Book Review: The Most Important Things Illuminated, Howard Marks
Howard Marks, the Chairman and co-founder of Oaktree Capital Management, is renowned (especially in the world of value investing) for his insightful of market opportunity and risk. I classified him as one of the leading world’s value investor Guru, his thought process, commentary (his Memo) and fundamental philosophy are worth learning and respected.
What makes it better was this book includes annotation by Christopher Davis, Joel Greenblatt, Paul Johnson, and Seth A. Klarman. It’s like combining 5 Master level Value Investoring Gurus into one book. I would probably give this the most undervalued book ever written.
I couldn’t agree more with Warren Buffett,
“This is that rarity, a useful book.”
Key Takeaways
- Second – Level Thinking
“First-level thinking says, ‘It’s a good company let’s buy the stock.’
Second-level thinking says, ‘It’s a good company, but everyone thinks it’s a great company, and it’s not. So the stock’s overrated and overpriced; let’s sell.’”
“First-level thinking says, “The outlook calls for low growth and rising inflation. Let’s dump our stocks.’
Second-level thinking says, ‘The outlook stinks, but everyone else is selling in panic. Buy!’”
“First-level thinking says, ‘I think the company’s earnings will fall; sell.’ Second-level thinking says, ‘I think the company’s earnings will fall less than people expect, and the pleasant surprise will lift the stock; buy.’
First level thinking is simplistic and superficial, and just about everyone can do. (Bullish)
Second-level thinking is deep, complex and convoluted. They takes many great things into account.
The environment isn’t controllable, and circumstances rarely repeat exactly. Psychology plays a major role in markets.
Investing should be intuitive and adaptive, rather than be fixed and mechanistic.
Seth Klarman; “Beating the markets matters, but limiting risk matters just as much. Ultimately, investors have to ask themselves whether they are interested in relative or absolute investing. Losing 45%, while market drops 50% qualifies as market outperformance, a victory for most of us.”
Christopher Davis; “ You must be patient and give yourself ample time – you’re not looking for short-term windfalls, but for long-term, steady returns.”
To accomplish that, you need either good luck or superior insight. Counting on luck isn’t much of a plan, so you’d better concentrate on insight.
Everyone wants to make money. All of economics is based on belief of profit motive. So is capitalism, the profit motive makes people work harder and risk their capital. The pursuit of profit motive produced much of the material progress the world has enjoyed. School teaches the concept of efficient market*, which constantly reflects that beating the market is a difficult task. Everyone is competing for each available dollar of investment gain. So who will get it? It’s the one who’s a step ahead. In some pursuits, getting to the front of the pack means more schooling, more time in the gym or the library, better nutrition, more perspiration, greater stamina or better equipment. But in investment, these are not important, what makes you stand ahead of the pack, is perceptive thinking / second level thinking.
Your goal in investing isn’t to earn average returns, you want to do better than average. Your thinking has to be better than that of others, both more powerful and at a higher level. Such as seeing think they haven’t thought of, seeing things they have missed, or bring insight they don’t possess, react and behave differently. Be more than right than others, ultimately your thinking has to be different.
You cannot do the same things as others and expect to outperform.
Of course, it’s not that easy and clear-cut, but I think that’s the general situation. If your behaviour is conventional, you’re likely to get conventional results (good/bad). Only if your behaviour is unconventional, your performance will be unconventional, and only if your judgements are superior, your performance is likely to be above average.
That means, to achieve superior investment result, you have to hold non-consensual views regarding value, and they have to be accurate. That’s not easy. You require exceptional analytical ability, insight or foresight. And because it’s exceptional, few people have it.
Be more than right, be different and better.
- Investing Philosophy
Q: “What have been your keys to your success”
A: “An effective investment philosophy, developed and honed over more than four decades and implemented conscientiously by highly skilled individuals who share culture and values.”
A philosophy has to be sum of many ideas accumulated over a long period of time from a variety of sources. One cannot develop an effective philosophy without having been exposed to life’s lessons.
Most importantly, please go through life with your eyes wide open. (Don’t just float through life). You must be aware of what’s taking place in the world and of what results in those events lead to. Only in this way can you put the lessons to work when similar circumstances materialize again. Failing to do this – more than anything else – is what dooms most investors to being victimized repeatedly by cycles of booms and bust.
