Insightful Quotes From Howard Marks’ “What Really Matters?” Memo

Here are a couple of noteworthy quotes from Howard Marks’ latest memo entitled, “What Really Matters?”.

On 22 November 2022, famed investor Howard Marks released his latest memo entitled, “What Really Matters?”

As usual, it was an insightful read. Marks talked about what really matters in the stock market for investors (and vice versa, what doesn’t matter).

Here are a couple of quotes in the memo that I thought would be worth highlighting.

Short-Term Events Don’t Matter

“One of the critical mistakes people are guilty of – we see it all the time in the media – is believing that changes in security prices are the result of events: that favorable events lead to rising prices and negative events lead to falling prices. I think that’s what most people believe – especially first-level thinkers – but that’s not right. Security prices are determined by events and how investors react to those events, which is largely a function of how the events stack up against investors’ expectations. “

“Macro events and the ups and downs of companies’ near-term fortunes are unpredictable and not necessarily indicative of – or relevant to – companies’ long-term prospects.  So little attention should be paid to them.”  

“It’s clear from observation that security prices fluctuate much more than economic output or company profits. What accounts for this? It must be the fact that, in the short term, the ups and downs of prices are influenced far more by swings in investor psychology than by changes in companies’ long-term prospects. Because swings in psychology matter more in the near term than changes in fundamentals – and are so hard to predict – most short-term trading is a waste of time . . . or worse.”

Trading Mentality Doesn’t Matter

“If you ask Warren Buffett to describe the foundation of his approach to investing, he’ll probably start by insisting that stocks should be thought of as ownership interests in companies.”

“To me, buying for a short-term trade equates to forgetting about your sports team’s chances of winning the championship and instead betting on who’s going to succeed in the next play, period, or inning.”

“Wanting to own a business for its commercial merit and long-term earnings potential is a good reason to be a stockholder, and if these expectations are borne out, a good reason to believe the stock price will rise.”

Short-Term Performance Doesn’t Matter

“Obviously, no one should attach much significance to returns in one quarter or year. Investment performance is simply one result drawn from the full range of returns that could have materialized, and in the short term, it can be heavily influenced by random events. Thus, a single quarter’s return is likely to be a very weak indicator of an investor’s ability, if that.”

Volatility Doesn’t Matter

“I define risk as the probability of a bad outcome, and volatility is, at best, an indicator of the presence of risk.  But volatility is not risk.  That’s all I’m going to say on that subject.”

“Volatility should be less of a concern for investors:

– whose entities are long-lived, like life insurance companies, endowments, and pension funds;
– whose capital isn’t subject to lump-sum withdrawal;
– whose essential activities won’t be jeopardized by downward fluctuations;
– who don’t have to worry about being forced into mistakes by their constituents; and
– who haven’t levered up with debt that might have to be repaid in the short run.”

“[I]nvestors should take advantage of their ability to withstand volatility, since many investments with the potential for high returns might be susceptible to substantial fluctuations.” 

“In many cases, people accord volatility far more importance than they should.”

Hyper-Activity Doesn’t Matter

“”When I was a boy, there was a popular saying: Don’t just sit there; do something. But for investing, I’d invert it: Don’t just do something; sit there. Develop the mindset that you don’t make money on what you buy and sell; you make money (hopefully) on what you hold.”

What Matters In the End?

“What really matters is the performance of your holdings over the next five or ten years (or more) and how the value at the end of the period compares to the amount you invested and to your needs.”

I think most people would be more successful if they focused less on the short run or macro trends and instead worked hard to gain superior insight concerning the outlook for fundamentals over multi-year periods in the future.  They should:

– study companies and securities, assessing things such as their earnings potential;
– buy the ones that can be purchased at attractive prices relative to their potential;
– hold onto them as long as the company’s earnings outlook and the attractiveness of the price remain intact; and
– make changes only when those things can’t be reconfirmed, or when something better comes along.

“Of critical importance, equity investors should make their primary goals (a) participating in the secular growth of economies and companies and (b) benefiting from the wonder of compounding. Think about the 10.5% yearly return of the S&P 500 Index (or its predecessors) since 1926 and the fact that this would have turned $1 into over $13,000 by now, even though the period witnessed 16 recessions, one Great Depression, several wars, one World War, a global pandemic, and many instances of geopolitical turmoil.”

““Asymmetry” is a concept I’ve been conscious of for decades and consider more important with every passing year. It’s my word for the essence of investment excellence and a standard against which investors should be measured.”

