Howard Marks: The Problem With Paying Up For A Popular Stock

Johnny HopkinsHoward MarksLeave a Comment

In his book – The Most Important Thing, Howard Marks discusses the problem with paying up for a popular stock. Here’s an excerpt from the book:

If you make cars and want to sell more of them over the long term—that is, take permanent market share from your competitors— you’ll try to make your product better. . . . That’s why— one way or the other— most sales pitches say, “Ours is better.” However, there are products that can’t be differentiated, and economists call them “commodities.” They’re goods where no seller’s offering is much different from any other.

They tend to trade on price alone, and each buyer is likely to take the offering at the lowest delivered price. Thus, if you deal in a commodity and want to sell more of it, there’s generally one way to do so: cut your price. . . . It helps to think of money as a commodity just like those others. Everyone’s money is pretty much the same.

Yet institutions seeking to add to loan volume, and private equity funds and hedge funds seeking to increase their fees, all want to move more of it. So if you want to place more money— that is, get people to go to you instead of your competitors for their financing— you have to make your money cheaper.

One way to lower the price for your money is by reducing the interest rate you charge on loans. A slightly more subtle way is to agree to a higher price for the thing you’re buying, such as by paying a higher price/earnings ratio for a common stock or a higher total transaction price when you’re buying a company. Any way you slice it, you’re settling for a lower prospective return.

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