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The Most Important Thing Illuminated

The Most Important Thing Illuminated: Uncommon Sense for the Thoughtful Investor

Christopher C. Davis
Joel Greenblatt
Paul Johnson
Seth A. Klarman
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  • Book Info
    The Most Important Thing Illuminated
    Book Description:

    Howard Marks's The Most Important Thing distilled the investing insight of his celebrated client memos into a single volume and, for the first time, made his time-tested philosophy available to general readers. In this edition, Marks's wisdom is joined by the comments, insights, and counterpoints of four renowned investors and investment educators: Christopher C. Davis (Davis Funds), Joel Greenblatt (Gotham Capital), Paul Johnson (Nicusa Capital), and Seth A. Klarman (Baupost Group).

    These experts lend insight into such concepts as "second-level thinking," the price/value relationship, patient opportunism, and defensive investing. Marks also adds his own annotations, expanding on his book's original themes and issues. A new chapter addresses the importance of reasonable expectations, and a foreword by Bruce C. Greenwald, called "a guru to Wall Street's gurus" by the New York Times, speaks on value investing, productivity, and the economics of information.


    Howard Marks, the chairman and cofounder of Oaktree Capital Management, is renowned for his insightful assessments of market opportunity and risk. After four decades spent ascending to the top of the investment management profession, he is today sought out by the world's leading value investors, and his client memos brim with insightful commentary and a time-tested, fundamental philosophy. Now for the first time, all readers can benefit from Marks's wisdom, concentrated into a single volume that speaks to both the amateur and seasoned investor.

    Informed by a lifetime of experience and study, The Most Important Thing explains the keys to successful investment and the pitfalls that can destroy capital or ruin a career. Utilizing passages from his memos to illustrate his ideas, Marks teaches by example, detailing the development of an investment philosophy that fully acknowledges the complexities of investing and the perils of the financial world. Brilliantly applying insight to today's volatile markets, Marks offers a volume that is part memoir, part creed, with a number of broad takeaways.

    Marks expounds on such concepts as "second-level thinking," the price/value relationship, patient opportunism, and defensive investing. Frankly and honestly assessing his own decisions--and occasional missteps--he provides valuable lessons for critical thinking, risk assessment, and investment strategy. Encouraging investors to be "contrarian," Marks wisely judges market cycles and achieves returns through aggressive yet measured action. Which element is the most essential? Successful investing requires thoughtful attention to many separate aspects, and each of Marks's subjects proves to be the most important thing.

    "This is that rarity, a useful book."--Warren Buffett

    eISBN: 978-0-231-53079-8
    Subjects: Finance, Management & Organizational Behavior, Business

Table of Contents

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  1. Front Matter
    (pp. i-vi)
  2. Table of Contents
    (pp. vii-viii)
  3. Foreword
    (pp. ix-x)

    For twenty years Howard Marks has been educating investors with his “Memos from the Chairman,” and in writing The Most Important Thing, Marks drew from these memos to compile the most important lessons he has learned as an investor. That he is an outstanding investor goes without saying; he is also a great teacher and a thoughtful author, and The Most Important Thing is a generous gift to all investors.

    In The Most Important Thing Illuminated, readers will benefit not only from Marks’s hard-earned wisdom, but also from the insights of three seasoned investors—Christopher Davis, Joel Greenblatt, and Seth...

  4. Introduction
    (pp. xi-xviii)

    For the last twenty years I’ve been writing occasional memos to my clients—first at Trust Company of the West and then at Oaktree Capital Management, the company I cofounded in 1995. I use the memos to set forth my investment philosophy, explain the workings of finance and provide my take on recent events. Those memos form the core of this book, and you will find passages from many of them in the pages that follow, for I believe their lessons apply as well today as they did when they were written. For inclusion here I’ve made some minor changes,...