Having your eyes wide open, allows you to live in the moment. To be aware of what’s going on, and not just letting it slip passed by you. You then will be prepared for something that has never before occurred. Alertness can help identify and possibly avoid growing risks before it is too late.
Experience is what you got when you didn’t get what you wanted.
Good times teach only bad lessons, that investing is easy, that you know its secret, and that you needn’t worry about risk. The most valuable lessons are learned in tough times.
- Market Efficiency
States that many participants in the market and they share equal access to all relevant information. Information reflected fully and immediately in the market price of each asset. Quick to incorporate information, not right information.
EMH, in short just want to conclude, “You can’t beat the market.”
Psychological influences are a dominating factor governing investor behavior. They matter as much as – and at times more than – underlying value in determining securities prices.
Second-level thinkers know that to achieve superior results, they either have to have an edge in either information or analysis or both. They are on the alert for instances of misperception.
However, most of the time it’s impossible to argue that market prices are always priced. Humans are not clinical computing machines, most people are driven by greed, fear, envy and other emotions that render objectivity impossible and open the door for significant mistakes.
Seth Klarman, “Silos are a double-edged sword. A narrow focus leads to potentially superior knowledge. But the concentration of effort within rigid boundaries leaves a strong possibility of mispricing’s outside those borders. Also, if others’ silos are similar to your own, competitive forces will likely drive down returns in spite of superior knowledge within such silos.”
Inefficient markets do not necessarily give generous returns. They provide raw materials – mispricing – that can allow some people to win and others to lose on differential skill.
Wrong Prices = either finding bargain or overpay.
- Value
For Investing to be reliably successful, an accurate estimated of intrinsic value is the indispensable starting point. Without it, any hope for consistent success as an investor is just that: Hope.
Buy at a price below intrinsic value, and sell at a higher price (Overvaluation).
Fundamentals VS Price behaviour
Price Behavior = Technical Analysis
A study of past stock behaviour (Historic Price Patterns)
Fundamentals = Value investing & Growth investing
Value Investor aim to come up with a security’s current intrinsic value and buy when the price is lower
Value Investors typically look at financial metrics (earnings, cash flow, dividends, hard assets and enterprise value) and emphasize buying cheap
Value investors buy stocks (even if intrinsic value shows little or no growth), out of conviction that the current value is high relative to its supposedly price
Growth Investor try to find securities whose value will rapidly increase in the future
Growth investing goal is to identify companies with bright future. Less emphasize on the company current attributes and more on its potential
Growth investor buys stock believing the value will grow fast enough in the future to produce substantial appreciation. (This may or may not materialize in the future)
What makes a company valuable?
Business Model (Factories, retail outlets), Management, Financial Resources, patents, human resources, brand names, growth potential and its Ability to generate earnings and cash flow.
Net-Net Investing
Buy when
The total market value of a company’s stock < Company Current Assets (Cash, Receivables and Inventories) exceed its total liabilities.
*Buy all the stock, liquidate the current asset, pay off the debts, and end up with the business with some cash
Net-Net can still be doomed if company’s assets are money-losing operations or unwise acquisition.
If you overpay (on the wrong estimate of value), it takes a surprising improvement of value, a strong demand or a greater fool* to bail you out
Seth Klarman, “The bigger the discount, the bigger your margin of safety. Too small a discount and the limited MOS provide no real protection.”
Joel Greenbatt,” If you do a good job valuing a stock, the market will agree with you. It could be weeks, months or years. Graham said market is a weighing machine over long term, especially more emotional over short term period.”
Chances to buy well below actual value don’t come along every day, and you should welcome them.
Fear of Looking Wrong, like participants in any field requiring the application of skill under challenging circumstances, superior investors’ battling averages will be marked by errors and slumps. Judgments that prove correct don’t necessarily do so promptly, so even the best investors look wrong all the time.
Many people tend to fall further in love with the thing they’ve bought as its price rises, since they feel validated, and they like it less as the price falls, when they begin to doubt their decision to buy. Making it very difficult to hold, and to buy more at lower prices (averaging down)
No one is comfortable with losses, and eventually any human will wonder, “Maybe it’s not me who’s right. Maybe it’s the market.” The red flag is maximized when one start to think, “it’s already down so much, better get out before it goes to zero.”
An accurate opinion on valuation, loosely held, will be of limited help. An incorrect opinion on valuation, strongly held, is far worse.
