy a company that he knows won't be swept away by a rival competition. It's also why he eschews tech companies - the competitive landscape changes too often. This is why he favors brand name companies too - it is hard to take away market share from a company with a strong brand, ensuring that company's earnings.If you think about it, it's not too different from the idea behind a quant's approach to investment. The goal is to maximize the profit to risk ratio. For quants, risk is measured in price volatility. But for Buffett, "Risk comes from not knowing what you're doing". That is, he minimizes risk by thoroughly understanding every single thing about a business he's analyzing.Also, with regards to the derivatives risk mentioned in the article - I think those are referring to the put options he's been selling. Basically, he wanted to buy stocks at a discount. So instead of buying huge quantities of stock in the market right away, he sold put options with the expectation that he'd keep the stocks that he's obliged to buy. A couple of years ago, he was sitting on over $40 billion of cash, so buying around $37 billion of stocks seems manageable. This is his shopping season - he doesn't buy much during bull markets.

You need to take context into account. As you say Buffet is a stockpicker with a very long investment horizon and deep pockets - meaning he can sit out losses, which psychologically is very hard to do (although easier than sitting out profits...). He's been saying stocks are cheap for a while - certainly in 2007 - so while he may be right in the long term, he could also possibly have bought those picks 50% cheaper. I think his approach is sensible for him, but anybody looking to emulate his success should make their own assessment of risk/return right now - for example whether equities are really the best way to invest money.

Buffet has already bought and now wants you to buy too, so that he can sell at a profit. 'nuff said.

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Buffett Will Give More Information on Derivatives - Bloomberg Nov 24"Nov. 24 (Bloomberg) -- Billionaire Warren Buffett, acknowledging investor concern, will provide more information on how he calculates losses on Berkshire Hathaway Inc.’s derivative bets. The firm’s annual report for 2008 will disclose “all aspects of valuation” and cover “deficiencies in the formula” for pricing the derivatives, “which we nevertheless use,” Buffett said in an e-mail... The information may calm investors concerned about losses and potential ratings downgrades tied to Berkshire’s sale of derivative contracts. Buyers of the derivatives would be entitled to billions of dollars from Omaha, Nebraska-based Berkshire if four stock indexes drop below agreed-upon levels on dates beginning in 2019. Berkshire shares have fallen about 23 percent since Nov. 7, when the insurer said its liability on the contracts totaled $6.73 billion at the end of the third quarter. Buffett’s e-mail said the four stock indexes, including the Standard & Poor’s 500, would all have to fall to zero for Berkshire to be liable for the entire $35.5 billion that’s at risk. The sum was estimated at $37 billion as of Sept. 30 in a filing and shrank because of fluctuations in currency exchange rates, he said. Berkshire slipped $2,500, or 2.8 percent, to $87,500 at 4:15 p.m. in New York Stock Exchange composite trading."

QuoteOriginally posted by: mackbarBuffett’s e-mail said the four stock indexes, including the Standard & Poor’s 500, would all have to fall to zero for Berkshire to be liable for the entire $35.5 billion that’s at risk. The sum was estimated at $37 billion as of Sept. 30 in a filing and shrank because of fluctuations in currency exchange rates, he said. then that's a misstatement by buffett:if currency fluctuations can reduce the liability, they can increase it to so he can be liable for more than $35.5B without the indices falling to zero