Warren Buffett (Trades, Portfolio), the Oracle of Omaha, believes that people looking to become better investors should spend more time reading and honing their writing skills, and that doing so can expand your knowledge base and improve critical thinking. In a similar vein, I now want to look at some comments that Buffett has made in the past concerning mathematics.
You don’t need to have a PhD from MIT
The first thing that jumps out here is that Buffett does not think that being a math wizard confers any real advantage to investors. Speaking at the 1995 Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) annual investor conference, he said:
“I don’t think advanced mathematical knowledge is of any use in the investment process. Understanding mathematical relationships, and having an ability to quantify - numeracy - I think that’s generally helpful in investment, because something that tells you when things make sense, or don’t make sense [is useful]”.
I think this is quite similar to comments that he has made in the past about intelligence, stating that investors don’t need to be more than moderately clever to succeed.
Optimization and opportunity cost
With that being said, Buffett does believe that one aspect of mathematical thought is highly relevant to investing - the ability to optimise, or choose the best possible configuration of options:
“When Charlie and I are reading about a business we are always comparing it to a screen of dozens of other businesses, it’s sort of automatic. But that’s just like a scout in baseball thinking about one baseball player against an alternative. You only have a certain amount of people on the squad, and one guy might be faster, another hits a little bit better - always in your mind you are prioritising and selecting in some manner”.
The ability to optimise is probably the most important mathematical skill for an investor. Successful investing is not just a question of picking good stocks: it’s about picking the best ones among a group of good ones. In other words, there is an opportunity cost to any investment. By buying $1,000 worth of company A, you are precluding the possibility of spending that $1,000 on company B.
The problem is that a lot of the time when you are doing this you are comparing apples to oranges. How does one go about comparing an energy company with a retailer? Clearly it’s not possible to look at industry-specific numbers and metrics, as these businesses are in different industries! Buffett might say that to do this, you have to understand how the final cash flows of the two companies compare to one another. This requires good critical thinking more so than it requires great mathematical skills.
Disclosure: The author owns no stocks mentioned.
Read more here:
- Stanley Druckenmiller: Invest In Post-Brexit Britain
- Charlie Munger: Be a Generalist in a World of Specialists
- Warren Buffett: Writing Will Make You a Better Investor
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