Howard Marks on How to Identify Investment Opportunities

Howard Marks on How to Identify Investment Opportunities

One of the questions I am asked often via emails or before my Workshops is – “How to identify the right stocks for investment?”

The core steps are well-known – look for simple businesses that fall under your circle of competence and avoid everything else, read their financial statements to assess their strength and also vis-a-vis their competitors, and then value them using a few intrinsic value methods. This process covers a large part of the “action” as far as identifying sound investment opportunities is concerned.

But there is a step prior to this process as well – a step where you create the right mental framework required to identify the right investment opportunities.

This step is courtesy Howard Marks who, in his memo to investors in January 1994, lays down seven thoughts on identifying sound investments. These are amazing ideas for the discerning investor, as these help him get into the right frame of mind before starting the hard work of finding the right opportunities for long term investment.

Random Thoughts on the Identification of Investment Opportunities
Howard Marks, Jan. 1994

1. No group or sector in the investment world enjoys as its birthright the promise of consistent high returns.

There is no asset class that will do well simply because of what it is. An example of this is real estate. People said, “You should buy real estate because it’s a hedge against inflation,” and “You should buy real estate because they’re not making any more.” But done at the wrong time, real estate investing didn’t work.

2. What matters most is not what you invest in, but when and at what price.

There is no such thing as a good or bad investment idea per se. For example, the selection of good companies is certainly not enough to assure good results – see Xerox, Avon, Merck and the rest of the “nifty fifty” in 1974.

Any investment can be good or bad depending on when it’s made and what price is paid. It’s been said that “any bond can be triple-A at a price.”

There is no security that is so good that it can’t be overpriced, or so bad that it can’t be underpriced.

3. The discipline which is most important in investing is not accounting or economics, but psychology.

The key is who likes the investment now and who doesn’t. Future prices changes will be determined by whether it comes to be liked by more people or fewer people in the future.

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 safest and most potentially profitable thing is to buy something when no one likes it. Given time its popularity, and thus its price, can only go one way: up.

Watch which asset classes they’re holding conferences for and how many people are attending. Sold-out conferences are a danger sign. You want to participate in auctions where there are only one or two buyers, not hundreds or thousands.

You want to buy things either before they’ve been discovered or after there’s been a shake-out.

4. The bottom line is that it is best to act as a contrarian.

An investment that “everyone” knows to be undervalued is an oxymoron. If everyone knows it’s undervalued, why haven’t they bought it and driven up its price? And if they have bought, how can the price still be low?

Yogi Berra said, “nobody goes to that restaurant; it’s too popular.” The equally oxy-moronic investment version is “Everybody likes that security because it’s so cheap.”

5. Book the bet that no one else will.

If everyone likes the favorite in a football game and wants to bet on it, the point spread will grow so wide that the team — as good as it is — is unlikely to be able to cover the spread. Take the other side of the bet – on the underdog.

Likewise, if everyone is too scared of junk bonds to buy them, it will become possible for you to buy them at a yield spread which not only overcompensates for the actual credit risk, but sets the stage for their being the best performing fixed income sector in the world. That was the case in late 1990.

The bottom line is that one must try to be on the other side of the question from everyone else. If everyone likes it, sell; if no one likes it, buy.

6. As Warren Buffet said, “the less care with which others conduct their affairs, the more care with which you should conduct yours.” When others are afraid, you needn’t be; when others are unafraid, you’d better be.

It is usually said that the market runs on fear and greed. I feel at any given point in time it runs on fear or greed.

As 1991 began, everyone was petrified of high yield bonds. Only the very best bonds could be issued, and thus buyers at that time didn’t have to do any credit analysis – the market did it for them. Its collective fear caused high standards to be imposed. But when investors are unafraid, they’ll buy anything. Thus the intelligent investor’s workload is much increased.

7. 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.

When undemanding investors appear, they’ll buy anything. Underwriting standards fall, and it gets hard for demanding investors to find opportunities offering the return and risk balance they require, so they’re forced to the sidelines.

Demanding investors must be willing to be inactive at times.

Simple, isn’t it?
What Marks wants you to do by sharing these ideas is to have the independence of mind.

He wants you to not get swayed by what everybody else is doing and, in fact, become “psychologically astute.”

As his third thought states – The discipline which is most important in investing is not accounting or economics, but psychology.

People who are not psychologically astute consistently make errors of judgement, something I stress upon in my Workshop.

Now the problem here is that despite appreciating the importance of this thought (and others as outlined above) in our investment framework, we often forget them in the heat of things – like when we are making or losing money fast.

Here’s what you can do to remember these thoughts before you sit down to identify the next stock for your portfolio – write them down in your “Diary of the Dumb Investor”.