    • 1 The Most Important Thing Is . . . Second-Level Thinking
      (pp. 1-7)

      Few people have what it takes to be great investors. Some can be taught, but not everyone . . . and those who can be taught can’t be taught everything. Valid approaches work some of the time but not all. And investing can’t be reduced to an algorithm and turned over to a computer. Even the best investors don’t get it right every time.

      The reasons are simple. No rule always works. The environment isn’t controllable, and circumstances rarely repeat exactly. Psychology plays a major role in markets, and because it’s highly variable, cause-and- effect relationships aren’t reliable. An investment...

    • 2 The Most Important Thing Is . . . Understanding Market Efficiency (and Its Limitations)
      (pp. 8-18)

      The 1960s saw the emergence of a new theory of finance and investing, a body of thought known as the “Chicago School” because of its origins at the University of Chicago’s Graduate School of Business. As a student there in 1967–1969, I found myself at ground zero for this new theory. It greatly informed and influenced my thinking.

      The theory included concepts that went on to become important elements in investment dialogue: risk aversion, volatility as the definition of risk, risk-adjusted returns, systematic and nonsystematic risk, alpha, beta, the random walk hypothesis and the efficient market hypothesis. (All of...

    • 3 The Most Important Thing Is . . . Value
      (pp. 19-28)

      The oldest rule in investing is also the simplest: “Buy low; sell high.” Seems blindingly obvious: Who would want to do anything else? But what does that rule actually mean? Again, obvious—on the surface: it means that you should buy something at a low price and sell it at a high price. But what, in turn, does that mean? What’s high, and what’s low?

      On a superficial level, you can take it to mean that the goal is to buy something for less than you sell it for. But since your sale will take place well down the road,...

    • 4 The Most Important Thing Is . . . The Relationship Between Price and Value
      (pp. 29-38)

      Let’s say you’ve become convinced of the efficacy of value investing and you’re able to come up with an estimate of intrinsic value for a stock or other asset. Let’s even say your estimate is right. You’re not done. In order to know what action to take, you have to look at the asset’s price relative to its value. Establishing a healthy relationship between fundamentals—value—and price is at the core of successful investing.

      For a value investor, price has to be the starting point. It has been demonstrated time and time again that no asset is so good...

    • 5 The Most Important Thing Is . . . Understanding Risk
      (pp. 39-56)

      Investing consists of exactly one thing: dealing with the future. And because none of us can know the future with certainty, risk is inescapable. Thus, dealing with risk is an essential—I think the essential—element in investing. It’s not hard to find investments that might go up. If you can find enough of these, you’ll have moved in the right direction. But you’re unlikely to succeed for long if you haven’t dealt explicitly with risk. The first step consists of understanding it. The second step is recognizing when it’s high. The critical final step is controlling it. Because the...

    • 6 The Most Important Thing Is . . . Recognizing Risk
      (pp. 57-70)

      Great investing requires both generating returns and controlling risk. And recognizing risk is an absolute prerequisite for controlling it.

      Hopefully I’ve made clear what I think risk is (and isn’t). Risk means uncertainty about which outcome will occur and about the possibility of loss when the unfavorable ones do.

      Paul Johnson: This is the clearest and most accurate definition of risk I have heard. Marks nails it with this statement.

      The next important step is to describe the process through which risk can be recognized for what it is.

      Recognizing risk often starts with understanding when investors are paying it...

    • 7 The Most Important Thing Is . . . Controlling Risk
      (pp. 71-80)

      Outstanding investors, in my opinion, are distinguished at least as much for their ability to control risk as they are for generating return.

      High absolute return is much more recognizable and titillating than superior risk-adjusted performance. That’s why it’s high-returning investors who get their pictures in the papers.

      Christopher Davis: For instance, lottery winners—though no one thinks they are investment geniuses.

      Since it’s hard to gauge risk and risk-adjusted performance (even after the fact), and since the importance of managing risk is widely underappreciated, investors rarely gain recognition for having done a great job in this regard. That’s especially...

