The 2-Minute Thought: Investing Is a Social Exercise

In one of his great papers on the ten attributes of great investors, Michael Mauboussin writes that “investing is an inherently social exercise” (“Thirty Years: Reflections on the Ten Attributes of Great Investors, Michael J. Mauboussin, Dan Callahan, Darius Majd, Credit Suisse, August 4, 2016). 

That’s both fact and warning.  The fact is that investing cannot be done in a vacuum without other people.  The warning is that, like other social exercises, investing exposes one to the thinking and behavior of others – and that sometimes can be detrimental. 

As an example, think of the internet stock bubble in the late 1990s, when soaring stock prices convinced many people to buy in without thinking carefully for themselves. 

Mauboussin likens that situation to the work Stanford sociologist Mark Granovetter did on how riots get started.  It may be that one person throws a brick through a window.  Afterwards, each additional person joins in according to his or her threshold for jumping into mayhem.  For one individual, that threshold may be seeing five others join in.  For another, it may be seeing 20 others.  Granovetter writes, “The cost to an individual of joining a riot declines as riot size increases, since the probability of being apprehended is smaller the larger the number involved.”  And yet individually, very few would think that rioting is a good idea.   

We all become susceptible to collective behavior after a certain threshold is reached.  In his paper on riots, Granovetter lists several situations that ring true: If you hear a rumor once, you may disregard it, but if you hear it from enough different people, you may spread the rumor too.  You may join a strike only after you see that a certain number of people already have committed to striking.  You may not adopt a new technology until you see that a certain number of people already have.  Or you may decide to leave a party only when enough others have already left and made it acceptable for you to leave too. 

But investing should never be one of these situations.  We should never have to see a threshold of “x” number of people buying a stock before we decide to buy it too. 

Perhaps that’s why it’s so disturbing that James Montier noted recently that more fund managers than ever believe that stocks are “excessively valued,” and yet, they still keep overweight positions in stocks.  That’s according to a recent Bank of America ML survey.

Montier calls it a “cynical bubble” (“The Advent of a Cynical Bubble,” James Montier, GMO, February 2018).  That is, not only are fund managers buying stocks because everyone else is, but they’re also fully aware they’re doing so when stocks are expensive.  Montier calls them “fully-invested bears.”  And if we’ve really reached that point, it’s cynical indeed. 

So let’s step back and remember what Mauboussin writes about great investors.  One of the attributes of great investors, he says, is that they know the difference between information and influence.  Great investors are never pushed into buying something they don’t value fundamentally.  They “don’t get sucked into the vortex of influence.”  They don’t care what other people think about them.  In fact, they have “a blatant disregard for the views of others.”  And as awful as that sounds for polite society, it’s a valuable trait for investors – and a rare one too. 

Please note: The 2-Minute Thought will be on break for two weeks and return March 29.

What It Takes To Be A Great Investor...

Investing is complicated. If you are a fundamental investor who looks at companies, you need to understand the company’s financials, grasp the underlying business, delve into how the company spends money to make money, and assess how it differs from its competitors. That work alone is substantial and hard. But it is not enough for a good investment decision.

On top of that, a good investor also has to understand what other people think about the company. Other people’s expectations are embedded in the stock price, and the primary work of an investor is deciding whether those expectations -- and the current price -- make sense.

In short, the investor’s job isn’t to find the best companies. It’s to find the best prices.

Investment thinker Michael Mauboussin compares it to horse betting: “The goal is not to figure out which horse will win but rather which horse has odds that are mispriced relative to how it will likely run the race.” To do well at this, you do need to understand the fundamentals of each horse – its capabilities and its racing attributes. But you also need to understand the public’s expectations about the horse, or how the betting odds were determined. 

“Perhaps the single greatest error in the investment business,” Mauboussin says, “is a failure to distinguish between the knowledge of a company’s fundamentals and the expectations implied by the market price.”

That is one of the main points in Mauboussin’s recent paper, “Thirty Years: Reflections on the Ten Attributes of Great Investors,” a deep and big-picture reflection on what makes great investors great. The big takeaway from the paper is that great investors think and behave differently from most. While the majority of people look to buy companies when fundamentals are good and sell when they are bad, great investors look for companies where their views are different from what the current price suggests. It is not enough for them to find companies that create value; they must also find companies that exceed the expectations embedded in their prices.

Doing this work, however, takes a certain kind of person. The picture that emerges from Mauboussin’s list of attributes (see box) is that great investors have a broad mix of hard and soft skills, quantitative and qualitative ones. They understand numbers, but they also know psychology and the hearts and minds of humans -- themselves and others. They are mentally flexible. They have a certain kind of rationality that helps them manage cognitive biases better than most.

Mauboussin emphasizes first that great investors must be numerate and comfortable with accounting. Financial statements are the pathway to understanding a company’s business, its strategy, and its competitive position, and so investors must be expert at interpreting them.

But because the information financial statements can convey is limited, that is not enough. Investors also need superior qualitative judgement. And beyond that, great investors share certain cognitive traits: They are actively open-minded. They are enthusiastic learners. They are curious about a wide range of disciplines. They make it a point to seek out views that are different from their own and are not afraid to change their minds when the evidence tells them to. In addition, they are very, very good about not caring about what others think.

Perhaps one of the most interesting attributes listed is that great investors read, and read a lot – as much as, Mauboussin says, 500 pages a day. While the number of pages is not important, what does matter is that investors allocate time during the day when they do nothing else, and that they read across disciplines and include things they do not agree with. Constantly seeing breadth in thinking is what lays the groundwork for one to be able to formulate one’s own unique opinions.