Investors can gainfully spend their time researching three areas:
1. Knowing the knowable, the fundamentals of an investment.
2. Understanding value and being disciplined on the price they pay.
3. Studying the investment environment we are in and appropriately positioning portfolios for it.
–Robert Farago – From book review of Mastering the Markets
Farago provides a useful framework for describing the great short book Mastering the Markets by Howard Marks. The Marks approach is simple but often not given enough attention. Know where you are in the business and credit cycle and you will make better decisions and miss blow-ups.
Most investors and analysts spend their time trying to research the fundamentals. If you know the investment details, you will surely do well. You can always talk with others about any investment in greater detail so many will view you as an expert. Unfortunately, everyone is doing this work, so it is hard to get an edge. Knowing the details is not the same as knowing how to make a good decision.
The second area for potential investment success is to spend your time focusing on valuation. Make sure you buy cheap. If you can focus on value, you will never make the big mistake. Unfortunately, understanding value is much harder than you think. It is not an issue of value today but what will be value in the future. Cheap securities are cheap for a reason and can become cheaper.
The third area of research is the core of global macro investing and is the most important when thinking about building a portfolio. Know where you are in the business cycle. The business cycle drives value. The business cycle will tell you a lot about the success of any company. Good companies in the wrong industry can still suffer in a market downturn. Knowing where you are in the cycle is the critical piece of knowledge for building a portfolio, finding value, and measuring the fundamentals.
You don’t need to know where you are going. You first need to know where you are. Know where you are in the cycle and most of your investment problems will be solved. Cycles have similarity. You cannot predict with certainty, but you can place a likelihood on what could be next and that is an edge.