Wednesday, April 22, 2015

Howard Marks on Valuations: "There's Nothing That Is Absolutely Cheap"

On CNBC earlier this month, Howard Marks had the following to say about the valuation of most assets:

"There's better and there's worse, but there's nothing that is absolutely cheap."

And later added...

"I describe most assets as being on the high side of fair."

He did also say that at least stocks are "not in the territory they were in 2000..."

Video: No compelling bargains right now, Oaktree's Marks

There are exceptions, of course, but it has become much tougher to find investments that are selling at a plain discount to value these days. The fact that they're not nearly as expensive as 15 years ago doesn't mean that finding assets with a sufficent margin of safety -- in order to buy meaningful amounts with warranted confidence -- is an easy thing to do right now. 

That doesn't mean I have an opinion on where prices are going. As always, I never do. It just means, for too many stocks, the current margin of safety makes establishing new positions, as well as incremental purchases of what's already partially owned, beyond token quantities, difficult at best.

Unfortunately, the valuation environment we are in does not reveal much of use about what direction stock market prices might go over the next several years. What's somewhat expensive can easily become even more so. Trying to guess near-term market moves (near-term being anything less than five years in my view) is a terrific waste of effort and focus.

What it does mean is that today's prices offer much more risk for a whole lot less reward.

Investing well requires, among other things, an ability to estimate value and price discipline. Several years ago -- and especially during the financial crisis -- it was not difficult to find shares of good businesses selling at a discount to a conservative estimate of intrinsic value. Some of my posts about stocks during that period more or less reflected that environment. It wasn't about timing. It was about market prices versus estimated per share intrinsic value. These days it's a very different situation. Bear markets -- or, at least, the prices that often become available during and sometimes after a bear market -- are an opportunity for the long-term investor.

"You make most of your money in a bear market. You just don't realize it at the time." - Shelby Davis

So, for those with a long enough time horizon, it makes little sense to hope for a bull market.

It feels more risky (and the headlines and commentators will do plenty to reinforce the feeling) to buy during a bear market but, if the assets are sound, the risks of ownership can actually be much reduced. A bear market -- usually accompanied by some form of macro turmoil -- is when risk and reward becomes more favorable even if temporary losses are almost a given.

It's worth mentioning attempting to avoid the temporary losses creates the possibility of a different kind of mistake.

A mistake of omission.

"The most extreme mistakes in Berkshire's history have been mistakes of omission. We saw it, but didn't act on it." - Charlie Munger

Munger describes this as "buying with an eyedropper things we should be buying a lot of."

The temporary loss might have been avoided but the possibility of buying too few shares (or, worse, buying no shares at all) of something at attractive prices when the opportunity arises gets larger. Permanent capital losses should be considered unacceptable but, at least with stocks, temporary losses are almost inevitable. The gains that were missed on those things that were well understood but weren't bought matter.*

For investors, it's not about what will happen in the coming weeks, months, or even years.

The emphasis should be on decades while knowing many unexpected things will happen and there's little point in trying to predict them.

Margin of safety, to some extent, can protect against uncertainty and misjudgments. An approach dependent on an unusual talent for guessing what's going to happen in the future, even if it involves using the most sophisticated tools and brainpower available, will likely work better on paper than the real world.

It's best to develop a flexible approach and to remain open-minded.

Investing involves lots of homework and lots of waiting.

It need not -- and I'd argue should not -- involve lots of transactions.

Those who choose to actively trade stocks aren't investing, they're speculating. Now, there's nothing inherently wrong with speculating on short-term price action. Some no doubt know how to do that sort of thing well but that's inherently a very different activity.


* There's almost always individual stocks that are cheap but doesn't mean they're understood well enough by the investor to buy. Buying what's not understood -- or worse, yet, confidently buying what someone thinks is understood but actually is not -- provides a great way to burn up a whole lot of capital. Only after the fact is something truly obvious. Missing a big gainer that's not fully understood by the investor is going to happen. That's not a mistake of omission. In fact, that's why, when I own shares of a good business that's been bought at a very attractive price, my preference is to NOT sell just because the shares happen to become more fully valued. Excessive buying and selling is a recipe for trouble. There are only so many good businesses that I can understand well enough. Others may be able to figure out more but I think some kid themselves that this is possible. When business prospects remain attractive then either opportunity costs or overvaluation must become substantial for selling to be warranted.
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