The Most Important Thing:
Howard Marks wrote a book entitled, The Most Important Thing. I like the book, sincerely, I do. There are a lot of chapters with a lot of important things, but I find it odd that he didn’t discuss the most important thing about investing in his book. I have read the book twice and skimmed it again this past weekend to make sure I didn’t miss it. You can read his memo, which the book is based on here.
The “most important thing” may seem so obvious until you realize that a well-known investor, such as Howard Marks, wrote an entire book called The Most Important thing and didn’t even touch on the subject.
Trust me, I will not win any investment pitches with this idea, but I am continually shocked at how few, if any, people focus on this “most important thing.”
The most important thing is Understanding the Business. The most succinct way to ask this question might be:
Can Company X profitability provide real value to its customers and will it be able to continue to do so in the future?
You are probably rolling your eyes at this point. Do a quick google search of “Duh memes”–there are some good ones. But I stand firmly behind this “most important thing.” This is the first and most important question you can ask when approaching any investment.
Companies that can profitability provide value to their customers thrive. The rest don’t.
Companies can temporarily “extract” profit from their customers without providing any value. I plan to do a separate post on these companies. In the short run, the stock prices of these companies do amazingly well, however, these profits are short-lived.
Here are two quick examples.
The first is a graphic illustration of the value Apple has provided to its customers. It’s simple, yet amazingly strong evidence of the value of an iPhone.
The second is from Valeant (VRX). Valeant was a different kind of pharma company.
VRX’s strategy was to buy branded drugs without patent protection and stick them into the system described below while dramatically raising the prices over the years.
VRX—–>Patients: VRX provided patients with discounts cards to make branded drugs cheaper than generics by waiving the co-pay, thus incentivizing patients to choose the lower priced (to the patient) but higher cost (to the system) drugs.
VRX—–>Pharmacy Benefit Managers (PBMs): VRX provided rebates to the PBMs on these branded drugs in order to allow these drugs to be on approved formularies and allow insurance payments without prior authorization.
VRX—–>Insurance Companies: VRX overcharged insurance companies due to artificially high demand for branded drugs (due to discount cards) as opposed to generics despite no medical difference. Insurance companies did not want to “blackball” VRX’s branded drugs because demand appeared to be there and not allowing doctor prescribed drugs is bad publicity for insurance companies.
As you can see, VRX is not providing the customer with any real, long-term value. At its height, VRX had an equity market capitalization of roughly $88B. Today’s the equity is “worth” around $5B and there is a high likelihood that the equity will be worthless in a few years.
I only bring up Valeant because this is a perfect example of long discussions among highly regarded investors without a clear understanding of the actual business. In other words, someone forgot to read/write the chapter entitled “Understand the Business.”
This reminds me of the trips to NYC museums. If you go with children in a group of adults, you will almost inevitably lose track of any number of kids at some point. You just assume the other adults are watching the kids. Whose job is it to do the most important analysis and understand the business?
Once again, this seems so obvious and you will look like a fool if you try to claim that your “competitive advantage” is understanding the businesses in which you invest. Even writing that, I feel a little sheepish.
What are the right questions to ask? The questions about the business depend on each business. Some will be cost driven, some will be price driven. Why do the customers pick Company X’s products, what value do these products provide for the customer? Other questions will focus on the competitors or changing industry landscape, regulatory and/or technology driven. All of the best questions focus on understanding the nature and quality of the business. This is the most important thing….