“Success in investing is not a function of what you buy. It’s a function of what you pay.”
– Howard Marks
Oh man. Rough week. All the momentum faves have been hammered, good companies thrown out with bad ones. The Social Media ETF (SOCL) is down 15% from its March 6th high, names like Facebook, Twitter, LinkedIn and Yelp have been absolutely pummeled. Biotechs have been the focal point of the selloff and even the “good ones” with realistic valuations like Celgene and Gilead are paying for the sins of the bubblicious Nasdaq Biotech Index. A fun fact – the biotech sector was up 21% year-to-date in the middle of February and as of yesterday it’s negative on the year.
Netflix, Tesla, Alexion, Biogen – so many “good companies” have found themselves caught up in a mass de-risking this spring. And while many will bounce back, others will have already reached their peak for the cycle – sorting out which is which is the meaning of investing. It’s not easy, some of the obviously cheap ones will turn out to have been not-so-cheap after all in the light of day.
But one thing that will probably not work is to just assume that they’re all going right back to the IBD 100 of hot momentum stocks and that everything will be back to where it was once the storm passes. Markets don’t work that way. Traders fall out of love with some stocks and become enamored with others; stories and narratives fall apart; Institutional investors become satiated and unwilling to eat any more of a particular cuisine, regardless of fundamentals.
It’s sometimes difficult for me to communicate this concept to investors and even to many professionals. People have a hard time processing the fact that the thing that was treating them well for so long is not going to be able to do so forever. A lot of pros I come into contact with are huge sports fans, and you can see the way they root for stocks as though they are teams. You can see the transference of their emotions from companies or products they like towards the stocks themselves. It’s a little embarrassing to witness, I try to keep my mouth shut and play politics during these types of conversations.
In a recent post we talked about not hating or loving the asset itself, but hating or loving the price. The Howard Marks quote I began this post with makes that point perfectly. Here’s more about how Marks learned this critical lesson at the start of his career while at Citibank, as bull market turned to bear market turned back to bull…
Via Knowledge @ Wharton:
When Marks joined Citibank in 1969, the company — along with other big New York banks like Chase and JP Morgan — practiced ‘Nifty 50′ investing, he said. They emphasized buying the stocks of the 50 highest-quality, fastest-growing companies in America, which at the time included Xerox, IBM, Kodak, Polaroid, Merck, Textron and Coca-Cola. “The official dictum was if you were buying the stock of a good enough company, it didn’t matter how high a price you paid.” But it did matter, Marks noted, and people were paying about five times what the stocks were worth. “By 1973, the people who held those stocks had lost 90% of their money.” The Nifty 50 stocks eventually became an often-cited example of unrealistic investor expectations.
“Then in September of 1978, Citibank asked me, ‘There’s some guy named Milken or something in California. He deals in high-yield bonds. Can you figure out what that means?’” Marks recalled. Meeting with controversial financier Michael Milken proved a pivotal moment for Marks. He started Citibank’s successful portfolio of high-yield bonds in 1978 and stayed until 1985.
What his career experience so far had told him was that with its Nifty 50 policy, Citibank had invested in “the best companies in America and lost a lot of money.” Then it invested in “theworst companies in America and made a lot of money,” Marks noted, adding that “it shouldn’t take you too long to figure out that success in investing is not a function of what you buy. It’s a function of what you pay.” An asset of high quality, Marks pointed out, can be overpriced and be a bad investment; an asset of low quality can be bought cheaply and be a good investment. Distressed debt is the lion’s share of what Oaktree handles today, and Marks said the company has been enormously successful – consistently so — in that area.
There are great companies trading at not-so-great prices for investors – and it is very difficult to parse this difference for people who aren’t interested in understanding it or are incapable of holding two opposing thoughts in their heads at the same time. Explaining to an investor that, “Yes, Tesla is an amazing company, but that paying a multiple based on everything going right between now and 2018 isn’t so smart,” is a really tough thing to do.