*Hard to get it all right
Value investors score their biggest gains when they buy an underpriced asset, average down unfailingly and have their analysis proved out. Thus, these are 2 essential ingredients for profit in a declining market: you have to have a view on intrinsic value, and you have to hold on that view strongly enough to be able to hang in and buy even as price declines suggest that you are wrong.
*And you have to right, in the end
- The Most Impt Thing,
The Relationship between Price and Value
Investment success doesn’t come from “Buying good things, but rather from buying things well.”
Time and time again, no asset is so good that it can’t become a bad investment if bought at too high a price. And there are few assets so bad, that they can’t be a good investment when bought cheap enough (value trap)
Joel Greenblatt, “No matter how good an investment sounds, if price has not yet been considered, you can’t know if it is a good investment.”
“Many value investors are not good at knowing when to sell (and many sell way too early). However, knowing when to buy cures many of the mistakes resulting from selling too early.
“The market eventually gets it right, bare in mind the market acts emotionally over the short term.”
“How to estimate value and how to think about market prices. Prices can deviate wildly from value over the short-term is key. Understanding psychology, so that you can take advantage of these deviations when they appear is the hard part.”
“Well Bought is half sold.”
If your estimate of intrinsic value is correct, over time an asset’s price should converge with its value. It’s not enough to buy a share in a good idea, or even a good business. You must buy it at a reasonable (or bargain) price.
Most of the time short-term fluctuations are determined primarily by mainly 2 factors, psychology and technical.
The safest and most potentially profitable thing is to buy something when no one likes it. Given time, its popularity, and price, can only go one-way up.
“The human side of investing is the critical side. It’s certainly an area in which superior investors must excel, since financial analysis won’t guarantee superior performance if your reactions to development are skewed by psychology just like those of others. Thus, control your emotion and ego. The challenge is to perform better than other investors even though we start with the same thing.
Leverage: Buying with borrowed money. Doesn’t make anything a better investment or increase the probability of gains. It merely manifies whatever gains or losses may materialize. It introduce the risk of ruin if a portfolio fails to satisfy a contractual value test and lenders can demand their money back at a time when prices and illiquidity are depressed.
“Buying at the right price is the hard part of the exercise. Once done correctly, time and other market participants take care of the rest.”
Risker investments involve greater uncertainty regarding the outcome, as well as the increased likelihood of some painful ones.
The positive relationship between risk and expected return and the fact that uncertainty about the return and the possibility of loss increase as risk increases.
Take note, the risk of permanent loss of capital comparing to it’s potential reward.
Risk of loss does not necessarily come from weak fundamentals. A fundamentally weak asset can make for a very successful investment if bought at a low-enough price. Risk can be present even without weakness in the macro environment. The combination of arrogance, failure to understand and allow for risk, and a small adverse development can be enough to wreak havoc. It mainly comes down to psychology being too positive and prices are too high.
- Projections tend to cluster around historic norms and call for only small changes, people usually expect the future to be like the past and underestimate the potential for change.
- The Most Important Thing is,
Recognizing Risk
Great investing requires both generating returns and controlling risk. And recognizing risk is an absolute prerequisite for controlling it
Risk means the uncertainty about which outcome will occur and about the possibility of loss when the unfavorable ones do.
Recognizing Risk,
- Paying too much for a given asset
- The Most Important Thing is,
Controlling Risk
Extreme volatility and loss surface only infrequently. And as time passes without that happening, it appears more and more likely that it’ll never happen- that assumptions regarding risk were too conservative. Thus, it becomes tempting to relax rules and increase leverage. And often this is done just before the risk finally rears its head.
Reality is far more vicious than Russian Roulette. First, it delivers the fatal bullet rather infrequently, like a revolver that would have hundreds, even thousands of chambers instead of six. After a few dozen tries, one forgets about the existence of a bullet, under a numbing false sense of security. Second, unlike a well-defined precise game like Russian Roulette, where the risks are visible to anyone capable of multiplying and dividing by six, one does not observe the barrel of reality. One is thus capable of unwittingly playing Russian roulette, and calling it some alternative “low risk” name.
Once in awhile, “Black Swan” will materialize. But if in the future we always said, “We can’t do such-and-such, because the outcome could be worse than we’ve ever seen before,” we’d be frozen in inaction.
Volatility + Leverage = Dynamite
Risk Control is the best route to loss avoidance.
