In a previous article, I wrote about blind spots in investing and shared a case study of how blind spots had led me to a mistake in my analysis of DaVita (DVA, Financial) a few years ago. It would be ideal if we could eliminate all blind spots when analyzing a business. But in practice, many daunting obstacles are present. Here are some thoughts on how to reduce blind spots.
The hardest, most diligent and admirable way dealing with blind spots is exemplified by Thomas Macpherson’s research process, which he generously detailed in his wonderful article earlier this month. It requires reading for at least hundreds, if not thousands of hours; speaking to all parties in the ecosystem; gathering, processing and synthesizing an enormous amount of data; and thinking about the long-term prospects of the business. But even Macpherson, who has extensive experience in the industry and who has built an impressive network of industry experts in health care, admits that his knowledge about some health care companies may not be sufficient. You can imagine how hard it is!
For most value investors, having access to the right information to read is usually not a problem. There is a vast amount of public information available for free, and there is also a good amount of information at reasonable prices. It’s the depth and breadth of reading that separates investors. But both depth and breadth can be overcome by spending more time.
The biggest challenge may be “gaining access” to and talking to enough people with deep industry knowledge who can help you understand all the moving parts. This is especially true in sectors such as health care when the system is so darn complicated and dynamic.
The best situation is when you work in the industry. For professional investors, this is rarely the case. But for retail investors who work in highly specialized industries such as specialty chemicals or technology, you know which companies are doing well and which ones are having trouble. You deal with all the parties in the ecosystem as part of your job. You have real information advantages over most professional investors. Take advantage of it.
What if you don’t work in the industry? How do you identify the right people and gain access to them?
A common practice to deal with the access problem is to pay an expert network, such as Gerson Lehrman Group or Capvision, which charge at least a few hundred bucks per hour to connect you with experts. Many buy-side funds happily pay for such expert network services. Bill Ackman (Trades, Portfolio) once said he had spent $50 million and at least two years doing research on Herbalife (HLF, Financial). This might be an extreme case. But it’s not uncommon for institutional investors to spend more than a few hundred thousand dollars per year, or even a few millions a year, on industry calls. I personally do not use any expert networks.
Another common approach to use LinkedIn and “cold call” people who work in the industry. Obviously, this is much cheaper but requires much more effort. You would also inevitably be dealing with rejections. If you reach out to enough people, the odds are pretty good that some of them will be both friendly and knowledgeable. I know some investors who are very good at this approach, and I’ll most definitely use LinkedIn more proactively going forward.
A third approach is to ask for introductions and referrals from friends, relatives and anyone else in your network. The effectiveness of this approach depends on the quality and breadth of your network and your network’s network. I’ve also found this approach useful. For instance, when conducting research on Kweichow Maotai (SHSE:600519), I was able to connect with a few of Kweichow Maotai’s distributors and group-buying customers in different provinces of China through my family and friends' network.
You can also go out and speak to a sample of people in each ecosystem group. This is particularly useful in any consumer-facing businesses and less effective in any business-facing and government facing businesses. Again, when doing research on Kweichow Maotai, I flew to the town of Maotai in Guizhou province with two other friends. We stayed there for a few days. During our stay, we visited museums, checked out a few local brands and distilleries, spoke to employees who work at Maotai and local liquor distributors, tried many different local liquors, and asked local experts the differences among qualities of Jiang flavor baijiu. I’ve also travelled to a few other provinces with friends. We would visit local supermarkets and liquor stores and ask the owners and sales representatives about consumer purchase behavior, or which brands are most popular and why. We would also visit local distilleries and compare them with each other. There’s much information you can gather through what is called “grassroots” research.
Reflecting upon my own mistakes and limited experiences, I come upon the following two lessons with regard to blind spots:
- Picking an industry in which the odds are not overwhelming against you in terms of gaining information advantage is enormously important. I have no chance of competing against Macpherson if I were to research iRadimed (RMD), or any U.S. health care companies. But for Kweichow Maotai or any other Chinese liquor companies, I’ll be more likely to have an information advantage over any non-Chinese investors.
- Establishing a methodical approach in terms of building a network of contacts in the industry you want to focus on is equally instrumental. I’ve listed a few options above, and I’d be delighted if readers can add to the list. Find the ones that fit your own background and personality type.
- Sometimes it’s more dangerous to have more information than less because we might be willing to pay a bit more when we think we know more. We have to acknowledge that no matter how much research we have done, there’s still a pretty good chance that the research is not sufficient to make a decision.
Last, you can choose not to do any of the scuttlebutt research and accept the fact that there are blind spots in your research, like Walter Schloss. A diversified portfolio of statistically cheap stocks may do the job. There are many successful value investors who have shunned communicating with any parties involved in the business. It’s perfectly fine.
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