Howard Marks – Investors Are Like Those Drivers Changing Lanes Every Minute, Cutting Off Half The Cars On The Road

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One of the best free resources for all investors are Howard Marks’ memos. Marks is the Co-Chairman of Oaktree Capital, which currently manages a portfolio valued at approximately $100 Billion. Since 1990 Marks has written 100+ memos which are full of valuable investing insights.

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One of our personal favorites here at The Acquirer’s Multiple is the 2002 memo is which Marks likens investing to driving saying:

“The fact that crowded highways are efficient allocators of space doesn’t mean people don’t try to beat them. How often do we see the guy in the souped-up ’67 Mustang careen back and forth just in front of us, changing lanes every minute and cutting off half the cars on the road? But does he get there any faster? Should he expect to?”

Here’s an excerpt from that memo:

The Tactics Others Adopt

The fact that crowded highways are efficient allocators of space doesn’t mean people don’t try to beat them. How often do we see the guy in the souped-up ’67 Mustang careen back and forth just in front of us, changing lanes every minute and cutting off half the cars on the road? But does he get there any faster? Should he expect to?

Of course, the analogy to investing holds beautifully. Knowing which lane to drive in has nothing to do with which lane has been going fastest. To chart the best course, one must know which one will go fastest. As usual, outperforming comes down to seeing the future better than others, which few drivers on crowded highways can do.

So half the time the lane-jumper moves into a fast-moving lane that keeps going fast, and half the time into one that’s just about to slow down. And the slow lane he leaves is as likely to speed up as it is to stay slow. Thus the “expected value” of his lane changing is close to zero. And he uses extra gas in his veering and accelerating, and he bears a higher risk of getting into an accident. Thus the returns from lane changing appear modest and undependable – even more so in a risk-adjusted sense.

There are lots of investors in our heavily populated markets who believe (erroneously, in my opinion) they can see the future, and thus that they can get ahead through market timing and short-term trading. Most markets prove to be efficient, however, and most of the time these machinations don’t work. Still, investors keep guessing at which lane on the investment highway will go fastest.

They are encouraged by the successes they recall and the gains they dream of. But their recollection tends to overstate their ability by exaggerating correct moves and ignoring mistakes. Or as Don Meredith once said on Monday Night Football, “they don’t make them the way they used to, but then again they never did.”

So most investors go on trying to time markets and pick stocks. When it works, they credit the efficacy of their strategy and their skill in executing it. When it doesn’t, they blame exogenous variables and the foolishness of other market participants. And they keep on trying.

In the ultimate form of capital punishment, the hyper-tactician – on the road or in the market-stands a good chance of repeatedly jumping out of the thing that hasn’t worked just as it’s about to start working, and into the thing that has been working moments before it stops.

This is why it’s often the case that the performance of investors in a volatile fund is worse than the performance of the fund itself. On its face this seems illogical . . . until you think of the unlucky lane-jumper described just above. People often jump into a hot fund toward the end of a period of good performance, when overvaluation in the market niche (or hubris on the manager’s part) has set the stage for a fall, and when the great results have brought in so much money that it’s impossible to keep finding enough attractive investments.

By the time a hot fund falls, it’s usually much larger than it was when it rose, and thus a lot more money is lost on a 10% drop than used to be made on a 10% rise. It’s in this way that the collective performance of a fund’s investors can be worse than that of the fund.

There are prominent examples of money managers who started small, made 25% a year for 25 years, got famous and grew huge, and then took a 50% loss on $20 billion. I often wonder whether their investors enjoyed any cumulative profit over the funds’ entire lives. Just as lane-jumping is risky on the road, following the hot trend is risky in the
investment world.

Isn’t There a Way to Make Good Time?

– If crowded highways are truly efficient, and the fast lane is destined to slow down, is there no way to do better than others? My answer is predictable: find the inefficiencies. Go where others won’t. Do the things others avoid. We all have our tricks on the road. We’ll take the route with the hazards that scare away others – after we’ve made sure we know the way around them. Or we’ll take the little-known back road. We’ll go through the industrial area, leaving the beautified route to the masses. Or we’ll drive at night, while others prefer the daylight.

All of these things are analogous to the search for inefficiency in investment markets. At Oaktree we invest in things that others find frightening or unseemly – like junk bonds, bankruptcies and non-performing mortgages. We spend our time in market niches that others ignore – like busted and international convertibles, and distressed debt bought for the purpose of obtaining control over companies.

We try to identify opportunities before others do – like European high yield bonds and power infrastructure. And we do things that others find perilous, but we approach them in ways that cut the risk – like investing in emerging markets without making sink-or-swim bets on the direction of individual countries’ economies and stock markets.

I continue to believe there are ways to earn superior returns without commensurate risk, but they’re usually found outside the mainstream. A shortcut that everyone knows about is an absolute oxymoron, as is one that’s found where the roads are well marked and mapped. The route that’s little known, unattractive or out of favor may not be the one that’s most popular or least controversial. But it’s the one that’s most likely to help you come out ahead.

You can read the entire 2002 memo here.

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The Acquirer’s Multiple® is the valuation ratio used to find attractive takeover candidates. It examines several financial statement items that other multiples like the price-to-earnings ratio do not, including debt, preferred stock, and minority interests; and interest, tax, depreciation, amortization. The Acquirer’s Multiple® is calculated as follows: Enterprise Value / Operating Earnings* It is based on the investment strategy described in the book Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations, written by Tobias Carlisle, founder of The Acquirer’s Multiple® differs from The Magic Formula® Earnings Yield because The Acquirer’s Multiple® uses operating earnings in place of EBIT. Operating earnings is constructed from the top of the income statement down, where EBIT is constructed from the bottom up. Calculating operating earnings from the top down standardizes the metric, making a comparison across companies, industries and sectors possible, and, by excluding special items–earnings that a company does not expect to recur in future years–ensures that these earnings are related only to operations. Similarly, The Acquirer’s Multiple® differs from the ordinary enterprise multiple because it uses operating earnings in place of EBITDA, which is also constructed from the bottom up. Tobias Carlisle is also the Chief Investment Officer of Carbon Beach Asset Management LLC. He's best known as the author of the well regarded Deep Value website Greenbackd, the book Deep Value: Why Activists Investors and Other Contrarians Battle for Control of Losing Corporations (2014, Wiley Finance), and Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors (2012, Wiley Finance). He has extensive experience in investment management, business valuation, public company corporate governance, and corporate law. Articles written for Seeking Alpha are provided by the team of analysts at, home of The Acquirer's Multiple Deep Value Stock Screener. All metrics use trailing twelve month or most recent quarter data. * The screener uses the CRSP/Compustat merged database “OIADP” line item defined as “Operating Income After Depreciation.”