The thing that most separates the truly great investors from the ones who are merely above average for an extended period of time is not their superior ability in number crunching – all lingo aside, most people with basic numerate skills are able to sort growing, solid, profitable companies from the ones that are not.
A lot of investors, too, can tell an undervalued company from a company at or above fair value, but this is not the primary difference. Neither is it in the difference between their forecasting skills. Some may be better at predicting global geopolitical – and macro – scenarios than others, but this is not where the difference is, either.
The primary common denominator for the investing greats rests in their aptitude for recognizing and overruling the emotions of greed, fear and the tendency to believe in what one wants to believe.
Daniel Kahnemann, one of the fathers of what is known today as behavioral finance, coined the metaphor of a system 1, which is quick to make decisions based on gut feelings, and a system 2, which requires conscious, demanding thought. System 1 is great for a lot of things such as recognizing a door or a dangerous situation, and as such it is indispensable from an evolutionary standpoint. However, when it comes to dealing with highly complex systems such as the workings of the body, or the financial markets, system 2 must do the bulk of the work.
If we want to be successful in investing, we must consciously overrule system 1 and analyze the data at hand without a certain outcome in mind. This means continuously updating our opinions as new information comes in and treat each piece of information with a healthy dose of skepticism in order to not succumb to the tendency of seeing whatever you want to see. It also means continuously testing your own beliefs and seeing if they hold up to close scrutiny.
One of my favorite and most profound quotes that relates to this is by Howard Marks (Trades, Portfolio), who said something along the lines of: “There is not an asset in the world which is not a bad buy at one price but a good buy at another.” This quote effectively illustrates something that few fail to realize but has far-reaching implications, namely that as the price of the asset changes, so does the opportunity for the investor.
Whichever way you turn it, price is inherently linked to value, and as such to the potential returns for the investor. Therefore one’s beliefs must be continuously updated as new information comes in, and the thesis changes, as it is bound to do in a highly dynamic and complex system such as the stock market.
In practical terms, this could take the form of writing down the thesis in one document, and writing everything that could possibly make the investment turn sour in another, and then updating them over time. Or better yet, have someone else challenge your opinion, either in writing or verbally.
This is not to make yourself a nihilist who does not believe any idea is good enough to invest in – rather, it is to understand the risks associated with the investment, and recognize that there might be pieces of the puzzle that you have overlooked. The GuruFocus community is a great way to do this, as it is populated by some very skilled investors.
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