Howard Marks’ Thoughts on Value Investing in 2022
Hello investors, welcome to my Substack, where I study the best Investors and businesses from around the world. In this week’s article, we’ll go over Howard Marks’ thoughts on what makes a good value investor and what the current climate looks like for value investors.
Howard Mark of Oaktree Management is one of my favorite investing legends. His investment knowledge and understanding of investor psychology and market dynamics are unrivaled. Given the ongoing "speculative mania" in the market, it might be good to review his annual letter.
According to Marks, value investors understand that rather than telling us what a given asset’s value is, Mr. Market offers securities at prices that can be disconnected from the actual value of a stake or claim in a business. In doing so, he sometimes gives us the opportunity to snatch up shares or bonds at a meaningful discount from their intrinsic value. This requires independent thought and a temperament that resists the emotional pull of the market cycle, as well as decision making based solely on value.
These are Howard Marks’ underlying principles of what makes for good value investing:
Understanding securities as stakes in actual businesses
A focus on true worth as opposed to price
The use of fundamentals to calculate intrinsic value
The recognition that attractive investments are a result of a wide discrepancy between the price at which something is offered on the market and its actual worth
Emotional discipline to act only when such opportunities are presented and not in other circumstances
You could argue that back in the old days, people like Warren Buffett could find businesses likely to remain prominent for long periods of time, and could perform straightforward analyses to assess their valuations. For instance, he could look at something like the Washington Post, which became a monopoly newspaper company in a major city, and invest on the basis of reasonable, consistent assumptions in regards to variables like circulation, subscription prices, and ad rates. It was assumed that the newspaper would remain dominant because of its strong economic moat, and that the company’s past would look very much like its future. However, in contrast, today:
Due to the global nature of markets, and the ability for the Internet and software to vastly increase their profit potential, technology firms or other technologically aided businesses have the capacity to become much more valuable than we previously could have imagined.
Innovation and technology adoption are happening at a much more rapid pace than ever before.
It has never been easier to start a company, and there has never been more capital available to fund entrepreneurship and start-ups.
There have also never been as many highly capable people focused on starting and building their own companies.
Since many companies are now selling products primarily made with code, their costs and capital expenditures are extremely low. Also, their profitability – especially on incremental sales – is unusually high. Thus, this economy of winners has never been more attractive. Because the marginal cost of scaling a business over the Internet is low, businesses can grow much more rapidly than ever before.
It’s become more acceptable for public companies to lose money in the pursuit of large earnings in the future. This can obscure the real potential economics of winners and can make differentiating between winners and losers difficult.
As developing and scaling new products is much easier in the digital world, often because they require little more than engineers and code, it’s now possible for companies to explore new avenues of growth. For example, Amazon’s AWS and Square’s Cash App. This gives more value to exceptional management, engineering talent, and the strategic leveraging of consumer wishes.
The moats protecting today’s winners have never been stronger. As Brian Arthur pointed out in “Increasing Returns and the New World of Business,” the winners often become stronger and more effective as they get bigger, rather than more bloated and inefficient.
On the other hand, the large increase in startups with readily available capital and minimal barriers to scaling means that the durability and legacy of businesses has never been more uncertain.
At the same time, however, it’s important to recognize that the leading tech firms face stricter anti-trust laws because policymakers believe they have developed excessive market power.
To summarize, businesses are both more vulnerable and more dominant in today’s world, with more opportunities for drastic changes in profit, whether positive or negative. On the positive side, successful businesses have more potential for long spurts of high growth, superior economics, and significant durability. This creates a huge pot of gold at the end of the rainbow and helps justify valuations that are remarkably high by historical standards. On the negative side, this also tempts investors to overvalue undeserving companies. And companies with here-and-now cash flows that seem stable can see those gains evaporate as soon as a bunch of Stanford computer science students get funding and traction for their new idea.
As you may already know, Warren Buffett is a friend and a fan of Howard Marks. Buffett has been quoted as saying - "When I see memos from Howard Marks in my mail, they're the first thing I open and read" - so on this substack, I hope to cover learning from his letters in the coming articles. Let me know if you think Howard Marks missed anything from his thoughts on the current economic climate.
Thank you for reading this article entirely till the end. Nothing helps me out more than y’all sticking it out till the end. Please consider subscribing to my substack if you haven’t already done so. Also if you enjoyed this article please like this article and subscribe to my substack so that I can continue to make articles like this for you to enjoy.