The Most Important Thing
Howard Marks
p.11 – We assume everyone knows everything
Investors need to have an informational edge or an analytical edge or ideally both.
In our current world of information availability, Saiwala assumes that everyone has all the available information, has processed it, and has already included the information into their investment decisions. They may have yet to act on the new information, but we assume they have processed it. Thus far we agree in the efficient market hypothesis. Where we differ is that the market over and underestimates the relevance of the available information, thereby driving prices below and above their intrinsic value. We wait for the market to create overreactions to information.
p. 13 – We look where most people do not
Mainstream securities are followed by so many professionals that they are likely priced efficiently most of the time
We agree with that and look for securities where most professionals are not looking. Our primary focus is on cloning. Our secondary focus is on micro-caps. People who are successful in investing in Micro-caps eventually must look at small caps as their asset base grows. This will always result in newcomers with skill having an opportunity.
p. 23 – Always check yourself if you’re right
Investors who buy into price declines and who have their thesis prove out stand to gain the most returns; but they must be right.
We exclusively try to buy securities when their price decline indicates that they are priced below intrinsic value. Of course, us purchasing implies that we believe the market is wrong and we are right. Thus, we consistently try and find disconfirming information after we make an investment.
p.26 – Be liquid enough to withstand market turmoil
Being a forced seller of securities is the worst
We must remind ourselves to always have our personal affairs in such an order that we are never forced to sell.
p.34 – Risk conceptualization with a graph
Howard has a great graph on this page
Risk increases as the probability distribution gets larger. This is a great way to think about risk: As the possible outcomes become larger, the risk of the investment increases.
p.39 – How to judge risk
(1) The dependability of value, (2) the relationship of price to value
How dependable is our estimate of current value and future value? In other words, is our analysis of the current value correct and does the company have a moat? Then, if we believe this to be the case, can we purchase the company at a price that protects us in case the worst possible outcome happens?
p.42 – The difficulty with probabilities
Improbable things happen all the time
It is important to focus on the improbable, the outliers of the probability distribution. If our margin of safety can protect us from the improbable, our risk adjusted returns are possibly maximized.
p.46 – High prices equal high risk
High risk primarily comes with high prices
We must have a margin of safety that protects us against the improbable from happening. The more pay, the more risk we accept. This requires patience and discipline. That’s why we try and focus on 10x free cash flow as a starting point for valuing a company without growth and then waiting for an additional margin of safety based on the worst possible outcome.
p.55 – Risk is located opposite of the herd
When everyone believes something is risky their unwillingness to buy it drives down the risk of the investment.
Perceived risk can become a self-reinforcing behavior in the market, thereby actually reducing the risk. The more people perceive an investment as risky, the more the price declines until it reaches a point where it is no longer risky. We wait for a situation where something can be purchased for less than 10x free cash flow considering the worst possible outcome.
p.58 – Loss happens when risk meets adversity
Losses happen when risk meets adverse conditions. If all goes well losses don’t arise, but that doesn’t mean that an investment was less risky. The outcome of an investment is independent of the risk taken.
This was one of the wisest statements of the book in my opinion. The most successful investment does not negate the risk it may have entailed. We just don’t see it because the risk of the investment didn’t encounter adversity. In other words, the outlier on the probability distribution didn’t happen. If it had happened our investment would have created losses. If that is the case, we had great risk regardless of the outcome. We must strive to make investments only if the outlier scenario will not hurt us too much.
p.72 – Cycles will repeat
p.80 – This is why markets are inefficient
People will come to similar conclusions based on available information, but what they do with it varies based on psychology.
It’s not the available information that gives us an edge. Most of the time it is not the superior analysis of the available information. Our advantage is in patiently waiting for the times when psychology offers us opportunities.
p.85 – Dangerous self-reinforcing pattern
When everything goes right it is great to feel smart
It is important to revisit our successes with a critical eye. How much risk did we truly take? Just because our thesis worked out doesn’t mean that an alternate outcome would have kept us safe. It is therefore of the utmost importance to invest for the worst possible outcome.
p.89 – We’re not immune to psychology
Why would the psychological forces that can move the masses to illogical actions pass you by?
This is correct. They do not pass us by. That is why we use our emotional journal to give our feelings an outlet in a safe environment. The feelings will be there, but we can choose how we react to them. Don’t suppress your emotions, because they do not go away that way, they fester and make you do many dumb things in the future in a more nefarious manner.
p.101 – The best alternative: compare investments
Investing is necessarily comparative.
One investment is only better than another if your next best alternative, which you already own, is obviously worse. Christopher Mayer (100 Baggers) says something similar. Don’t make a new investment if it is perceived as only slightly better than one you already own. You could be wrong is always a possible outcome. Worse still would be to sell a good investment for something that may possibly be slightly better.
p.113 – Getting out too early
Getting out of the market in 2005 was a good reminder of the pain of being early. But it was much better than the alternative.
Being conservative can be painful when others around us are making a lot of money. Therefore, we often remind ourselves of the simple math: a 50% loss requires a 100% gain to come back to the baseline. Therefore, we focus most of our attention on the downside protection.
p.130 – Focus on what is knowable
In most other professions we adapt to our environment. Golfers choose their clubs based on the wind etc.
The present is knowable. We see it all around us, by watching people’s decisions unfold in the markets. We don’t need to prepare for an unknowable future if we can prepare for a knowable present. If people around you start acting foolish, banks are lending to anyone, and your neighbors nine-year-old son is giving out stock advice you can adapt to it.
p.135 – Evaluate past decisions through the filter of luck
Many successful investment outcomes are due to random events (luck) and not superior skill.
We use our emotional journal and our general thought writings to evaluate outcomes we did not foresee even after they didn’t happen. Yes, the demand for the product exceeded our thesis expectation and we made money. However, did we truly anticipate this by superior analysis or did some event we couldn’t possibly foresee create the conditions to cause the increase in demand?
p.141 – Essay Recommendation
Charles Ellis: “The Loser’s Game”
p.154 – Cycles will repeat
Cycles repeat over the long term and most people forget it quickly.
We try to remind ourselves of cycles by re-reading books about past boom and busts more frequently to pound the lessons into our heads. It requires discipline, but it is worth it.
p.155 – Invest for outliers to happen
When something “should happen” but then it doesn’t happen it can kill you.
This concept is repeated throughout the book. We need to invest, with a margin of safety, considering that the outlier event will happen. If you can find an investment where with a margin of safety you can lose very little if the world seems to be ending, you’re going to be in good shape. Page 160 repeats this concept again. Page 164 as well.