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Optimizing BRK via Market Timing?

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July 05, 2013 – Comments (0) | RELATED TICKERS: BRK-A

Board: Berkshire Hathaway

Author: rationalwalk

Let's say that a Berkshire shareholder has no need for his funds until December 31, 2018 and expects book value per share to compound at 9% per year for the next 5 1/2 years. If we estimate 6/30/13 book value at $123,500, that would imply book value of around $198,000 by 12/31/18. The shareholder considers fair value to be around 1.5x book which implies that intrinsic value should be at roughly $300,000 (let's use a round number) by 12/31/2018. Assume that one of the rare moments when IV=MV is also 12/31/2018.

From the current price of $168,600, this shareholder would compound his investment at just over 11% over the next 5 1/2 years.

But this investor has a negative short term view of the markets (Fed "tapering", sequester, tax increases, debt ceiling, whatever) and believes that Berkshire is correlated with the markets (which it is to some extent). He expects a 20% correction over the next six months and expects Berkshire to correct 20% as well.

So the brilliant idea of selling Berkshire at $168,600 on Monday morning and buying back the shares at around $135,000 seems attractive, right? Ignoring taxes and assuming that the funds sit in zero return cash, the investor will raise $168,600 on Monday, invest $135,000 of this amount on 12/31/13 and end up with $300,000 worth of Berkshire five years later plus the $33,600 still sitting in cash (ignore for the moment whether cash ever again yields over 0%).

The brilliant investor will therefore have total funds of $333,600 on 12/31/18 which is a 13.2% annualized return. 13.2% is better than 11% so clearly his action was worthwhile, right?

Well maybe not because the market may not cooperate this year. Let's say that at year-end, Berkshire's book value has grown only modestly to $125,000 but maybe Ben Bernanke softens up and says the Fed won't even begin to taper until 2017. So the markets shoot up and Berkshire's P/B rises to 1.6x (just somewhat over its historical average this century). So Berkshire is trading at $200,000 at 12/31/13. Our not-so-brilliant investor, if he wants to get back in, will have to take the $168,600 he raised and add $31,400 just to get back in the game. His annualized return will end up being around 8.5%, far short of the 11% he could have achieved by following the "Munger rule" of Berkshire ownership. And the damage will likely be worse considering tax effects but that will depend on the individual's unique situation.

I would suggest that no one here can confidently assert that they KNOW FOR A FACT that the markets and Berkshire will be 20% lower by year-end or that such an outcome is MORE LIKELY than the markets and Berkshire being higher by year-end due to some currently unforeseen factor, or for no apparent "reason" at all.

What happens if the June and July job numbers are abysmal? Or if inflation measures show a decline toward 0%? The markets will probably start pricing in continued super-easy Fed policy for much longer than the current consensus believes. Bernanke's successor is very unlikely to be more hawkish and will probably be more dovish.

In any case, there is little point pounding away at this perennial topic other than to suggest that market timing over a very short period of time such as six months is futile unless someone has unique insights that are DIFFERENT from the current market consensus and has good reason to believe in the reliability of his insights. 

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