Rationality is a core skill that any value investor should possess. If you are someone who is looking to buy assets when their owners are panic selling because you believe them to be undervalued, then you - by definition - have to be a very rational person. This type of contrarian behavior can only result in success if you are able to really cut through the emotion of the situation and drill down to the core value proposition of an investment.
Berkshire Hathaway's (BRK.A, Financial) (BRK.B, Financial) Charlie Munger (Trades, Portfolio) is a person who has this kind of rationality in spades. Over the course of his long career, he has shown the willingness time and time again to be a big picture thinker and not let himself be distracted by the irrationality of the people around him. At the 2020 annual shareholder meeting of the Daily Journal Corp. (DJCO, Financial), of which he is the chairman, Munger talked at length about the value of rationality.
Becoming more rational
Munger was asked by a shareholder to explain how one can become more rational. He said that while this is not an immediate process, it can be done with enough time and effort. One way to do this is to challenge your closely-held beliefs:
"Rationality is something that you get slowly and it has a variable result. But it's better than not having it. I just think that you can see how awful it is when people get into these furies of resentment and anger, and sure they're right about everything...I actually work at trying to discard beliefs. Most people just cherish whatever idiotic notion they already have because they assume it must be good. Think of the brilliant people who do some of the dumbest things."
Munger's advice is to try and avoid confirmation bias. This bias occurs when investors go looking for evidence that supports a belief that they already hold, rather than looking for evidence that challenges that belief.
This is particularly true of "story" companies, like Tesla (TSLA, Financial), where large parts of the investment community have siloed themselves into believing the stock is a good buy at any price and refuse to consider any opinions that contradict that orthodoxy. And of course, it is easy to think of examples where investors have become excessively bearish on stocks and will not consider buying at any price, no matter how low.
"Brilliant" people who are able to think very deeply and intensely about things can sometimes fall into the trap of confirmation bias because they can't imagine being wrong in their convictions. Rational investors understand their own limitations and are open to ideas that challenge their positions. You don't have to be a genius, you just need to be open-minded.
Disclosure: The author owns no stocks mentioned.
Read more here:
- Bill Nygren Explains How to Look Beyond GAAP Accounting
- Warren Buffett Explains How to Improve Financial Regulation​
- Bill Nygren on How Business and Investing Have Changed
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
