Howard Marks Memo – bubble.com – 2000

In this fantastic memo from 2000 H. Marks starts out with an overview of The South Sea Company and the bubble, known as The South Sea Bubble, that followed in its path. With that overview he sets the stage for his review of what “certainly seems to me to be another market bubble“. This is the longest and most detailed memo so far. In order to fully grasp the stories and all the wisdom it contains I recommend that you read it in full.

Please comment if you have read the memo and what you thought of it. Also, if you have found a worldly wisdom in the memo that you think I should have included please comment on that as well. I’m very interested in what caught your eye while reading and why.

Worldly wisdom’s from bubble.com – 2000

1.

Changing the world — Of course, the entire furor over technology, e-commerce and telecom stocks stems from the companies’ potential to change the world. I have absolutely no doubt that these movements are revolutionizing life as we know it, or that they will leave the world almost unrecognizable from what it was only a few years ago. The challenge lies in figuring out who the winners will be, and what a piece of them is really worth today.

[…]

As usual, Buffet puts it as succinctly as anyone could: “The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors.”

My thoughts: The extracts above perfectly demonstrates second-level thinking. In the memo, H. Marks shares an interesting story about the invention of the radio (which was expected to change the world, and did) and a company called RCA (Radio Corporation of America). Based on the lessons from that story it seems likely that investors will overpay for companies with the characteristics and the ability to change the world.

2.

“I feel strongly that no investment opportunity is so good that it can’t be screwed up by the wrong relationship between supply and demand. Too much money for too few ideas can mean ruinous terms and purchase prices that are too high.

[…]

In my experience, the big, low-risk profits have usually come from investments made at those times when recent results have been poor, capital is scarce, investors are reticent and everyone says “no way!” Today, great results in venture capital are in the headlines, money is everywhere, investors are emboldened and the mantra is “of course!”

My thoughts: Although the extracts above are related to venture capital I would argue that they are equally relevant for the public capital markets. Also, what H. Marks explains in the second extract above are the endpoints on the market pendulum (greed and fear) as he laid out in the 1991 memo – First Quarter Performance.

3.

How will the companies make money? — […]

I don’t think anyone would disagree that it’s one thing to innovate and change the world and another thing entirely to make money. Business will be different in the future, meaning that not all of the old rules will hold. On the other hand, profits come from taking in more in revenue than you payout in expense, and I don’t think that’s going to change. I’ll highlight below just three of the areas in which I have questions about profitability.

First, will the Internet and dot-com companies be able to charge enough for their products to make money? […]

Second, how practical are the business models of the dot-com firms? […]

Lastly, what will be the effect of competition? […] 

My thoughts: The three questions above should be remembered and applied to any innovation that you come across with a promise to “change the world”. Similar to H. Marks argument about profits, these questions will most likely not come to change. In other words; pricing power, the application/execution of a business model and competition will always be relevant to review and asses from the perspective of profitability. Especially for companies that “will change the world”.

4.

“As Alan Abelson wrote when he ran the graph, “Our reservation here is that (a) technology, like everything else in life, is cyclical; and (b) there’s something goofy about the price of a stock discounting as much as a century of earnings for a company in a field where change is the only constant and where the pace of change is constantly quickening.””

My thoughts: One should always be on the lookout for similar subtle oxymoronic assumptions built into a situation that one tries to analyze and understand.

5.

“I am convinced that a few essential lessons are involved here.

  1. The positives behind stocks can be genuine and still produce losses if you overpay for them.
  2. Those positives – and the massive profits that seemingly everyone else is enjoying – can eventually cause those who have resisted participating to capitulate.
  3. A “top” in a stock, group or market occurs when the last holdout who will become a buyer does so. The timing is often unrelated to fundamental developments.
  4. “Prices are too high” is far from synonymous with “the next move will be downward.” Things can be overpriced and stay that way for a long time … or become far more so.
  5. Eventually, though, valuation has to matter.

My thoughts: As always, H. Marks makes a good job summarising the lessons from the memo.

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