One of the recurring topics that is discussed in many of Howard Mark’s famous memos is the concept of risk and reward. In his 2020 memo to clients entitled, "Calibrating," Marks provides some interesting insight into how investors can ascertain risk in the current coronavirus environment that is fraught with risk and uncertainty about the future.
Marks addresses some of the issues raised related to trying to remain on the sidelines auspiciously, until one has perfectly timed the market bottom and thus can be assured that he has eliminated all risk in connection with the purchase.
Should those who bought Target (TGT), for $97 on March 20th waited until April 3d, when it could have been had for $92? Or, bought Chevron (CVX, Financial), for $70 on March 17th, when it could have been bought a week later for $54? Bank of America (BOAC), for $22 on March 6th vs. $17 on March 23rd?
Shouldn't an investor have waited for a more propitious opportunity in light of the panic selloff and continuing bad news?
For Marks, the “answer clearly is no.”
In his memo entitled, "Which Way Now?," the guru was characteristically humble in terms of how much he doesn’t know. His point is those who think they are good at divining the future are playing a fool’s errand. Marks wrote:
“The bottom” is the day before the recovery begins.Thus it’s absolutely impossible to know when the bottom has been reached ... ever
Then what are the criteria that should inform our investing? Marks responds by noting, that for purposes of value investing, trying to time the bottom is irrelevant and unnecessary.
What I would do, is is figure out how much you’ll want to have invested by the time the bottom is reached — whenever the tis — and spend part of it today. Stocks may turn around and head north, and you’ll be glad you bought some. Or they may continue down, in which case you’ll have money left (and hopefully the nerve) to buy more. That’s life for people who accept that they don’t know what the future holds.
But no one can tell you this is the time to buy. Nobody knows.”
Marks discusses timing decisions in the context of his notion of how risk should be assessed. He believes any informed investment decision must weigh:
“'Twin risks' investors face everyday:the risk of losing money and the risk of missing opportunity. At least in theory, you can eliminate either one but not both. Moreover, eliminating one exposes you entirely to the other. Thus we tend to compromise or balance the two risks, and every individual investor or institution should develop a view as to what their normal balance between the two should be.”
Then Marks summarizes how investment risk should be determined when he says: “The investor’s goal should be to make a large number of good buys, not just a few perfect ones.”
Marks notes that waiting for the bottom is, in a sense, anathema to the principles of value investing. If there is one thing Benjamin Graham taught repeatedly in his writings and teachings it is that trying to predict the future can only lead to poor decisions and, at times, crushing losses.
Marks restates these principles when he urges intelligent investors to get back to basics:
“So it’s my view that waiting for the bottom is folly. What, then, should be the investor’s criteria?
The answer’s simple: if something’s cheap – based on the relationship between price and intrinsic value – you should buy, and if it cheapens further, you should buy more.”
So how would Marks have advised an investor considering purchasing stocks as the market continued its rapid descent into bear market territory? Marks would ask the investor if his temperament remains steadfast:
“Do you insist on being sure the thing in question will never be available lower? That is, that you’re buying at the bottom? I doubt it. You probably buy because you think you’re getting a good asset at an attractive price. Isn’t that enough? And I trust you sell because you think the selling price is adequate or more, not because you’re convinced the price can never go higher. To insist on buying only at bottoms and selling only at tops would be paralyzing."
Intelligent investors should always adhere to value investing principles first, no matter the overall market environment. For Marks, the question always remains the same. Is the current price below that which the investor determines is the company’s intrinsic value?
Disclosure: I recently established a long position in Chevron.
Read more here:
- Tech Stocks: New Coronavirus Safe Haven?
- Where Can Dividend Investors Hide?
- Warren Buffett on Risk and Reward
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