Risk Avoidance is likely to lead to return avoidance.
The road to long-term investment success runs through risk control more than through aggressiveness. Investors results will determined more by how many losers they have, and how bad they are, than by the greatness of their winners. Skillful risk control is the mark of superior investor.
The math behind compounding negative returns helps ensure this outcome.
(NEGATIVE 40% loss in one year, requires a return of 67% to fully recover)
- The Most Important Thing is,
Being Attentive to Cycles
We will never know what lies ahead, but we can prepare for the possibilities and reduce their sting.
There are very few sure things,
- Circumstances can change
Main reason are resulted by the fact, people are emotional and inconsistent, not steady and clinical. Psychology to these things causes investors to overreact or underreact, and thus determines the amplitude of the cyclical fluctuations.
Everything that was good for the market yesterday is no good for it today. The extremes of cycles result largely from people’s emotions, non-objectivity and inconsistency.
- The Most Important Thing is,
Awareness of the Pendulum
When things are going well and prices are high, investors rush to buy, forgetting all prudence. Then, when there’s chaos around and assets are on the bargain counter, they lose all willingness to bear risk and rush to sell. And it will be ever be so.
The mood swings of securities markets resemble the movement of a pendulum. This also describe, the mid-point of the pendulum (which is also the average), it actually spend very little of its time there. Most of the time, it is swinging towards or away from the extremes of its arc. The energy from movement from an extreme point to another, cause it to go on and on.
Investment markets are very similar to a pendulum swing,
- Between overpriced and underpriced
Bull Market Sentiments,
Paul Johnson,” It is hard for the average investor to commit capital to a new investment when the outlook is gloomy. Yet, it is precisely in these moments that potential returns are at their highest.”
The depressing outlook keeps them there, and only a few astute and darling bargain hunters are willing to take new positions.
“What the wise man does in the beginning, the fool does in the end.”
The pendulum cannot continue to swing toward an extreme, or reside at an extreme, forever (although when it’s positioned at its greatest extreme, people increasingly describe that as having become a permanent condition).
The swing back from the extreme is usually more rapid, and thus takes much less time than the swing to the extreme (A balloon air goes out much faster than the air goes in)
And we will never know,
- When this reversal will occur
For a bullish phase, the environment has to be characterized by greed, optimism, exuberance, confidence, credulity, daring, risk tolerance and aggressiveness. But these traits will not govern a market forever. Eventually, they will give way to fear, pessimism, prudence, uncertainty, skepticism, caution, risk aversion and reticence. Busts are the product of booms.
- The Most Important Thing is,
Combating Negative Influences
The desire for more, FOMO, the tendency to compare against others, the influence of the crowd and the dream of the sure thing, these factors have profound impact on most investors and most markets. The result is mistakes, and those mistakes are frequent, widespread and recurring.
Inefficiencies – Mispricing, misperceptions, mistakes that make other people make, provide potential opportunities for superior performance. Exploiting them is the only road to consistent outperformance.
Emotion and ego, psychological influences have great power over investors. Most succumb, permitting investors’ psychology to determine the swings of the market. When those forces push markets to extremes of bubble or crash, they create opportunities for superior investors to augment their results by refusing to hold at the highs and insisting on buying at the lows.
Greed is an extremely powerful force. It’s strong enough to overcome common sense, risk aversion, prudence, caution, logic, memory of painful past lessons, resolve, trepidation, and all the other elements that might otherwise keep investors out of trouble. Time after time, greed drives investors to throw in their lot with the crowd in pursuit of profit, and eventually they pay the price.
Greed + Optimism repeatedly leads people to pursue strategies they hope will produce high returns without high risk, paying elevated prices for securities that are in vogue, and hold things after they have become highly priced in the hope there’s still some appreciation left. Resulting in expectations was unrealistic and risks were ignored.
Charlie Munger, “ Nothing is easier than self-deceit. For what each man wishes, that he also believes to be true.”
Warren Buffet, “Rising prices are narcotic that affects the reasoning power up and down the line.”
Killer = Tendency to conform to the view of the herd, rather than resist
Killer = Envy (People who might be perfectly happy with their lot in isolation, become miserable when they see others do better)
Killer = Ego
Capitulation: Investor behavior late in cycles. Investors hold their conviction as long as they can, but when the economic and psychological pressures become irresistible, they surrender and jump on the bandwagon.
