Howard Marks: "Worst-Case" Projections
We probably look at 175 – 200 investment opportunities
annually (someone actually employs me...). Most of these are brought to us by investment banks, and some come
with projections offering a range of outcomes. The best-case projection often
looks like a hockey stick: historically flat or with a slight positive trend,
but showing explosive growth for the projected period. In stark contrast, the
worst-case projection hardly ever shows revenue declining. At worst (according
to the materials provided) revenues will remain constant.
We then take this information and develop our own scenarios
to appropriately stress test various capital structures under a variety of
conditions. In this process I occasionally think back to this entertaining
quote from Howard Marks:
We hear a lot about “worst-case” projections, but they often
turn out not to be negative enough. I tell my father’s story of the gambler who
lost regularly. One day he heard about a race with only one horse in it, so he
bet the rent money. Halfway around the track, the horse jumped over the fence
and ran away. Invariably things can get worse than people expect. Maybe
“worst-case” means “the worst we’ve seen in the past.” But that doesn’t mean
things can’t be worse in the future. In 2007, many people’s worst-case
assumptions were exceeded.
About Howard Marks:
When I see memos from Howard Marks in my mail, they’re the first thing I open and read. I always learn something, and that goes double for his book.
Warren Buffett