For those who are interested, you can access the full memo here.

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10 Interesting Facts About Bear Markets

Bear markets are very common.

A bear market (a market decline of at least 20% from high to low) is a common occurrence in the stock market.

I recently read 10 facts about bear markets written by Tsai Capital, an investment management firm.

Here’s a summary of what I read:

1. Bear markets are defined as a fall of at least 20% from peak to trough. A new bull market occurs when there’s a 20% gain from the most recent trough. Bull markets usually start during periods of maximum pessimism.

2. Bear markets are common. Since 1928, there were 26 bear markets in the S&P 500 index, a US-centric index that consists of major companies like Apple, Alphabet, and Amazon.

3. Bear markets occur, on average, every 3.6 years.

4. Bear markets are usually short-lived since the average length of a bear market is about 9.6 months. That’s way shorter than the average length of a bull market, which is 2.7 years.

5. Bear markets have been less frequent since World War II.

6. During a bear market, stocks lose an average of 36%.

7. 50% of the market’s strongest days in the past 20 years occurred during a bear market. Another 34% of the best days occurred in the first two months of a bull market, when we may not even know that we are past a trough. That’s why we shouldn’t time the market.

8. A bear market doesn’t equate to an impending recession. Since 1929, there have been 26 bear markets but only 15 recessions.

9. Over a 50-year investment horizon, you can expect to go through around 14 bear markets. This shows that market downturns are a normal part of the investment process.

10. Bear markets are painful, but overall, markets have been rising most of the time. Over the last 92 years, bear markets made up only 20.6 of those years. In other words, stocks have been on the rise 78% of the time. This is despite pandemics, recessions, inflation, deflation and wars.

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Why You Shouldn’t Take Financial News Reports at Face Value

Going beyond the headlines…

On 12 December 2019, CNBC reported that Apple’s shares fell after Credit Suisse said that iPhone sales in China tumbled 35% year-on-year in November that year.

Source: CNBC

I was curious to find out what really happened with Apple’s business during that quarter in 2019 and whether what Credit Suisse mentioned was true.

Upon looking at Apple’s quarterly report for the three months ended 28 December 2019, I found that the company’s Greater China sales actually increased 3% during the quarter.

Source: Apple 10-Q 2020 first-quarter

Apple said that the growth in Greater China was mainly due to higher net sales from the Wearables, Home and Accessories sub-segment.

This could mean that the iPhone sales in the region wasn’t that great. So, the prediction by Credit Suisse could have been right.

However, looking at Apple’s overall iPhone sales for the quarter, the company posted an 8% increase in revenue.

Source: Apple 10-Q 2020 first-quarter

What this means is that while iPhone sales in Greater China could have slowed, other regions made up for it, leading to an overall increase in iPhone revenue for Apple.

Investors who had sold Apple shares upon seeing CNBC’s negative news that day would be kicking themselves.

Since 12 December 2019, Apple’s share price has gone up 147%, even after taking into account the large declines in early 2020 and 2022.

Financials-wise, Apple’s revenue, net income, and free cash flow have also stepped up from fiscal year 2019 (ended 28 September 2019) to fiscal year 2021.

Source: Tikr

So the quick lesson from this post is that we shouldn’t make investment decisions based on news reports and emotions.

We should always go deeper and think critically. Some questions to ask would be:

  • Is there a chance that the report is wrong?
  • Even if the report is right, can the company still continue doing well?
  • Is the company fundamentally shaky?
  • Is it a one-time solvable issue (temporary), or is there a structural damage to the business?
  • Is the investment thesis busted?

Hope this article gives you some clarity as to what to do when you come across negative financial news, especially amid the volatile stock market period like now.

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Disclaimer: The information provided in this article is purely based on my opinions and is not intended to be personalised investment advice. The ideas discussed here are not recommendations to buy/sell any stock.

What to Do With Your Investments Now?

Howard Marks interview with his company summarises my thoughts perfectly.

A common question on investors’ minds currently might be this:

“What should I do with my stock portfolio now that inflation is high and geopolitical tensions are still raging?”

While I can take a stab at answering that question, Howard Marks, an investor I follow closely, has done the job perfectly.

In a recent interview with his company, he shared his thoughts surrounding the markets right now and what investors should consider.

The sharing is entitled “Insights Live: Which Way Now? A Conversation with Howard Marks” and it can be found on Oaktree’s website.

