Buy the best stocks, sell the losing stocks, and avoid the worst stocks

Howard Marks, born during the 1940s, is a renowned investor and writer in the United States. He is the co-founder and co-chairman of Oaktree Capital Management, the largest investor in distressed securities worldwide.

A renowned contrarian, his insightful assessment of market opportunity and risk is well known in the investing world. Here are a few pointers from his time-tested, fundamental philosophy. 

1. View Market Movements Constructively

Investors tend to perceive market activity through the prism of boom-and-bust cycles and anticipate future movements based on past patterns. 「The cycle, generally speaking,」 Marks explained, 「is a series of up and down oscillations around a central trend line.」

But the conventional terms that describe these market movements — boom and bust, up and down — carry connotations that can influence an investor's perspective and create a distortive effect. So Marks avoids them.

「I tend to think of them, more productively, as excesses and corrections,」 he said.

Bloomberg

2. You cannot be successful if you have no patience. 

Be patient. Underpriced does not mean 「going up tomorrow」. Overpriced does not mean 「going down tomorrow」. Markets can be over- or underpriced and stay that way -- or become more so -- for years. 

Sometimes there are plentiful opportunities for unusual returns with low risks; the global financial crisis of 2008 threw up plenty of opportunities. Other times they are fewer. It's important to wait patiently for the former. 

Even if you are correct in identifying a divergence of popular opinion from eventual reality, it can take a long time for the price to converge with value and it can require something that acts as the catalyst. You should have the emotional strength to be able to stick with an approach or decision until it proves out, which can be a long time.

Bloomberg

3. Psychology is more important than market predictions.

You don't have a crystal ball to predict the future. You can't forecast how the market will perform tomorrow. You can only mentally prepare yourself for probable situations in the market. To make money in the stock market you require having a deep insight into companies, asset classes, and sectors.

You can't let your emotions get the better of your investment strategies. What matters most is your psychology. You have to be either aggressive or defensive in your approach. It doesn't matter whether you are investing in stocks or bonds.

It hardly matters whether you pour your money into domestic or international markets. Your returns remain unaffected irrespective of the fact whether you invest in a developed economy or an emerging market.

Bloomberg

4. Be Different, But Be Correct

Following the market does not lead to outperformance.

To generate better investment returns, you have to separate yourself from the herd. And you have to be right.

「If you think and behave differently from other people — and you're more right than they are, that's a necessary ingredient — then you can have superior performance,」 Marks said.

The approach may sound simple. But it's much more difficult in practice. Rejecting the consensus is an easy reflex, but in investing, that consensus — the market — is right more often than not.

「Knee-jerk contrarianism is certainly not a successful strategy,」 he said.

Bloomberg

5. Insist on a Margin of Safety

The margin of safety is a key concept among value investors searching for undervalued securities. 「For any given investment that you consider making, you evaluate the investment relative to the underlying fundamentals,」 Marks said.

To define the margin of safety for a particular investment, Marks recommends investors consider the company, the stability of the industry, and the underlying predictability of both as well as the lowness of the price.

「The expert calibrates the expression of his opinion based on how firm the evidence is,」 Marks said. 「The investor should calibrate his confidence in his investment based on how much margin of safety there is.」

Source: CFA Institute, Morningstar, Trade Brains