Summary of The Most Important Thing by Howard Marks

on March 24, 2016 Leave a Comment

By Ken Faulkenberry of Arbor Investment Planner
Howard Marks, author of The Most Important Thing: Uncommon Sense for
the Thoughtful Investor, is the Chairman of the Oaktree Capital Management.
Marks was one of the original founders and is famous for his memos to
Oaktree clients which he uses liberally throughout the book to add value.
Even though value investing is about numbers, this book has no numbers.
This book is about psychology and thinking differently about value portfolio
management. I highly recommend this book to every investor. Its easy to
read and easy to understand. It can change the way you think about investing.
These are my summaries of the chapters of the book.
Summary of The Most Important Thing by Howard Marks
Chapter 1
No rule always works. The environment isnt controllable, the circumstances
rarely repeat exactly. Psychology plays a major role in markets, and because
its highly variable, cause-and-effect relationships arent reliable.
This most important thing is second level thinking. You have to think beyond
the obvious (first level thinking). The first level thinker sees favorable
circumstances and decides to buy. The second level thinker sees that the
investment is over hyped and too expensive to provide a margin of safety.
The first level thinker sees unfavorable circumstances and decides to sell.
The second level thinker sees that investors have panicked and driven the
price to bargain levels and buys.
Chapter 2
Inefficient markets do not necessarily give their participants generous returns.
Rather, its my view that they provide the raw material mispricings that
can allow some people to win and others to lose on the basis of differential
skill.
The most important thing is understanding market efficiency and its
limitations. While it is true that many markets are fairly efficient most of the
time, they are not always efficient. Investors allow greed, fear, and other
emotions to defeat their objectivity. This leads the way to significant
mistakes.
Investors who choose to believe the market cant be beat leave the
inefficiencies for those willing to be second level thinkers. Understanding

market inefficiencies is important so that you recognize opportunities that can

be exploited for profit.
Chapter 3
Investors with no knowledge of (or concern for) profits, dividends, valuation
or the conduct of business simply cannot possess the resolve needed to do the
right thing at the right time.
The most important thing is value. Marks talks about the difference between
growth and value. Growth is a bet on the future, an uncertain future.
Therefore you may be paying for something that does not materialize.
Value is more consistent. Paying less than something is really worth today is
less of a risk than guessing what will happen in the future. The best value is
when you can buy growth at a value price, but that may not always be
available.
Chapter 4
No asset is so good that it cant become a bad investment if bought at too high
a price. And there are few assets so bad that they cant be a good investment
when bought cheap enough.
The most important thing is the relationship between price and value.
Investors psychology can cause a stock price to be mis-priced. In the short
run, investing is more like a popularity contest.
The most dangerous time to buy an investment is at the peak of its popularity.
At that time, all the positive data and assumptions are reflected in the price.
Everyone that is going to buy has already bought.
The optimal time to buy an investment is when no one else wants it. At that
point, all the negative data and assumptions are reflected in the price.
Everyone that is going to sell has already sold.
Buying at a price below the real worth of an investment is the most reliable
approach to making an investment profit.
Chapter 5
The possibility of permanent loss is the risk I worry about.
The most important thing is understanding risk. There are several
misconceptions about risk: Riskier assets dont necessarily provide higher
rates of return or they wouldnt be riskier. Risk doesnt come from weak
fundamentals because almost any investment, bought at the right price, can
be a profitable investment. Risk does not come from volatility; risk comes
from how an investor reacts to volatility.
Risk can be greatly reduced by 1) making an accurate assessment of the real
value of an investment and 2) making sound decisions based on the
relationship of the price to the value. Investments that are overpriced should
be avoided or sold. Investments that are underpriced are candidates for
purchase.