Have the courage to resist doing foolish things
- The Most Important Thing is,
Contrarianism
To buy when others are despondently selling and to sell when others are euphorically buying takes the greatest courage, but provides the greatest profit
Warren Buffet, “The less prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs.”
Be alert to the pendulum-like swing of the markets, it’s possible to recognize the opportunities that occasionally are there for plucking
It can be extremely painful when the trend is going against you
When buying something has become comfortable again, its price will no longer be so low that it’s be much harder
Contrarians role is to catch falling knives, hopefully with care and skill. That’s why the concept of intrinsic value is key. Greatest rewards with least risk
- The Most Important Thing is,
Finding Bargains
The failure to distinguish between good assets and good buys, get most investors into trouble
Fairly priced assets are never our objective, it’s giving only fair returns for the risk involved.
Overpriced won’t do us any good.
The goal is to find underpriced assets.
Value trap = things that is cheap can get cheaper
- The Most Important Thing Is,
Patient Opportunism
You’ll do better if you wait for investments to come to you rather than go chasing after them. You will tend to get better buys if you select from the list of things sellers are motivated to sell rather than buy recklessly
What’s past is past can’t be undone. It has led to the circumstances we now face. All we can do is recognize our circumstances for what they are and make the best decisions we can, given the givens.
Joel Greenblatt, “High Valuations can often go higher and last longer than expected, continually frustrating disciplined and patient value investors
To succeed in crisis,
Patient Opportunism, buttressed by a contrarian attitude and a strong balance sheet, can yield amazing profits during meltdowns.
- The Most Important Thing is,
Knowing What You Don’t Know
Awareness of the limited extent of our foreknowledge is an essential component of my approach to investing.
I’m firmly convinced that,
However,
- The more we concentrate on smaller-picture things, the more it’s possible to gain a knowledge advantage. With hard work and skill, we can consistently know more than the next person about individual companies and securities, but that’s much less likely with regard to markets and economics. Thus, I suggest people try to “know the knowable.”
- An exception comes in the form of my suggestion, on which I elaborate in the next chapter, that investors should make an effort to figure out where they stand at a moment in time in terms of cycles and pendulums. This won’t render the future twists and turns knowable, but it can help one prepare for likely developments
Understanding uncertainty: Risk and uncertainty ain’t the same as loss, but they create the potential for loss when things go wrong. Some of the biggest losses occur when overconfidence the range of possibilities, the difficulty of predicting which one will materialize, and the consequences of a surprise
It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.
Overestimating what you’re capable of knowing or doing can be extremely dangerous. Acknowledging the boundaries of what you can know, and working within those limits rather than venturing beyond, can give you a great advantage
- The Most Important Thing is,
Having a Sense for Where We Stand
We may never know where we’re going, but we’d better have a good idea where we are
Superior results in investing come from knowing more than others, and it hasn’t been demonstrated to my satisfaction that a lot of people know more than the consensus about the timing and extent of future cycles.
Try to make good investments and hold them throughout (Buy-and-hold approach)
Nothing is as dependable as cycles. Fundamentals, psychology, prices and returns will rise and fall, presenting opportunities to make mistakes or to profit from the mistakes of others. They are the givens.
We cannot know how far a trend will go, when it will turn, what will make it turn, or how far things will then go in the opposite direction. But I’m confident that every trend will stop sooner or later. Nothing goes on forever.
We can’t know in advance how and when the turns will occur, how can we cope? We may never know where we’re going, but we’d better have a good idea where we are. That is, even if we can’t predict the timing and extent of cyclical fluctuations, it’s essential that we strive to ascertain where we stand in cyclical terms and act accordingly.
Stay alert for occasions when a market has reached an extreme, adjust our behavior in response, and most importantly refuse to fall into line with the herd behavior that renders so many investors dead wrong at tops and bottoms.
Those who cannot remember the past, are condemned to repeat it
Try to figure out what’s going on around us, and use that to guide our actions.
- The Most Important Thing Is,
Appreciating the Role of Luck
Paul Johnson, “ Learn to be honest with yourself about your successes and failures. Learn to recognize the role of luck has played in all outcomes. Learn to decide which outcomes came about because of skill and which because of luck. Until one learns to identify the true source of success, one will be fooled by randomness.”
