Bibliophile: The Most Important Thing by Howard Marks “Second- Level Thinking”

One of the books which has influenced me and my investment journey is “The Most Important Thing by Howard Marks”. This book teaches us the most important thing which we need to develop for becoming a wise investor. In this article, I include my learning from the 1st chapter of the book – “Second Level Thinking”.

This chapter talks about in-depth thinking for each and every opportunity and even before making any decisions. As the name suggests, we need to enhance our thinking level for making a decision. I found this concept similarly useful in my life also as it’s useful to the investment world. So, I am starting my learning from the 1st chapter of the book.

If we want to get a return as similar as market returns, then we do not need to enhance our level of thinking. We can just make an investment into the index fund, ETF etc., which are listed on exchanges. But what if we want to earn an above average return, we need to make a different decision and need to think differently.

We should need to come out of the crowd and take our stand. We might get right or might get wrong, but should not stop our thinking and decision making. We should keep in mind that even successful investors do not prove right all the time. Even Warren Buffett has made an investment mistake such as Salomon Brothers Inc., Tesco, a Dexter shoe company. We should not fear from making a mistake but should learn from it and should not make the same mistake again and again.

Mr. Howard Marks has discussed that how we can think differently about making a good return on investment. And he gave the name of the concept “Second Level Thinking”.

2nd-lt

Source: The Most Important Thing by Howards Mark

There are many incidents which I personally have experienced in my investment journey where I found real effects of this concept.

Let me explain the 2nd level thinking with an example.

  • One good company which treated as a great company by the market.

The company has a good network effect, reliable brand name and also many news making a tie-up with e-commerce enterprises. Also, got hurt due to changes in the traditional tax structure. Once in a while, the company traded at a valuation of ~140x P/E, ~58x P/BV, ~7x Market cap/Sales, ~76x EV/EBITDA etc.

The company has a good track record and a good brand name but the market has treated it as the great and current valuation of the company is ~64x P/E, ~20x P/BV, ~4x Market cap/Sales and ~44% fall in price from its high price.

This suggests that if any opportunity is much discussed at market space, then we should be more cautious regarding that opportunity and if possible need to stay away from it.

Same with the reverse scenario. Making an investment in metals, sugar sector when everyone fearing from these sectors. When sugar and metal prices were on the lower side, then that was the best time to make an investment in these sectors.

sugar-prices

sugar

We can see that all sugar stocks have started performing after August-2015 from where also prices of sugar started increasing.

  • There are many examples where we have experienced this situation. We can able to create huge wealth when we have made an investment in the adverse scenario.

The scenario of the year 2008 subprime crisis, 2013 or 2016 demonetization situation. If we have made an investment at such panic situations, we can able to create a huge wealth.

ob-yx856_wsj091_g_20130916145022

Same with the reverse situation. When there are a high growth and happy scenario starts, we should keep cautious with our investment. We cannot able to catch the bottom and the high of the market, but we can able to stay with cautious with the surrounding scenario.

The Cocktail Party Stock Market Indicator

i-cant-change-the-direction-of-wind

  • When news of falls in corporate earnings at everywhere and everyone dumps stocks, then it’s a good buying opportunity. If earnings fall less compared to expectations, then we can see a huge shock. And if everyone is expecting to fall in earnings then only we can able to get the good opportunity to enter into a particular business.

tamo

tamo1

Second level thinking is different, difficult and more detailed compared to the first level of thinking. When the 1st thought comes in our mind, we always need to think deeply about it before making any decision.

First level thinking is very easy and many are following it but for getting a different result from the crowd, we need to think differently. As Mr. Howard Marks has quoted results matrix for the second level thinking.

matrix

Our unconventional behavior can help us to achieve unconventional results. Thus, for getting a superior return we need to adopt the second level thinking. And for developing a second level thinking, we need to work hard. We need a huge courage for going against the crowd and it’s not an easy task to perform.

returns-and-how-they-get-that-way

Read for more detail: The Most Important Thing Illuminated by Howard Marks

Disclaimer

Above article is just my perception, and perception can be wrong. For me, my perception can be right but for others, it might be wrong.

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