Chapter 6
The degree of risk present in a market derives from the behavior of the
participants, not the securities, strategies, and institutions.
The most important thing is recognizing risk. Risk is actually highest when
everyone believes risk is low. This is because investors bid up the price of
the asset to the point it really is risky. At a high price favorable outcomes
have low expected returns and unfavorable outcomes can result in large
losses.
Risk is lowest when everyone believes that risk is high. This is because
investors have reduced the price to the point its no longer risky. At a low
price favorable outcomes have high expected returns and unfavorable
outcomes result in smaller losses.
Investors should recognize risk comes with price; not the quality of an
investment. High quality assets can be risky, and low quality assets can be
safe. Its just a matter of the price paid for them.
Related Reading: Perceived Risk vs. Real Risk
Chapter 7
The road to long-term investment success runs through risk control more
than aggressiveness. Skillful risk control is the mark of the superior investor.
The most important thing is controlling risk. Over an entire investment career,
the amount and size of investment losses will most likely have more to do
with returns than the magnitude of winners.
Controlling risk is not risk avoidance. The stock market will have more good
years than bad years. The fact that the benefits of controlling risk only come
in the form of losses that dont happen, make it hard to measure and easy to
succumb to ignoring. It is just at that time that risk meets adversity and
punishes you. Controlling risk is a permanent task.
Chapter 8
Cycles will never stop occurring. If there were such a thing as a completely
efficient market, and people really made decisions in a calculating and
unemotional manner, perhaps cycles would be banished. But thatll never be
the case.
The most important thing is being attentive to cycles. Cycles have a way of
being self-correcting. Reversals dont necessarily need outside
events. They reverse on their own. Success creates the seeds of failure, and
failure creates the seeds of success.
Periodically investors decide that a trend will never end. When times are
good they conclude the trend will continue upward forever. When times are
bad they talk about vicious cycles and self-feeding developments that will
not end.

Dont assume trends will continue forever. Instead be aware of possible major
turning points.
Chapter 9
When investors in general are too risk-tolerant, security prices can embody
more risk than they do return. When investors are too risk-adverse, prices can
offer more return than risk.
The most important thing is awareness of the pendulum. Markets
fluctuate between euphoria and desperation. The happy medium is the
average. But in reality the market spends very little time at the average. The
pendulum swings back and forth, creating opportunities for the astute
investor who is aware of the swings (and extremes) in investor sentiment.
Chapter 10
The biggest investing errors come not from factors that are informational or
analytical, but from those that are psychological.
The most important thing is combating negative influences. Greed, fear, the
tendency to dismiss logic, the tendency to conform, envy, and ego are
psychological forces that can be negative influences.
These forces are universal and become very powerful as a group. This is
especially true at market extremes and results in mistakes that can damage
personal returns for a lifetime.
There are several guidelines that increase your odds. Stick to the concepts of
intrinsic value and margin of safety. Use the principles in this book (The Most
Important Thing) to stay cognizant of the investment environment.
Chapter 11
To buy when others are despondently selling and to sell when others are
euphorically buying takes the greatest courage, but provides the greatest
profit. Sir John Templeton
The most important thing is contrarianism. Most investors are trend followers.
The best investors do just the opposite. When there is a broad consensus
among investors it means that most have acted and the current price reflects
those actions.
If the majority of investors have bought because conditions are perceived as
favorable the price is high. This leaves lots of risk but little potential for
reward. If the majority of investors have sold because conditions are
perceived to be unfavorable the price is low. This reduces the risk and
provides a large potential for reward.
Chapter 12
The necessary condition for the existence of bargains is that perception has to
be considerably worse than reality.

The most important thing is finding bargains. Investment bargains have

nothing to do with quality. A high quality investment can be a good or bad buy.
It depends on what you pay for it.
A failure to differentiate between good assets and good buys will get most
investors into trouble. What it comes down to is that for an investment to be a
bargain, perception has to be worse than reality. In other words, if the
perceived risk is greater than the real risk the price will be a bargain.
Chapter 13
You want to take risk when others are fleeing from it, not when theyre
competing with you to do so.
The most important thing is patient opportunism. Sometimes the best action is
no action. Waiting for lower prices is often the prudent strategy.
Marks provides a tip: Select from a list of things sellers are motivated to sell
instead of having a fixation on what you want to own. He points out that in
investing you never have to swing (baseball analogy). There are no penalties
for patience.
Maintain a balanced perception of market conditions. Buy and sell at price
points that are favorable to you. That is usually the opposite of the crowd
consensus.
Chapter 14
No one likes having to invest for the future under the assumption that the
future is largely unknowable. On the other hand, if it is, wed better face up to
it and find other ways to cope than through forecasts.
The most important thing is knowing what you dont know. Forecasts about
the economy and future twists and turns in stock markets are dangerous and
probably worthless in the long run.
Pay attention to valuations, balance sheets, and income statements and less
on economic forecasts and markets. Have a general idea of where valuations
are in terms of cycles and pendulums, but dont try to forecast the
unknowable.
Chapter 15
We may never know where were going, but wed better have a good idea
where we are. That is, even if we cant predict the timing and extent of cyclical
fluctuations, its essential that we strive to ascertain where we stand in cyclical
terms and act accordingly.
The most important thing is having a sense for where we stand. We need to
be aware of the current environment. Is the outlook for the economy positive
or negative? Are the capital markets loose or tight? Are risk spreads narrow
or wide? Are investors eager to buy, or eager to sell? Are asset prices high
or low?

