A good company or a good price, which one is more important

1/7, Howard Marx’s position

Last year, the global investment masters did not perform well, and the only one with a positive return was Howard Marx’s 18.36%.

As of the end of the third quarter, Howard Marx’s top ten holdings included many oil stocks and utility stocks, and almost no technology stocks. This is the reason for his good performance last year.

Howard Marx has two classic books “The Most Important Thing in Investing” and “Cycle”. In addition to common points, Howard Marx emphasized the following three points:

1. Emphasis on risk and margin of safety : Compared with Buffett’s emphasis on finding good companies with “long slopes and thick snow”, Howard Marx emphasizes choosing good companies with “low risk and high returns” with a margin of safety, that is, good prices are better than good companies more important

2. Cycle perspective : everything is a cycle, try to avoid hot industries that are at the apex of the cycle, and try to choose industries that are at the bottom of the cycle

3. Limitations of investors : Every investor has limitations in understanding, investment results are greatly affected by luck and style

I’m guessing the second is why he’s avoiding technology stocks this year, and the first is why he’s buying oil stocks.

But many times, the principle is vague, such as the question of when to sell. If oil stocks are gradually bought in 2021, what did he sell before? Will he keep his positions in these oil stocks next year? Dealing with these specific issues is much more difficult than the abstract principle of “friends of time”.

Howard Marx writes an annual memo to communicate with investors. His first memo was titled “selling out” early last year. In this article, he discusses the “When to sell profitable assets” is one of the most important questions in investing.

To read this article, I messed up the order of the original text. Some of them are generally accepted views of value investing, such as patiently holding those excellent companies with long-term compound interest and not being affected by trends and news events . This is a big principle. I will briefly introduce it in the second section;

But the article also discusses many specific selling principles in actual investment, involving investment goals, the nature of funds, and even deeper investment philosophy. Key Analysis.

2/7. Two wrong reasons for selling

This article has a half-fictional half-real conversation with my son, the first half of which is as follows:

Howard: Son, I see that XYZ is up xx% this year and has a P/E ratio of xx. Do you want to sell it so you can make some profit?

Andrew: Dad, I told you I’m not a seller, why should I?

Howard: You can sell some at this time because (a) it has risen a lot; value, it may be overestimated and unstable. Of course, (d) nobody goes bankrupt from taking profits.

Andrew: Yes, but on the other hand, (a) I’m a long-term investor, and I don’t think of stocks as scraps of trading, but as fractional ownership of businesses; (b) the company still has huge potential; (c) I can live with the short-term downside volatility that is part of the opportunity. In the end, it’s the long term that matters.

According to Howard Marx, the average investor tends to sell stocks for two reasons:

The first is because of the rise , people like profits, worry about losses, and want to keep the profits to avoid regret.

The other is because of the decline , which makes people feel that there is something wrong with the company, and they are afraid of continuous decline.

Of these two selling mentalities, the latter is the reason for the former. Because they have experienced turning from profit to loss, they are dominated by the emotion of “fear of regret” and easily sell positions with floating profits; the former is also the reason for the latter. If a profitable position loses money, you will have a loss position in your hands. The psychological pressure will be greater, and it will be easier to sell the floating loss position.

As a result, most investors are caught in frequent short-term operations, selling low and buying high.

Most value investors have no objection to this point of view, so the question arises, it is wrong to sell when the price rises, and it is also wrong to sell when the market falls, so when is the right time to sell?

According to Howard Marx:

The reason to sell should be based on investment prospects, which must be judged by solid financial analysis and discipline, not on investor psychology.

When you find an investment with long-term compounding potential, the most difficult thing is to be patient and how to be safe in terms of expected return and risk. Investors are easily swayed by news, sentiment, and the fact that they have made a lot of money so far, or a new idea that seems more promising.

For most investors, it is enough to understand this, and remember “don’t sell because it rises, and don’t sell because it falls”, at least it can reduce most of the operating mistakes.

