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.