Use the information we have and know today to make investment decisions
based on probability, not forecasts. We should be cautious when others have
aggressively driven prices higher. We should be more aggressive when
others have panicked and driven prices lower.
Chapter 16
Randomness contributes to (or wrecks) investment records to a degree that
few people appreciate fully. As a result, the dangers that lurk in thus-farsuccessful strategies often are underrated.
The most important thing is appreciating the role of luck. You cannot judge
the propriety of an investment decision by the outcome. Some bad decisions
produce good outcomes. Some good decisions produce bad outcomes.
Some investors build their portfolio to maximize profits based on their
forecasts. If by random chance their forecast is correct, they look like a
genius. However, since we know the future is unknowable, that investor may
have just been lucky.
A sound investor will invest defensively based on a broad range of
probabilities. High priority will be placed on respect for risk and randomness
of events; including attempting to avoid pitfalls that could devastate a
portfolio.
Chapter 17
Investment defense requires thoughtful portfolio diversification, limits on the
overall riskiness borne, and a general tilt toward safety.
Most investment managers fail because they are too aggressive; not because
they are too careful. Trying to make above average gains through taking on
more risk is a fools game for most investors.
In reality, a balanced but somewhat defensive game, based on keeping
individual losses to a minimum and avoiding very poor years, makes more
sense.
The best risk control is insisting on a margin for error. Having a healthy
respect for risk, paying a low price, and acknowledging what they dont know
makes the best investment managers.
Chapter 18
At the important turning points, when the future stops being the past,
extrapolation fails and large amounts of money are either lost or not made.
The most important thing is avoiding pitfalls. Rationales that dominate cycles
usually coincide with the belief that its different this time. They are pitfalls
that cause maximum harm to the maximum number of herd followers. These
rationales should be recognized and avoided by the second-level thinkers.
In the short term, psychological and technical factors can override or
subjugate fundamentals. By definition most people join the trend and help
create the bubble or crash. These are times its especially important to be
contrarian and think defensively.

Leverage multiplies results but does not add value. Leverage might make
sense when purchasing assets at bargain prices with high expected returns.
On the other hand, using leverage to buy assets with low expected returns
and high risk is a recipe for exaggerated losses.
Chapter 19
Asymmetry better performance on the upside than on the downside relative
to what your style alone would produce should be every investors goal.
The most important thing is adding value. Marks advocates being the
defensive investor who strives to lose less than the market in downturns, but
capture a fair amount of the gains in a rising market.
Beta is a measurement of how much a portfolio moves compared to the
market. An aggressive investor (high beta) without skill will gain a lot when
the market goes up and lose a lot when the market falls. The defensive
investor (low beta) without skill wont lose much when the market falls, but
wont gain much when the market rises. This kind of investor adds no value.
Alpha is a measurement of personal investment skill. This is a measurement
of portfolio performance that is unconnected to the movement of the market.
Positive alpha would mean that over a down and up cycle the investor does
better than the market. A negative alpha would mean that over a down and up
cycle the investor underperforms the market.
Chapter 20
To achieve superior investment results, your insight into value has to be
superior. Thus you must learn things others dont, see things differently, or do
a better job of analyzing them ideally, all three.
The most important thing is pulling it all together. You have to be confident in
your assessment of value. You have to have the courage to stay disciplined
when the price varies from your valuation assessment. You must be strong
enough to overcome the powerful psychological influences that will attempt to
get you to join the consensus.
The risk that matters is the risk of permanently losing your principal. Risk
control is the heart of defensive investing. Put a heavy emphasis on not doing
the wrong thing.
The key to investment success is getting the price and value relationship
right. There is no way to know what the future holds, so insisting on a margin
for error is the best approach to adding value. The larger the margin for error
the higher the probability of success.