    • 8 The Most Important Thing Is . . . Being Attentive to Cycles
      (pp. 81-88)

      The more time I spend in the world of investing, the more I appreciate the underlying cyclicality of things. In November 2001 I devoted an entire memo to the subject. I titled it “You Can’t Predict. You Can Prepare,” borrowing the advertising tagline of MassMutual Life Insurance Company because I agree wholeheartedly with their theme: we never know what lies ahead, but we can prepare for the possibilities and reduce their sting.

      In investing, as in life, there are very few sure things. Values can evaporate, estimates can be wrong, circumstances can change and “sure things” can fail. However, there...

    • 9 The Most Important Thing Is . . . Awareness of the Pendulum
      (pp. 89-96)

      The second investor memo I ever wrote, back in 1991, was devoted almost entirely to a subject that I have come to think about more and more over the years: the pendulum-like oscillation of investor attitudes and behavior.

      Paul Johnson: Chapter 9 is essentially an extension of the three earlier chapters on risk and offers additional insight into how to analyze the current risk temperature in the markets.

      The mood swings of the securities markets resemble the movement of a pendulum. Although the midpoint of its arc best describes the location of the pendulum “on average,” it actually spends very...

    • 10 The Most Important Thing Is . . . Combating Negative Influences
      (pp. 97-110)

      Inefficiencies—mispricings, misperceptions, mistakes that other people make—provide potential opportunities for superior performance. Exploiting them is, in fact, the only road to consistent outperformance. To distinguish yourself from the others, you need to be on the right side of those mistakes.

      Why do mistakes occur? Because investing is an action undertaken by human beings, most of whom are at the mercy of their psyches and emotions.

      Christopher Davis: And not only their psyches and emotions—perverse incentives can influence institutional investors’ decision making in negative ways.

      Many people possess the intellect needed to analyze data, but far fewer are...

    • 11 The Most Important Thing Is . . . Contrarianism
      (pp. 111-121)

      There’s only one way to describe most investors: trend followers. Superior investors are the exact opposite. Superior investing, as I hope I’ve convinced you by now, requires second-level thinking—a way of thinking that’s different from that of others, more complex and more insightful. By definition, most of the crowd can’t share it. Thus, the judgments of the crowd can’t hold the key to success. Rather, the trend, the consensus view, is something to game against, and the consensus portfolio is one to diverge from. As the pendulum swings or the market goes through its cycles, the key to ultimate...

    • 12 The Most Important Thing Is . . . Finding Bargains
      (pp. 122-130)

      The process of intelligently building a portfolio consists of buying the best investments, making room for them by selling lesser ones, and staying clear of the worst. The raw materials for the process consist of (a) a list of potential investments, (b) estimates of their intrinsic value, (c) a sense for how their prices compare with their intrinsic value, and (d) an understanding of the risks involved in each, and of the effect their inclusion would have on the portfolio being assembled.

      Christopher Davis: This is a great summary.

      The first step is usually to make sure that the things...

    • 13 The Most Important Thing Is . . . Patient Opportunism
      (pp. 131-141)

      The boom-bust cycle associated with the global financial crisis gave us the chance to sell at highly elevated levels in the period 2005 through early 2007 and then to buy at panic prices in late 2007 and 2008. This was in many ways the chance of a lifetime. Cycle-fighting contrarians had a golden opportunity to distinguish themselves. But one of the things I want to do in this chapter is to point out that there aren’t always great things to do, and sometimes we maximize our contribution by being discerning and relatively inactive. Patient opportunism—waiting for bargains—is often...

    • 14 The Most Important Thing Is . . . Knowing What You Don’t Know
      (pp. 142-150)

      I’ve chosen three quotes with which to lead off this chapter, and I have a million more where those came from. Awareness of the limited extent of our foreknowledge is an essential component of my approach to investing.

