process
Second-level thinking
The rule
First-level thinking says 'good company, buy it'. Second-level thinking asks what everyone already believes, and whether that is already baked into the price.
Where it flips
Being contrary just to be contrary is only first-level thinking flipped over. Being different is worthless unless you are also right. And sometimes the crowd's obvious view is simply correct.
Marks separates the easy reaction from the deeper one. First-level thinking is 'the company is good, so I should buy'. But if that is obvious to everyone, it is already in the price, and you have no edge. Second-level thinking asks more. What does the crowd expect? How might they be wrong? What is already priced in? To beat the market you must be both different from the crowd and more right than it. Just being right about a well-known fact earns you nothing. It is the cure for buying a story simply because it is true and popular.
A worked example
'This is India's best FMCG company, so buy' is first-level. Second-level says: everyone knows that, it trades at 60 times earnings, and the price already assumes ten years of perfection. So the good news is already spent. [illustrative]
How to spot it
- ·the question 'what is already in the price?' asked
- ·the crowd's view spotted before you disagree with it
- ·no mixing up a true fact with a real edge
Howard Marks · The Most Important Thing