- The Most Important Thing is,
Investing Defensively
Understand one’s attitude toward risk and return
Investing is pretty similar to sports as well,
- It’s competitive – Some succeed and some fail, and the distinction is clear
- It’s quantitative – You can see the results in black or white
- It’s meritocracy – In the long term, the better returns go to the superior investors
- It’s team oriented – an effective group can accomplish more than one person
- It’s satisfying and enjoyable – but much more so when you win
- There can be a premium on aggressiveness, which doesn’t serve well in the long run
- Unlucky bounces can be frustrating
- Short-term success can lead to widespread recognition without enough attention being paid to the likely durability and consistency of the record
Conscious balance between Offensive and Defensive, largely giving up on tactical timing but aiming to win through superior security selection in both up and down markets (Striving for return and limiting risk)
Defense,
- Exclusion of losers from portfolios (Throughout DYODD, applying high standards, demanding low price and generous margin for error, being less willing to bet on continued prosperity, rosy forecasts and developments that may be uncertain)
- Avoidance of poor years, especially exposure to meltdown in crashes
Worry about the possibility of loss. Worry that there’s something you don’t know. Worry that you can make high quality decisions but still be hit by bad luck or surprise events. Investing scared will prevent hubris; will keep your guard up and your mental adrenaline flowing; will make you insist on adequate market of safety; will increase the chances that your portfolio is prepared for things going wrong. And if nothing does go wrong, surely the winners will take care of themselves.
- The Most Important Thing is,
Avoiding Pitfalls
An investor needs to do very few things right as long as he avoids big mistakes
Sources of error,
- Analytical / Intellectual or Psychological / Emotional
- Greed and Fear, Willingness to suspend disbelief and skepticism, Ego and envy, The drive to pursue high returns through risk bearing, the tendency to overrate one’s foreknowledge
- The failure to recognize market cycles and manias and move in the opposite direction (Extremes in cycles and trends don’t occur often, and thus they’re not a frequent source of error but they give rise to the largest errors)
How investors harmed by such factors?
To avoid pitfalls consists of being on the lookout for them,
Learning lesson from a Crisis,
- Too much capital availability makes money flow to the wrong places
- When capital goes where it shouldn’t, bad things happen
- When capital is in oversupply, investors compete for deals by accepting low returns and a slender margin for error
- Widespread disregard for risk, creates greater risk (No price is too high)
- Inadequate due diligence leads to investment losses (Margin of safety, thorough, insightful analysis and insistence)
- In heady times, capital devoted to innovative investments, many of which fail the test of time. (Bullish investor focus on what might work, not what might go wrong)
- Hidden fault lines running through portfolios can make the prices of seemingly unrelated move in tandem. (Correlation)
- Psychological and technical factors can swamp fundamentals (Supply VS demand, Overconfidence)
- Market change, invalidating models (AI can attempt to profit from patterns that held true in the past, but they can’t predict changes in those patterns, they can’t anticipate aberrant periods, and they generally overestimate the reliability of past norms)
- Leverage magnifies outcomes, but doesn’t add value
- Excess Correct (Market being too rosy)
- Be alert to what’s going on around you, with regard to the supply/demand balance for investable funds and the eagerness to spend them
- Taking note of the carefree, incautious behavior of others
- Preparing psychologically for a downturn
- Selling assets, or at least the more risk-prone ones.
- Reducing leverage
- Raising cash
- Converting portfolios towards increased defensiveness
- Maintain their equanimity and resist the psychological pressures that often make people sell at lows
- Being in a better frame of mind and better financial condition, they are more able to profit from the carnage by buying at a low (Generally will do better in recoveries)
- One way to improve investment results (which we will try hard to apply at Precession) is to think about what “today’s mistake” might be and try to avoid it
When there’s nothing particularly clever to do, the potential pitfall lies in insisting on being clever
- The Most Important Thing is,
Reasonable Expectations
Return expectation must be reasonable. Anything else will get you into trouble, usually through the acceptance of greater risk than is perceived
What your return goal is,
How much risk can you tolerate,
And how much liquidity you’re likely to require in the interim
The Bottom*, is the point at which the price of an asset stops going down and gets ready to start going up.
There are 3 times to buy an asset that has been declining: on the way down, at the bottom or on the way up. We won’t ever know when is the bottom has been reached, and even if we did, there might not be much for sale there.