Source: Oaktree

Some of the topics Marks and Anna Szymanski (Oaktree’s senior financial writer) covered are:

  • How to determine your normal risk appetite
  • Reasons to be more defensive
  • Reasons to be less defensive
  • Should you time the market?
  • What should you focus on?

I hope the 11-minute interview is insightful for you as it was for me.

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Key Insights From This Market-Beating Fund’s Semi-Annual Letter

A couple of key learnings from Terry Smith’s market-beating fund.

Terry Smith, who’s the portfolio manager of Fundsmith Equity Fund, is an investor I follow closely. I got to know about Terry Smith through my good friend, Chong Ser Jing, who runs The Good Investors blog together with another friend of mine, Jeremy Chia.

Since its inception in November 2010, the Fundsmith Equity Fund has produced an annualised total return of 15.8%, handsomely beating the MSCI World Index by 4.6 percentage points during the same time frame.

Fundsmith Equity Fund invests in global equities with a long-term focus. It has strict criteria for picking stocks, and this ensures that the fund only buys:

  • high-quality businesses that can sustain a high return on operating capital employed (ROCE);
  • businesses whose advantages are difficult to replicate;
  • businesses that do not need large amounts of leverage to generate returns;
  • businesses with a high degree of certainty of growth from reinvestment of their cash flow at high rates of return;
  • businesses that are resilient to change, especially technological changes;
  • businesses with an attractive valuation.

As of June 2022, Fundsmith Equity Fund’s top 10 holdings were:

  • Microsoft
  • Novo Nordisk
  • Philip Morris
  • L’Oréal
  • Estée Lauder
  • McCormick
  • Stryker
  • Pepsico
  • Waters

With that, let’s explore four quotes from Fundsmith Equity Fund’s letter for the first half of 2022 that stood out for me.

Current Inflation Worries

If a recession ensues but inflation persists we will not have seen conditions of this sort since the 1970s when the term ‘stagflation’ was coined. My first full year in work was 1974 when inflation in the UK, as measured by the CPI, was 24.24%. In an example of history not repeating itself but rhyming, as Mark Twain observed, the 1970s inflation was boosted by the Arab oil embargo which followed the Yom Kippur War. On this occasion we have a similar effect from the Russian invasion of Ukraine.

I have no insight into how severe or persistent the rise in interest rates will need to be to quell inflation, but I am not optimistic. Interest rates as a tool to combat inflation are a blunt instrument at the best of times and I suspect more so in this instance where the inflation has not been caused by demand exceeding supply during an economic boom.

Best Protection Against Inflation

Inflation causes an increase in the cost of the ingredients, components and other inputs which constitute companies’ Cost of Goods Sold (‘COGS’). The best defence against this inflation is a high gross margin — the difference between sales revenues and COGS. On average last year the companies in our portfolio had a gross margin of 60% compared with about 40% for the average large, listed company. Our companies make things for £4 and sell them for £10 whereas the average company makes things for £6 and sells them for £10. A 10% rise in the COGS clearly has much less effect on the profitability of the companies in our portfolio than the average. Moreover, if they want to compensate for say a 10% rise in COGS, our portfolio companies can achieve this with a much smaller price rise than the average company. The effect on COGS is not the only effect of inflation but it is clear that the high and sustainable gross profit margins of our companies provide a robust first line of defence.

Missing Out on Value?

Did we miss out by not owning more lowly-rated ‘value’ stocks during this period? Not much. The much talked about ‘rotation’ from ‘growth’ to ‘value’ stocks during the first half of 2022 was rather underwhelming from the perspective of the latter. In the US, the S&P Value Index did indeed significantly outperform its S&P Growth counterpart and the NASDAQ but this outperformance took the form of a 12% fall for the S&P Value Index versus a 28% decline for the S&P Growth Index and a 30% decline in the NASDAQ. Falling less than others when times are tough has obvious merit but still isn’t a sufficient payback for the long preceding wait during which value stocks underperformed massively.

On Meta Platforms

The title for the lowest-rated belongs to Meta Platforms. Meta’s stock now trades on a FCF yield of 8.7%. At this level it is either cheap or a so-called value trap. We will let you know which when we find out, but we are inclined to believe it is the former.

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Disclaimer: This information provided in this article is purely based on my opinions and is not intended to be personalised investment advice. The ideas discussed here are not recommendations to buy/sell any stock.