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Stepan Lavrouk
Stepan Lavrouk
Articles (104) 

Howard Marks on Being a Contrarian

Why you should buy unpopular assets

February 07, 2019

Howard Marks (Trades, Portfolio) of Oaktree Capital is known for his well-written and informative memos. Featuring a combination of astute market commentary and an discussion of Marks’ own investment principles, the memos are a goldmine of both pithy aphorisms about life and the markets, and also a useful window into the decision-making process of one of the best living value investors.

Oaktree has always been an unconventional asset management firm, specializing in distressed debt and special situations. Although distressed debt as an asset class is somewhat inaccessible to the average retail investor, the manner in which Marks and his partners go about investing in this market can provide individuals with plenty of heuristics for their own investing toolkits.

Unpopular assets are cheap assets

Marks once said:

“Because of the fluctuation of both fundamental developments and investor behavior, assets are sometimes offered for sale at bargain prices and at other times at prices that are too high. A technique that works most dependably is putting money into things that are out of favor.

Although investors often seem not to grasp it, it shouldn’t be hard to understand: only unpopular assets can be truly cheap. And those that are in favor are likely to be dear”.

This is a simple yet surprisingly powerful idea. A hot glamour stock is unlikely to be cheaply, or even reasonably, priced. This means it is unlikely to provide good value for money, regardless of the strength of the underlying company. The corollary to this is that to find truly good bargains, one must look at companies and industries that are unpopular.

The belle of the ball is not your friend

Marks noted:

“One of the best reasons for the profitability of distressed debt over the years is that there’s no such thing as a distressed company everybody loves. By the time they’ve made their way to our arena, distressed companies can no longer be on what I call “the pedestal of popularity”. We buy at low dollar prices from depressed owners at a time when corporate performance is well off from the top. Not a bad formula. Certainly that doesn’t have to mean that the investment’s cheap enough, but at least there’s a low probability it’s pumped up on hot air (or investor’s ardor)”.

An important caveat here is that Marks is an investor in distressed debt, whereas the average retail investor typically deals in equity. Buying the stock of distressed companies is a dangerous proposition due to the fact common equity lies at the top of the capital stack, meaning that in the event of bankruptcy, holders of common stock are the last to receive liquidated capital. Oftentimes, they are completely wiped out and receive nothing. For this reason, we recommend exercising extreme caution when bargain-hunting for shares of distressed companies. But the overall principle here is still applicable to individual investors - look for plays in areas that are not currently in favor with the market for the best prices.

Stand by the courage of your convictions

Buying assets that everyone around you thinks are worthless is not an easy task. But it is a necessary undertaking for those of us that truly seek value. Marks distinguishes very clearly between trend-followers and value-seekers, implying he considers the former to be closer to speculators than investors:

“The momentum player buys what’s up and bets that it’ll keep going up. The style devotee buys one thing whether its up or down. But the contrarian, or value investor, buys something that other people aren’t interested in, in the belief that it’s cheap and will become less cheap someday. There’s no sure recipe for profit, but I think this one stacks the cards in your favor. As Sir John Templeton put it, 'To buy when others are despondently selling and to sell when others are euphorically buying takes the greatest courage but provides the greatest profit.'”

Not a bad reward for standing by your convictions.

Disclosure: The author owns no stocks mentioned.

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About the author:

Stepan Lavrouk
Stepan Lavrouk is a financial writer with a background in equity research and macro trading. Specific investing interests include energy, fundamental geoeconomic analysis and biotechnology. He holds a bachelor of science degree from Trinity College Dublin.

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