If we wait until the bottom has been passed, and the price has started to rise, the rising price often caused others to buy, just as it emboldens holders and discourages them from selling. Supply dries up and it becomes hard to buy in size. The would-be buyer finds it’s too late
That leaves buying on the way down, which we should be glad to do. Buying only at the bottom, can cause you to miss out on a lot. Perfection, in investment is generally unobtainable, the best we can hope for is to make a lot of good investment and exclude most of the bad ones.
Give up on trying to attain perfection or ascertain when the bottom has been reached. If you think something is cheap, buy.
- The Most Important Thing is,
My Takeaways
- To achieve superior investment results, your insight into value has to be superior. Thus you must learn things others don’t, see things differently or do a better job of analyzing them, ideally all three.
- Your View of Value has to be based on a solid factual and analytical foundation, and it has to be held firmly. Only then will you know when to buy or sell. Only a strong sense of value, will give you the discipline needed to take profits on a highly appreciated asset that everyone thinks will rise nonstop, or the guts to hold and average down in a crisis even as prices go lower everyday. Your efforts in these regards to be profitable, the estimate of value has to be on target.
- Buying below value is most dependable route to profit. Paying above value rarely works out as well.
- What causes an asset to sell below its value? Outstanding buying opportunities exist primarily because perception understates reality. It takes keen insight to detect cheapness. Investors often mistake objective merit for investment opportunity. The superior investor never forgets that the goal is to find food buys, not good assets.
- Giving rise to profit potential, buying when price is below value is a key element in limiting risk. Neither paying up for high growth, nor participating in a hot* momentum market can do the same.
- R/S between price and value is hugely influenced by psychology and technical, forces that can dominate fundamentals in the short-run.
- Extreme swing in price, provide opportunities for big profits or big mistakes.
- Markets cycle up and down. Whatever direction they’re going at the moment, most people come to believe that they’ll go that way forever. This thinking is a source of great danger since it poisons the market, sending valuation to extremes, and igniting bubbles and panics that most investors find hard to resist.
- The psychology of the investing herd moves in a regular pendulum-like pattern, from optimism to pessimism, from credulousness to skepticism, from FOMO to fear of losing money, and thus from eagerness to buy to urgency to sell. In result of them, buying high, selling low. Being a part of herd is a formula for disaster, whereas contrarianism at the extremes will help to avert losses and lead eventually to success.
- The power of psychological influences must never be underestimated. Greed, fear, suspension of disbelief, conformism, envy, ego and capitulation are all part of human nature, and their ability to compel action is profound, especially when they’re at extremes and shared by the herd. They’ll influences others, and the thoughtful investor will feel them as well. We can’t be immune nor isolated by the fact of that. Although we will feel them, we must not succumb. We must recognize them for what they are, and stand against them. Reasons must overcome emotion.
- Most trends eventually become overdone. (Bull and bear). Profiting those who recognize them early but penalizing the last to join. “What the wise man does in the beginning, the fool does in the end.”
- Impossible to know when an market will turn down. We never know where we’re going, but we ought to know where we are. We can infer where markets stand in their cycle, from the behavior of those around us. When other investors are unworried, we should be cautious, when investors are panicked, we should turn aggressive.
- We must recognize when the odds are less in our favor and tread more carefully.
- Buying based on strong value, low price relative to value, and depressed general psychology is likely to provide the best results. But things can go against us for a long time, before turning as we think they should. Underpriced is far from going up soon*. “Being too far ahead of your time is indistinguishable from being wrong.” Value Investing requires patience and fortitude to hold positions long enough to be proved right.
- Understand the part where there is the loss potential that’s present in each investment and be willing to bear it only when the reward is more than adequate.
- If we avoid the losers, the winners will take care of themselves
- Risk control lies at the core of defensive investing. Instead of trying to do the right thing, the defensive investors place a heavy emphasis on not doing the wrong thing.
- Margin of Safety render outcomes tolerable when the future doesn’t oblige.
- We won’t know what lies ahead in terms of the macro future. The investor’s times are better spent trying to gain a knowledge advantage regarding “the knowable”; industries, companies and securities. The more micro your focus, the greater the likelihood you can learn things others don’t.
- Investing on the basis strongly held but incorrect forecasts is a source of significant potential loss.
- Most investors ignore the randomness of things and the probability distribution that underlies future developments.
- Awareness of potential dangers represents the best starting point for an effort to avoid being victimized by them.
- Reasonable expectation = Understanding of your risk appetite.
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