      I’m firmly convinced that (a) it’s hard to know what the macro future holds and (b) few people possess superior knowledge of these matters that can regularly be turned into an investing advantage. There are two caveats, however:

      The more we concentrate on smaller-picture things, the more it’s possible to gain a knowledge advantage. With hard work and skill, we can consistently...

    • 15 The Most Important Thing Is . . . Having a Sense for Where We Stand
      (pp. 151-160)

      Market cycles present the investor with a daunting challenge, given that:

      Their ups and downs are inevitable.

      They will profoundly influence our performance as investors.

      They are unpredictable as to extent and, especially, timing.

      So we have to cope with a force that will have great impact but is largely unknowable. What, then, are we to do about cycles? The question is of vital importance, but the obvious answers—as so often—are not the right ones.

      The first possibility is that rather than accept that cycles are unpredictable, we should redouble our efforts to predict the future, throwing added...

    • 16 The Most Important Thing Is . . . Appreciating the Role of Luck
      (pp. 161-170)

      The investment world is not an orderly and logical place where the future can be predicted and specific actions always produce specific results. The truth is, much in investing is ruled by luck. Some may prefer to call it chance or randomness, and those words do sound more sophisticated than luck. But it comes down to the same thing: a great deal of the success of everything we do as investors will be heavily influenced by the roll of the dice.

      Paul Johnson: For me the theme of this chapter is: Learn to be honest with yourself about your successes...

    • 17 The Most Important Thing Is . . . Investing Defensively
      (pp. 171-184)

      When friends ask me for personal investment advice, my first step is to try to understand their attitude toward risk and return. Asking for investment advice without specifying that is like asking a doctor for a good medicine without telling him or her what ails you.

      So I ask, “Which do you care about more, making money or avoiding losses?” The answer is invariably the same: both.

      The problem is that you can’t simultaneously go all out for both profit making and loss avoidance. Each investor has to take a position regarding these two goals, and usually that requires striking...

    • 18 The Most Important Thing Is . . . Avoiding Pitfalls
      (pp. 185-200)

      In my book, trying to avoid losses is more important than striving for great investment successes. The latter can be achieved some of the time, but the occasional failures may be crippling. The former can be done more often and more dependably . . . and with consequences when it fails that are more tolerable. With a risky portfolio, a downward fluctuation may make you lose faith or be sold out at the low. A portfolio that contains too little risk can make you underperform in a bull market, but no one ever went bust from that; there are far...

    • 19 The Most Important Thing Is . . . Adding Value
      (pp. 201-208)

      It’s not hard to perform in line with the market in terms of risk and return. The trick is to do better than the market: to add value. This calls for superior investment skill, superior insight. So here, near the end of the book, we come around full circle to the first chapter and second-level thinkers possessing exceptional skill.

      The purpose of this chapter is to explain what it means for skillful investors to add value. To accomplish that, I’m going to introduce two terms from investment theory. One is beta, a measure of a portfolio’s relative sensitivity to market...

    • 20 The Most Important Thing Is . . . Reasonable Expectations
      (pp. 209-214)

      I want to point out that no investment activity is likely to be successful unless the return goal is (a) explicit and (b) reasonable in the absolute and relative to the risk entailed. Every investment effort should begin with a statement of what you’re trying to accomplish. The key questions are what your return goal is, how much risk you can tolerate, and how much liquidity you’re likely to require in the interim.

      Return goals must be reasonable. What returns can we aspire to? Most of the time—although not necessarily at any particular point in time (and not necessarily...

    • 21 The Most Important Thing Is . . . Pulling It All Together
      (pp. 215-224)

      The best foundation for a successful investment—or a successful investment career—is value. You must have a good idea of what the thing you’re considering buying is worth. There are many components to this and many ways to look at it. To oversimplify, there’s cash on the books and the value of the tangible assets; the ability of the company or asset to generate cash; and the potential for these things to increase.

      Paul Johnson: All of the snippets offered in this chapter are worth reading and remembering. This chapter is an excellent recap of the book and the...

  6. About the Contributors
    (pp. 225-226)