An inspiring story that shows just how simple it can be for one person with an idea to make a difference.

An inspiring story that shows just how simple it can be for one person with an idea to make a difference.

Aabid Surti is an odd character. A few years ago, the angular, bearded author was invited to meet the President of India to receive a national award for literature at a ceremony in the capital, New Delhi. He politely declined. Absorbed in writing the first draft of his new novel, he cited the reason that he did not have time. But what he has made time for every Sunday for seven years now, is going door-to-door in Mira Road, a non-descript suburb of Mumbai, with a plumber in tow, asking residents if they need their tap fixed for free!

As a distinguished Indian painter and author, Aabid has written around 80 books but no story so moved him as the truth about water scarcity on the planet. “I read an interview of the former UN chief Boutros Boutros Ghali,” he recalls, “who said that by 2025 more than 40 countries are expected to experience water crisis. I remembered my childhood in a ghetto fighting for each bucket of water. I knew that shortage of water is the end of civilized life.”

Around the same time, in 2007, he was sitting in a friend’s house and noticed a leaky tap. It bothered him. When he pointed it out, his friend, like others, dismissed it casually: it was too expensive and inconvenient to call a plumber for such a minor job – even plumbers resisted coming to only replace old gaskets.

A few days later, he came across a statistic in the newspaper: a tap that drips once every second wastes a thousand litres of water in a month. That triggered an idea. He would take a plumber from door to door and fix taps for free – one apartment complex every weekend.

As a creative artist, he had earned more goodwill than money and the first challenge was funding. “But,” he says, “if you have a noble thought, nature takes care of it.” Within a few days, he got a message that he was unexpectedly being awarded Rs.1,00,000 ($2,000) by the Hindi Sahitya Sansthan (UP) for his contribution to Hindi literature. And one Sunday morning in 2007, the International Year of Water, he set out with a plumber to fix the problem for his neighbors.

He began by simply replacing old O-ring rubber gaskets with new ones, buying new fixtures from the wholesale market. He named his one-man NGO ‘Drop Dead’ and created a tagline: save every drop… or drop dead.

Every Sunday, the Drop Dead team – which consisted of Aabid himself, Riyaaz the plumber and a female volunteer Tejal – picked the apartment blocks, got permission from the housing societies, and got to work. A day before, Tejal would hand out pamphlets explaining their mission and paste posters in elevators and apartment lobbies spreading awareness on the looming water crisis. And by Sunday afternoon, they would ensure the buildings were drip-dry.

By the end of the first year, they had visited 1533 homes and fixed around 400 taps. Slowly, the news began to spread.

In March 2008, director Shekhar Kapur, who was working on his own water conservation film, heard about Aabid’s efforts and wrote on his website: ‘Aabid Surti, thank you so much for who you are. I wish there were more people like you in this world. Keep in touch with us and keep inspiring us. Shekhar.’

Local newspapers began to write about Drop Dead, which prompted a further flood of grateful emails and spontaneous messages. One of the most heartfelt messages was from superstar actor-producer Shah Rukh Khan, a longtime fan of Aabid’s work as a comic book creator. After reading the newspaper report titled ‘City of Angels’, he wrote to Aabid: “…It sounds like one of the little big things my dad would have done.Strange that I have enjoyed [your comic] Bahadur in my childhood and enjoyed reading your tap story so many years down the line… when I am father myself. God bless you and yes, I believe in angels after reading the newspaper.”

In 2010, Aabid Surti was nominated for the CNN-IBN CJ ‘Be The Change’ Award. In the same year, a television crew from Berlin flew down to follow him on his Sunday rounds which continued come monsoon or shine.

It’s hard to say how much water he has saved with his mission, given that the faucets he fixed could have continued leaking for months, and maybe years, had he not rung the doorbell one Sunday morning. But conservatively, it could be estimated that he has single-handedly saved at least 5.5m litres of water till date.

In the summer of 2013, the state where Aabid lives is expecting its worst drought in 40 years. Months in advance, the Chief Minister Prithviraj Chauhan has warned citizens to begin conserving water. While ministers lobby for drought-relief packages worth millions of dollars, Aabid sees his own approach as simple and inexpensive.

As he rings another door-bell on yet another Sunday in Mira Road, seven years into his one-man mission, he says: “Anyone can launch a water conservation project in his or her area. That’s the beauty of this concept. It doesn’t require much funding or even an office. And most importantly, it puts the power back in our own hands.”

