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Howard Marks: Thoughts on Identifying Investment Opportunities

Psychology is more important than accounting

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Jul 31, 2019
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Having a detailed and well-thought-out philosophy is a mark of a good investor. So is being able to articulate it in plain English. In this memo from 1994, value investor

Howard Marks (Trades, Portfolio) does just that. Here are his most prescient thoughts.

No asset has the birthright of superior returns

“There is no asset class that will do well simply because of what it is.”

It’s often said that some assets are "hedges against downturns" or "countercyclical." The truth of the matter is there are no hard and fast rules. No asset can guarantee performance simply by virtue of the category it has been put into. If it were that easy, everyone would do it. Marks gives the example of real estate, which is often considered to be a hedge against inflation. While that is sometimes true, such reasoning obscures the fact that what really matters is the price of the asset.

Psychology is more important than accounting

Investing is a popularity contest, and the most dangerous thing is to buy something at the peak of its popularity. At that point, all favorable facts and opinions are already factored into its price and no new buyers are left to emerge.”

The market is a weighing machine in the long run, but it is a voting machine in the short term. Price doesn’t always correlate with value, and the reason why it doesn’t is that the most popular stocks are rarely the most sensible investments. In fact, popularity means the stock has been closely scrutinized, all possible information about it is known and it is probably priced at a premium. By contrast, securities that are unpopular are often priced at a discount simply because so many investors dismiss them out of hand.

Bad money drives out good

“Gresham's Law says 'bad money drives out good.' When paper money appeared, gold disappeared. It works in investing too: bad investors drive out good.”

Marks often says the most worrying words in the English language are “too much money chasing too few deals.” When investors' spirits are ebullient, and people become less discerning and care less about the quality of their investments, that makes it much more difficult for value investors to ply their trade as asset prices are bid up across the board. This has been the case for arguably most of the last decade, as ultra-low interest rates have unleashed a flood of easy money on the markets. One can only hope that at some point mean reversion will kick in and we will return to an environment where value strategies can once again be implemented.

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