“The Art and Science of Value Investing – Something of Value”, A Memo by Howard Marks

I had the privilege of meeting Howard Marks in person and hearing his views at an event hosted by CFA Society India in Mumbai during early 2017. This January, I am keenly looking forward to hearing him again at the upcoming India Investment Conference, the 11th edition of the annual marquee event of CFA Society India.

“The greatest investors I know, starting with Warren Buffett, are unemotional,” Howard Marks , CFA, of Oaktree Capital Management, L.P. had said at a past event. “Most of the errors in our business are errors of emotion.”

I am sure that like me, many of you would have followed and read the famous “Memos” published by Howard Marks as a part of outreach from his company Oaktree.

The memos from Howard Marks are followed globally by the best investors and analysts alike. Warren Buffet has famously said, “…When I see memos from Howard Marks in my mail, they’re the first thing I open and read. I always learn something…”

In a period where Growth has meaningfully outperformed value for past 13 years, Howard Marks has come out with his latest Memo titled “Something of Value” (Link: bit.ly/HMValueJan21) discussing his views on some key points about the art and science of value investing.

While the entire 18 page note is very engaging, I would suggest reading the last 2 pages where Howard has put up some Q&A format points between him, and his son Andrew.

The points made in the note are bound to make you think, and debate. Some interesting ones were:

• Value & growth investing should not be viewed as mutually exclusive
• Only pursuing low valuation metrics can lead to “value traps”
• Value investing should consist of buying whatever represents a value proposition
• The fact that a company is expected to grow rapidly doesn’t mean its unpredictable – the fact that another company has a history of steady growth doesn’t mean it cant run into trouble
• Central Bank’s easy money and low interest rates have HELPED “Growth” stocks. As the tide turns on monetary stimulus (some signs were seen even close to home in India last week), rising interest rates could disproportionately HURT “Growth” stocks

In a world where we have seen a surge in ETFs and passive investing, smart beta, quant and rules based investing (referring to Howard’s quote I mentioned above that the greatest investors are unemotional) the memo makes a strong point where Howard Marks debates in detail about quantitative vs fundamental.

Howard notes that since “Quantitative” information regarding the past and present is so readily available, success in the highly competitive field of investing is more likely to be the result of superior judgements about “Qualitative” factors and future events

While one cannot ignore the qualitative aspects, rules based quantitative strategies are also very useful – some of the arguments outlined in the memo are very compelling and it could be a great point of debate.

In the world of investments over the past century, before we got factors and quant strategies and ETFs, first, value investing got established as the only style of investing – the basic principle of investment.

Value Investing

Value Investing is one of the key disciplines in the world of investments. In simple terms – it means quantifying intrinsic worth of something, and then buying it IF its prices represents a meaningful discount from that intrinsic worth.

Three essential underlying principles of value investing:

1)    The understanding of securities as stakes in actual businesses (and not just a stock that trades)

2)    The focus on “true worth” as opposed to price

• The use of fundamentals to calculate intrinsic value

3)    The recognition that attractive investments come when there is wide gap in intrinsic worth and price in market

• The emotional discipline to act ONLY when such opportunity is seen, and NOT otherwise

Growth Investing

– Next came “Growth” investing

• targeting a new breed of companies expected to grow rapidly, and in recognition of their exceptional long-term potential, these companies were given higher valuation metrics

Earlier, Value investing comprised buying stock if trading price was below intrinsic value while growth investing means targeting companies that are expected to grow rapidly.

The New World

• We are not in your grand father’s days in the markets.
• Businesses are more vulnerable and more dominant in today’s world, with much greater opportunities for dramatic changes in fortune, both positive and negative.
• Growth has meaningfully outperformed value for past 13 years.
• Many of the great bonanzas for value investors have come in periods of panic following the bursting of bubbles
• This has led value investors to be very sceptical of market exuberance, especially in companies with “Intangible” assets

We often get anchored to historical data and talk about “Mean Reversion”

When it comes to investing and businesses, the mental models in our head help us answer the question “..What does the future hold?..” But applying the mental model of “mean-reversion” for a “fade-defying” business model will lead to an erroneous conclusion (Investment Master Class, December 21, 2020 Santa Fe Institute)

I found this memo very engaging because it has arguments for both sides – detailed rationale of why we can expect a resurgence in Value Investing and strong arguments for its permanent impairment. But this debate gives rise to a false and unhelpful discussion. In today’s world, investors need to have an open mind and come to terms with the reality that most likely, there is a lot more to the story of a company’s business, than what appears on the Bloomberg screen or in a management meeting. Welcome to 2021; welcome to the New World of investments. Happy Investing!!

Disclaimer: “Any views or opinions represented in this blog are personal and belong solely to the author and do not represent views of CFA Society India or those of people, institutions or organizations that the owner may or may not be associated with in professional or personal capacity, unless explicitly stated.”