I would call him a modern-day angel;

9 Business Books That Will Change Your Life ~~ Dave Kerpen

9 Business Books That Will Change Your Life ~~ Dave Kerpen

Great leaders learn everyday, and reading great books is the one of the best ways to learn. I've been fortunate enough to read some excellent books over the last fifteen years - books that have inspired me to change the way I see the world, my business, and the opportunities in front of me. In the order in which I've read them, here is a list of nine books which have changed my life. May they change yours as well:

1) What Color is Your Parachute? A Practical Manual for Job-Hunters and Career Seekers by Richard Bolles

I read this book when I was 21 years old and didn't know what to do with the rest of my life. It helped me go from a Crunch n Munch vendor at the ballpark to a top salesperson at Radio Disney. Ffifteen years later, I have given at least 40 copies away to interns, staff and friends who are searching for their career purpose. It's difficult work - because not only will you read the book, but you'll have to do a lot of exercises and soul searching throughout - but whether you're 21 or 61, you'll emerge with a clearer vision of what you want to do next and where you'll want to work.

2) Permission Marketing: Turning Strangers Into Friends & Friends Into Customers by Seth Godin

No author has influenced me more as a marketer, business person and writer than Seth Godin. I could have easily included 9 books just by Godin - Purple Cow, Tribes, Linchpin, Poke the Box & his latest, Icarus Deception are all amongst my favorites. But Permission Marketing described social media marketing before it existed. Seth understood push-vs-pull marketing long before others, and this book, published in 1999, is still a must read for anyone in marketing today.

3) The Tipping Point: How Little Things Can Make a Big Difference by Malcolm Gladwell

This classic, one of three by Gladwell (Blink & Outliers are the others), demonstrates how successful products are launched, how ideas spread and how a trend can take off. It's influenced me a great deal, as a word of mouth and social media marketer. And it's an essential read, whether you're in marketing or sales, or just want to become better at getting your ideas to spread.

4) Good to Great: Why Some Companies Make the Leap - and Others Don't by Jim Collins

Collins is scientist of great companies - and this is his best work - chock full of case studies and simple yet profound principles like Level 1 Leadership. Even though I read this book when my company was only a handful of employees, it inspired me to want to build something great, and enduring. Whether you work at a large company that has the potential itself to become great and enduring, or you have a vision of a company you'd like to one day build, this is a must-read.

5) Mastering the Rockefeller Habits: What You Must Do to Increase The Value of Your Growing Firm by Verne Harnish

It's hard to believe I even had a business before I read this book by the founder of my favorite business group, Entrepreneurs Organization. Verne's 1-page strategic plan is now used by both companies I've founded, and thousands of other companies. And our management teams use much of the methodology from this book. What's great is that it's both inspirational and quite practical - an excellent read for any entrepreneur or manager at a small business.

6) The E-Myth: Why Most Small Businesses Don't Work, and What to Do About It by Michael Gerber

This is a must read for any small business owner - especially "technical" owners such as lawyers, accountants, florists, restaurateurs, consultants and dentists. Gerber inspires the small business owner to get out of his/her own way, and to build systems and processes that scale and allow the business owner to work "on" the business and not "in" the business.

7) Built to Sell: Creating a Business That Can Thrive Without You by John Warrilow

Make no mistake - if you are an owner or leader at a business - this is a great, super valuable read, even if you or your owners have no intention or ever selling the business. The idea isn't to create a business in order to sell it - it's to create a business that has sustaining value beyond you and without you. Warrilow's book is a short, easy story - with powerful, unforgettable lessons - so much so, that after my business partner and I read it, we gave copies to the entire Likeable team to read.

8) Rework by Jason Fried and David Heinemeier Hansson

No matter what you do, this easy read will change the way you think about your work. It is so simply written, with small words and big pictures - and yet contains profound wisdom about how to be more productive and successful without being a workaholic or sacrificing anything. I read it in an hour on a plane, and have since shared it with two dozen colleagues, and referred back to it myself at least a dozen times.

9) The Three Big Questions for a Frantic Family: A Leadership Fable About Restoring Sanity to The Most Important Organization in Your Life by Patrick Lencioni

Along with Seth Godin, Patrick Lencioni is my favorite business author. I've read and love The Advantage, Getting Naked, The Five Dysfunctions of a Team, and The Five Tempations of a CEO. But the reason I've selected this one as my favorite, is that, as I've written before here, our ultimate legacy isn't our career, but our family. In this book, Lencioni applies his management consulting methodology and brilliant storytelling ability to the running of a family. It's amazing how little strategy most of us parents apply to the most important organization we've got, our families, and this book helps change all that. Six months after my wife and I read this book, I'm proud to report that our family now has a strategic plan, complete with a mission statement, quarterly objectives, and weekly 10-minute meetings. And it's going GREAT.