But the real investment is not so simple. It cannot be summed up by one or two principles. For example, Oaktree Investment is best at dealing with non-performing assets. It often invests in bad companies, similar to participating in Evergrande’s loan last year. There is also an attitude towards Bitcoin, which is also the most open among the investment masters.

How on earth did Howard Marx make the decision to sell?

3/7. There is always an irresistible reason to sell

Let’s take a look at the second half of the conversation—starting to get closer to real dilemmas in investing.

Howard: But if it’s overvalued in the short term, shouldn’t you lighten up and pocket some gains? By doing this, if it continues to fall, (a) you have limited your losses, and (b) you can buy in at a lower price.

Andrew: If I own a stake in a private company with great potential, strong momentum, and top-notch management, I would never sell part of it just because someone offered me a reasonable price. Good compounding companies are hard to find, so it’s usually a mistake to pass them up. Also, I think it’s much simpler to predict a company’s long-term outcome than short-term price action, and it doesn’t make sense to weigh a decision in an area where you firmly believe…..

In this conversation, it can be seen that the son Andrew Marx is a firm long-termist, and Howard Marx plays the role of the “devil’s temptation” common to investors- if the stock price is too high, why not sell first? Drop some and make up for it?

Real investment is of course not a theory, nothing is impossible, continue to watch the dialogue.

Howard: Is there no point in time when you will sell it?

Andrew: In theory, but it depends a lot on (a) whether the fundamentals are what I want them to be, and (b) how this opportunity compares to other opportunities, also considering whether I am highly satisfied with this opportunity.

In addition to the price of the stock, the fund manager also needs to consider the safety of the portfolio, continue to watch the dialogue:

Howard: You’re managing a concentrated portfolio. When you invested, XYZ was a large position, and given its appreciation, it is now a larger percentage. Smart investors concentrate their portfolios and stick to what they know to be profitable, but they spread out their holdings and sell on the upside to control potential risk. Will the increase in the concentration of holdings now make our investment portfolio out of control?

Andrew: Maybe yes, it depends on your goals. But adjusting means selling something I feel comfortable holding in favor of something (or cash) that I don’t feel so good or understand. For me, it’s much better to have a handful of things that I feel solid. I’ll only have a few high-quality insights in my life, so I have to make the most of them.

Howard basically agrees with his son’s point of view, but actually has some vague concerns.

The theory of “Friends of Time” is perfect, but the problem is that people are not perfect, people make mistakes in judgment, and it is difficult to find these mistakes alone. In “The Psychology of Human Misjudgment”, Munger pointed out 25 psychological tendencies that are often misleading, including “avoiding doubt tendencies”, “avoiding inconsistency tendencies”, “avoiding painful psychological denial”, “self-esteem “Tendency to over-optimism” and “Tendency to Mismeasure Ease” are all psychological tendencies that prevent us from correcting our mistakes.

So in investment practice, if you implement long-termism perfectly, you have almost no chance to sell your positions, and it can easily become an excuse to “avoid selling decisions”, and your income will depend entirely on your judgment at the initial moment of buying , without any possibility of error correction, it is easy for you to use long-termism to cover up the poor investment performance.

To sum up, the problems of different investors are different. The problem of most non-professional investments is that there are not too many resources, no professional guidance, and too little time. The psychological reasons mentioned above are superimposed, and the final operation is too frequent. Adhering to long-termism and insisting on holding only a few companies that you are sure of may be a relatively correct approach for ordinary retail investors.

But for professional investors, for investors who want to obtain excess returns, they need to give “long-termism” a reasonable price to sell, and give the individual stocks in the portfolio a position limit.

Howard Marx argues that selling is not an isolated decision and cites two situations in which to sell:

1. If your investment thesis appears to be less valid than it once was, or the likelihood of proving accurate has decreased, it may be appropriate to sell some or all of your shares.

2. Likewise, it would be reasonable to reduce or liquidate an existing holding if another investment that appears to be more promising offers a higher risk-adjusted expected return.

Simply put, there are two reasons for selling: fundamental reasons and price reasons.

