In the case of Berkshire Hathaway, our analyses lead us to conclude that the share’s value will exceed USD 400,000 during 2019, and that should create a sufficiently strong pull for further price growth. Berkshire’s share value is currently about 15% greater than its price. That is a much smaller difference than between the value and price of our portfolio as a whole (which is currently about 40%). If we consider, however, that the development of Berkshire’s value is relatively well foreseeable and that the entire company’s business bears a substantially below-average risk, this creates a combination that seems to us very attractive.

(By the way, I also have my private prediction for when Berkshire share value will exceed USD 1,000,000. I enjoy playing with numbers, and this is an internal test of mine to see how wide of the mark I can be when I attempt to look far ahead into the future. I now estimate that this will happen a year earlier than when I first estimated it two years ago. So far it seems I was originally too conservative. We’ll see.)

Value of the Portfolio as a Whole

Because we have estimates of the individual companies’ values, we can easily calculate the value of the Fund’s portfolio as a whole, which is the number we now state also in the monthly fact sheets. Its amount and development are influenced primarily by the following factors:

  1. The selection of the individual companies for the portfolio, their representation in the portfolio, and the prices at which we acquire them. The more undervalued companies we successfully find and the more diligent we are about making sure to buy them at prices discounted to deeply below their values, the better.
  2. The development of the individual companies’ values over time. It is not enough just to buy a stock that appears to be cheap. The important thing is where its value will move over time. The sooner that value grows, the stronger will be the draw it exerts upon the share price.
  3. Portfolio turnover. When the price of some stock we are holding rises to or even above its value, we can sell it and replace it with another having a more favourable price/value ratio. These transactions can contribute substantially to growth in the portfolio’s value if they are made shrewdly and while maintaining a long-term perspective.
  4. Currency movements. Even though currency movements have minimal impacts on the Fund’s NAV because most of the currency risk is hedged, they do have short-term effects on portfolio value because they create transient unrealised loss or gain from currency swaps and forwards, and this is reflected in the Fund’s value.
  5. Additional smaller influences come from dividends received (positive), gains or losses from option trades (predominantly positive), and the Fund’s operating costs (negative).

Of course, still one important subjective factor needs to be added to these objective factors, and that is our own idea as to the value of the individual companies. We cannot say with complete certainty whether we are too optimistic or pessimistic in our estimates. Moreover, it can be neither confirmed nor refuted a priori whether we are approximately correct in our estimates or entirely wrong. It is impossible to determine the objective truth. A subjective view will always prevail, but that is the very nature of investing. It comes down to reaching a conclusion on the basis of one’s rational analysis and then investing on that basis.

If we look several back years, we can find many cases when our value estimates for the individual companies were excessively conservative and low, but also cases when they were exaggerated. Therefore we had to correct them over time. On average, however, they turned out to be pretty reliable based on the companies’ earning performances in subsequent years. At that point, once we know how that future actually turned out, we receive feedback indicating how near or distant we had been in our initial estimates of value compared to reality.

This is why we have not three companies in our portfolio but 19. It is probable that we are quite wrong in our estimates of value for some of them (and we do not even know whether we are over- or underestimating the value), but this error will be much smaller in the portfolio as a whole. In other words, we diversify the portfolio to a reasonable extent.

It may seem academic to rely on company value, but this is used more often in practice than you might think. A good example can be seen in the case of private equity funds. They hold shares in companies that are not publicly traded and which therefore cannot be valued according to their current prices. Instead, they are valued on the basis of models, which in other words means by estimating their values. While we use value estimates only as an internal indicator, private equity funds use them to establish fund NAV, for valuation in relation to subscribing new shares, and also for calculating fees. And yet, this is something few people call into question.

I sometimes say that private equity funds have rather comfortable lives. Calculating NAV on the basis of their own models allows them completely to avoid price volatility on the markets and thereby to create the impression of greater stability. If we could calculate our Vltava Fund’s NAV using the same method, we would be in positive-gains territory every month. I would not want to trade places, though, because it is that very volatility of share prices on the public markets that is the source of large and readily exploitable opportunities which private equity funds do not have.

How to Work with the Information About Portfolio Value

We believe that the information on the Fund’s portfolio value is an important piece of the information mosaic you regularly receive from us. Its level indicates where the Fund’s NAV should be headed in future. The difference between value and NAV also suggests something about the degree of risk that is associated with holding our portfolio. Price is always one of the crucial parameters in managing risk, and a larger difference between NAV and value not only increases expected return but also reduces risk.

I consider portfolio value 25% higher than NAV to be a healthy, normal level. If you see this difference substantially narrow, it means that the portfolio is becoming more expensive, that we are struggling to find sufficient attractive investment opportunities, and probably that we are also holding more cash than usual. At such times, you should postpone increasing your investments into the Vltava Fund. On the other hand, when you see that the difference between value and NAV is substantially greater, this means that the portfolio is attractively valued and that there are plenty of good investment opportunities. This also is a time during which you ideally should direct your potential additional investments into the Fund.

Changes in the Portfolio

Over the summer, we wanted to narrow the Vltava Fund’s portfolio a little. We sold two positions: Navient and Resona Holdings.

We had begun buying Navient in 2014 after it was spun off from Sallie Mae and started to be traded on the exchange on its own. The stock did very well initially, but we failed to take advantage of that by selling. To put it in hockey jargon, we overextended our shift and did not sell the stock until this year. Our gain was 12%, and that is a disappointment for us. We should have handled this more shrewdly.

Resona Holdings is a Japanese bank and an interesting restructuring story. Unfortunately, because of persisting very low interest rates in Japan, interest rate margins have narrowed so much for the local banks that in an effort to achieve higher returns they are forced to take on greater risks than seem reasonable to us, and therefore we thought it better to sell the stock. Our return was 40%.

We used the money from these two sales primarily to strengthen some existing and more attractive positions in the portfolio.

Invitation to a Conference

In November, Lenka Schanova and I are organizing the fifth annual Czech Investment Conference. You all are cordially invited!

I will be looking forward to seeing you at the Pyramida hotel in Prague during 19–20 November!

Programme and registration:
www.czechinvestmentconference.cz

Daniel Gladis, October 2018

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