Sunday, July 24, 2011

The Most Important Thing: Chapters 17 and 18


Value investor Howard Marks shares his investment philosophy in his book, The Most Important Thing: Uncommon Sense for the Thoughtful Investor. "This is that rarity, a useful book," according to Warren Buffett. Marks' estimated net worth is over $1 billion and his firm, Oaktree Capital, manages $80 billion.

Marks finds it illustrative to use sports analogies to describe certain facets of investing. In professional tennis, for example, players are aggressive in that they win by going for winners i.e. they win with offense. Amateur tennis players, however, win by just keeping the ball in play and letting the opponent make a mistake i.e. they win by playing defensively.

Investing is much more like amateur tennis, Marks argues. While professional tennis players can take certain actions that will result in a highly accurate and precise shot, investors are subject to a whole lot more randomness. A company can be affected by unforeseen forces from economic factors to new government rules to management actions to competitor activities, all of which make a "precise shot" extremely difficult.

But most investors seem to be playing offense, picking their investments such that they will only work out if everything goes as planned. In other words, they go for homeruns. In Marks' experience, however, the careers of professional investors are remarkably short, considering investing is not physically demanding. He believes this is not due to a lack of homeruns, but an abundance of strikeouts.

At Marks' firm, they win by avoiding losers, which is not the same as picking winners. Marks wants companies with margins of safety, so that even if things don't work out as planned, the investment won't be a loser. To continue the baseball analogy, he goes for batting average instead of homeruns.

Marks also makes the point that making an investment because everyone believes something to be true is a very bad idea. Often, the fact that everyone believes something to be true can contribute to making it not true. For example, in 2007 (and the years leading up to it) everyone thought house prices could not go down. This in turn affected how conservative lenders and borrowers were with respect to leveraging residential real estate, which led to the downturn. As a result, it became more likely that house prices would go down because of the belief that house prices could not fall!

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