4/7. Sell to avoid mistakes

Most investors have no practice of running a company, and their judgment on company value only comes from some theories of value investing, such as moat, competition pattern, industry space, strategic layout, and so on. However, a large number of investors accept the same theory, and in the end they are easy to buy together, causing the stock price to rise. Once the value cannot be proved by the company’s performance growth, the stock price will fall, such as the “beautiful 50” in the late 1960s, such as the “X Mao bubble” in 21 years.

The failure probability of the company’s value judgment is very high, and most investors may be 50%. At this time, what determines the performance is the timing of the sale-before other investors find out that the judgment is wrong, and before the loss does not expand, stop in time. damage.

This is “if your investment thesis appears to be less valid than it once was, or the probability of proving accurate decreases, it may be appropriate to sell some or all of your shares”.

This sentence includes two possibilities:

Possibility 1: The company has changed, and the original reason for holding is not valid

Possibility 2: Your judgment has not been verified by the actual operation of the company

Because the investment itself is a prediction of the company’s future, these two possibilities are actually one: the investor made a mistake.

“The Most Important Thing to Invest” spends a chapter analyzing “avoiding mistakes”, but the conclusion is quite weak. Any good investor will make different mistakes at different times. What is right today will be wrong tomorrow, and even avoid making mistakes It could also be a bug.

Understanding “sell” from this perspective is similar to my previous article ” When it rises, the position feels light, but when it falls, the position feels heavy? Here are four position management methods ” The position management method mentioned in “The position management method: When you lose money continuously and doubt your own judgment, you need to actively reduce the position and sell the position that is not very sure.

This kind of selling is similar to “selling because of falling”, but it is different in fact. It is based on your actual performance, not the stock price itself. You need to reduce the risk of misjudgment.

So in this article, while Howard Marx continues to affirm long-term holdings, his attitude is not as firm as his son’s.

5/7, Exchange stock, or exchange cash?

The second is based on the consideration of opportunity cost , which is actually a share exchange. This is actually the most frequent selling reason for most investors.

In my article ” The cost of buying stocks, you may have never calculated it correctly… ” I analyzed the “opportunity cost” of buying stocks: a sum of money, at the same time, if you buy company A, you cannot buy company B, then The future growth rate of company B is naturally the “cost” for you to buy company A.

For example, after you sold company A, the stock price fell, but you regretted it because you bought company B again, and the price fell even worse.

For the factors considered when selling, the article has a more specific description:

Do you have any ideas that might yield a higher return?

What would you miss if you switched to a new investment?

What are you giving up if you continue to hold assets without making adjustments?

How likely is it that taking cash is better than holding previous assets?

Simply put, at any given time, you are making a choice, either between holding Company A and not holding Company B, or comparing it with cash (Treasury bonds).

And which one you choose as the comparison object also affects your selling decision.

Howard Marx’s choice is to always compare companies A and B and never hold cash. In his article, he articulates one of the six principles of Oaktree’s investment philosophy:

We don’t believe in the predictive power needed to time the market correctly, so we keep our portfolios high as long as we can buy attractively priced assets. Concerns about the market environment may cause us to lean towards more defensive investments and take more cautious actions, but we will not increase our cash holdings.

On the contrary, Buffett holds a large amount of cash (treasury bonds) for a long time, especially in the bull market , which is obviously different from Howard Marx.

The value judgment behind this distinction is that Howard Marx believes that the value of most assets is higher than cash most of the time, while Buffett is not so optimistic, so he avoids this judgment.

Why is there such a difference, I see it this way:

From the century-old business history of the United States, most companies have disappeared in the long history, and only a few companies have been acquired at high prices or grown into large companies. Therefore, in the long run, most companies cannot outperform the national debt ; but in terms of the stock market as a whole In the long run, it has steadily outperformed national debt, and the reason is that a small number of “super companies” contributed most of the gains.

Therefore, as long as the company outperforms the national debt for a long time, they have a high probability of being a “super company”. Buffett chose to look for these few companies and hold them intensively, so the object of his comparison is the national debt;

Most of the asset management companies, including Oaktree Capital, use portfolio investment to outperform national debt, as long as they constantly replace companies with stronger phases and avoid companies that are heading for recession , so they compare with other companies when selling.

