tag:blogger.com,1999:blog-7294165939647321702.post2594612664885919583..comments2023-09-19T20:13:47.384-04:00Comments on <center><a href="http://www.barelkarsan.com">Barel Karsan - Value Investing</a></center>: Investing For Expected Value?Saj Karsanhttp://www.blogger.com/profile/04493152766022812984noreply@blogger.comBlogger7125tag:blogger.com,1999:blog-7294165939647321702.post-33138242685735869452011-08-12T17:57:32.315-04:002011-08-12T17:57:32.315-04:00Anon2,
Yes, that's a good point. The insuran...Anon2,<br /><br />Yes, that's a good point. The insurance business is a great of example of when to use EV as an analytical technique.<br /><br />So actually, I'm pretty confident that Buffett would endorse this way of thinking about investing. Especially in a case such as the example I described in a previous comment (10 independent bets in a "basket", each of which has a 50% probability of total loss but an attractive EV).<br /><br />- aagoldAnonymousnoreply@blogger.comtag:blogger.com,1999:blog-7294165939647321702.post-85441963923223345082011-08-12T06:30:14.881-04:002011-08-12T06:30:14.881-04:00Hi,
Buffet did similar style investment..Check An...Hi,<br /><br />Buffet did similar style investment..Check Annual Meeting Transcript (not sure abt the year)<br /><br />Bufffet: Pepsi is running a contest in which one person will have a 1-in-1,000 chance of winning $1 billion -- a present value of $250 million [since the billion is paid out over time]. [If the person wins,] we will pay it. We are willing to assume that for a payment, and very few people would be. We would be willing to assume a $2.5 billion payout (but not $25 billion) if we got paid more than proportionally more.<br />Munger: If you're risking a $250 million payout and you have $60 billion of capital, it's not crazy. But I think it's crazy to do it based on someone else's circumstances or abilities.<br /><br />Regards<br />VishnuAnonymousnoreply@blogger.comtag:blogger.com,1999:blog-7294165939647321702.post-82053070761836817562011-08-12T03:06:28.673-04:002011-08-12T03:06:28.673-04:00Hi aagold,
I definitely don't think you'r...Hi aagold,<br /><br />I definitely don't think you're the only one, I would say most investors would shoot for EV. I would agree with you that it can be useful when applied very selectively. I just reject the notion that the odds and results can be accurately calculated most of the time, making it difficult to apply Kelly C (which I <a href="http://www.barelkarsan.com/2009/09/dhandho-investor-chapter-10.html" rel="nofollow">covered in this book review</a>)Saj Karsanhttps://www.blogger.com/profile/04493152766022812984noreply@blogger.comtag:blogger.com,1999:blog-7294165939647321702.post-52778325412673247012011-08-10T16:11:50.969-04:002011-08-10T16:11:50.969-04:00Anon,
Yes, I agree that "Fortune's Formu...Anon,<br /><br />Yes, I agree that "Fortune's Formula" is a great book to read on this topic. That's where I was first introduced to it. Your first comment was a bit too brief for me to figure out that's what you meant by "expected growth". But now that I know what you meant, then yes I agree with you. <br /><br />I partially agree with what you said about the Kelly Criterion precluding an investment with a high probability of loss, even if it has a high EV. However, the analysis is more complex than that. The impact of diversification, for example, is very important. <br /><br />Let's say I have a basket of 10 *statistically independent* investments, each of which has a 50% chance of total loss. What's the probability of a total loss on the whole basket? Less than 0.1%. In a case like this, the key factor ends up being the EV of each one of the investments considered separately. In other words, if the price one pays for each investment in the basket is low enough to provide a very high expected rate of return, and the investments are independent, then the basket becomes a *very* attractive investment.<br /><br />Now obviously in the real world no investments are truly independent of all others in a basket, but the basic idea is sound and it can be extended to the more realistic case where there's some correlation between investments.<br /><br />- aagoldAnonymousnoreply@blogger.comtag:blogger.com,1999:blog-7294165939647321702.post-11988923620890008262011-08-10T15:17:43.664-04:002011-08-10T15:17:43.664-04:00"3) Knowing how to size bets like these is cr..."3) Knowing how to size bets like these is crucial. I think a solid understanding of the "Kelly Criterion" is necessary. Are you familiar with that concept? Wikipedia has an ok introduction"<br /><br />I alluded to this in my previous comment. The Kelly Criterion sizes bets to maximize expected growth. This will eliminate placing bets on situations Saj was referring to: "a high expected value can still be derived from a set of scenarios with a high frequency of losses."<br /><br />If anyone is interested in the Kelly Criterion, I highly recommend reading the book Fortune's Formula, where it is used in both blackjack and investing.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-7294165939647321702.post-58909876694217980022011-08-10T13:33:53.552-04:002011-08-10T13:33:53.552-04:00Saj,
Thanks for replying to my comment. I happen...Saj,<br /><br />Thanks for replying to my comment. I happen to believe this is an extremely important topic. I could fill many pages with my thoughts, but given the limitations of this forum I'll try to be brief.<br /><br />1) Whitney Tilson agrees with me on this point, so at least I'm not alone! :-) If you haven't seen this already, take a look at this excerpt from one of his investor letters:<br /><br />http://www.gurufocus.com/news/126411/whitney-tilson-disagrees-with-buffett-on-investing-rule-1<br /><br />2) Thinking about an investment in terms of EV certainly isn't the best analytical technique in all cases. Far from it. It's best used in special situations that have discrete outcomes whose probabilities can be estimated by someone knowledgeable in the field. A great recent example would be GCVRZ, which is a "contingent value right". Here's an example of how to value a security like this:<br /><br />http://longtermvalue.wordpress.com/2011/05/05/special-situation-genzyme-contingent-value-rights-gcvrz/<br /><br />3) Knowing how to size bets like these is crucial. I think a solid understanding of the "Kelly Criterion" is necessary. Are you familiar with that concept? Wikipedia has an ok introduction:<br /><br />http://en.wikipedia.org/wiki/Kelly_criterion<br /><br />4) As with any investment methodology, the EV method should only be used within one's "circle of competence". In other words, if you don't know how to estimate the relevant probabilities conservatively, don't make the investment. When in doubt, use a large margin of safety on the probabilities and outcomes.<br /><br />- aagoldAnonymousnoreply@blogger.comtag:blogger.com,1999:blog-7294165939647321702.post-69108171714895859582011-08-10T10:49:23.152-04:002011-08-10T10:49:23.152-04:00It is probably better to think in terms of expecte...It is probably better to think in terms of expected growth rather than expected value when it comes to investing.Anonymousnoreply@blogger.com