Renowned value investor and Graham-Dodd disciple Howard Marks freely shares his investment philosophy by way of his memos to clients of Oaktree Capital Management. Marks’ 2017 memo, “There They Go Again… Again,” is particularly instructive for investors today as it raised points about risk that many still enamored of the heady days neglect to incorporate into their security analysis. Against a historical backdrop, Marks asked questions concerning risk that many have dismissed as outdated, or irrelevant.
Marks used the lofty valuations of the FAANG stocks to illustrate how investors can miss signals, reliably present in other bull markets, that should inform or guide their investment decisions. In an environment where the market has suffered no prolonged downturns for an extended period, “propositions are accepted that would be questioned if investors were more wary,” he said.
Marks listed several factors that are common to every bull market and that can create the “seeds for a boom.” Their presence makes assessment of the risk-reward tradeoff more difficult. Here are some of the factors that have particular relevance to the valuation levels of the FAANG stocks and whether they are consonant with intelligent risk analysis that underlies all successful value investing:
A benign environment – good results lull investors into complacency, as they get used to having their positive expectations rewarded.
A grain of truth – the story supporting a boom isn’t created out of whole cloth; it generally coalesces around something real. The seed usually isn’t imaginary, just eventually overblown.
Early success – the gains enjoyed by the “wise man in the beginning” – the first to seize upon the grain of truth – tends to attract “the fool in the end” who jumps in too late.
More money than ideas – when capital is in oversupply, it is inevitable that