The latter naturally requires a higher selling frequency.

So why did Buffett choose a different path from other investment gurus?

6/7, good company, or good price?

If you look at the opinions of value investment masters, you will find that they are similar, such as buying cheap, and Buffett and Howard Marx are both concerned about it. Pay more attention to the price factor.

Buying for less than it’s worth, in my opinion, is what investing is all about – the surest way to make money. (“The Most Important Thing to Invest”)

What you buy is not important, the cost you pay is the key, and the purchase cost is the decisive factor for the success of an investment. (Investment Memorandum for 2021)

At least half of Buffett’s articles are devoted to “how to find excellent companies”, but Howard Marx’s book “The Most Important Thing in Investing” has very little relevant content, and most of the articles are devoted to risk analysis , Analyze the relationship between value and price, analyze cycle and reverse investment.

Of course, some people think that the focus of “The Most Important Thing in Investment” is investment philosophy rather than company analysis, so the author of the book “Cycle” about industrial development also pays more attention to external factors than company quality.

The conclusion is self-evident. Relatively speaking (note these two words), Buffett pays more attention to good companies, while Howard Marx pays more attention to “good prices”.

This small difference triggers a series of changes:

If your investment income comes more from “good companies”, because there are very few good companies, you can’t sell them easily, then you have to prolong the holding time, and you have to increase the tolerance for selling valuations , That’s how Andrew Marx sees it.

But if your investment income pays more attention to “good prices”, because the stock market fluctuates greatly, the chances of “good prices” appearing are much higher, and you need to prepare funds to capture opportunities at any time, and often make reverse investments, then you Many positions will be shortened, and the tolerance for selling valuation must be reduced.

The difference between “good company” and “good price” comes from the focus on the cycle.

Good prices are often “given” by the cycle. Howard Marx is very sensitive to the cycle. The cycle does not depend on the subjective will of the company. When you hold a long-term excellent company and experience a long decline cycle, do you Still continue to insist on long-term holding?

It’s clear that both Buffett and his son answered “yes,” but Howard wasn’t so sure.

The trough of the cycle can give a good buying price. Buffett also cares about this, but Buffett’s income is inter-cyclical. Many of his positions are weak-cyclical consumer stocks, which leads to his holdings also inter-cyclical. good company” rather than “good price”.

There are many reasons for the difference besides the value, for example, one reason is mentioned in the article:

The decision to sell is not always within the control of the investment manager and clients can withdraw funds from accounts and funds. … In this case, the fund manager can “choose what to sell” based on expectations of future returns, but “deciding not to sell” is not within the manager’s choice.

And Buffett’s funds come from stable insurance float, which can prevent him from being “sold out.”

7/7. The source of income is the position

In Chapter 19 “The Meaning of Adding Value” of “The Most Important Thing in Investing”, Howard Marx expounded Oaktree Investment’s “performance vision”, that is, the method to achieve excess returns:

Be in line with the market performance when the market is doing well and beat the market performance when the market is not doing well.

A careful analysis of this “vision” shows that it is a basic requirement for value investors to outperform the index in a bear market. Bear markets emphasize quality, and the role of good companies is revealed at this time.

However, running the index in a bull market is easy for new investors who do not control risks, but it is difficult for investment masters.

The bull market is in full swing, and most stocks are still rising above their intrinsic value. You need to pinch your nose and continue to hold.

At the same time, in order to guard against the risk of a sudden plunge and realize the requirement of “beyond market performance when the market performance is bad”, you need to constantly replace varieties that may perform better in a bear market —just like Howard Marx held oil stocks and public utilities last year. Business shares are the same.

Therefore, if you believe that market fluctuations can bring you huge returns, even as much as the company’s growth returns, and that A shares fluctuate more significantly than U.S. stocks, then Howard Marx’s selling method is likely to be more suitable for A shares than Buffett’s. share.

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