The game of investing is one of making better predictions about the future than other people. How are you going to do that? One way is to limit your tries to areas of competence. If you try to predict the future of everything, you attempt too much. You’re going to fail through lack of specialisation.
Charlie Munger
The process of crystalising my investment thoughts has been quite trying. Having to put into words the amorphous set of quotes, readings, learnings, and experiences is not easy. Most worthwhile things are not pleasant.
The more I revisit the teachings of some of the greats, the more I realise how profound they are. In many ways they are not for the know nothing investor. If you really do know nothing, how could you possibly see the future, or value it? The answer to that question should be quite clear.
A recent Twitter/X post, which has since been taken down, encapsulated the idea of this article perfectly. To summarise in my own thoughts - at the first I didn’t know what I didn’t know and I went head long into all kinds of misadventures. So the learning began. I then became aware of how little I knew. Thirdly, some will achieve success, but only through great effort. For a narrow few success can become a habit.
Personally, I have found the best results in investing at the end of accurate information, and proper foresight. Many investors never graduate from analysing past financial information, often through the prism of ratios and return on investment calculations. That information is essential, but you don’t get paid for regurgitating past performance metrics. You get paid for predicting the future better than other market participants. This is no easy feat.
My submission to you would be that these opportunities for any individual are extraordinarily rare. The important thing, however, is that they do exist. Just a few times in your life you might accurately see the future. Then the question really becomes: what gives you the right to say that you can see what will happen better than anyone else?
My take on this particular question would be idiosyncratic to my own approach. Only a few times over the past five or ten years have I seen a company in a situation where it’s business position and/or it’s operational execution was enough to overwhelm the entropy that characterises capitalist economies. If I were to explain post-facto why these situations were investment opportunities, it would be that many market participants are an inch deep and a mile wide. They don’t specialise, and so they never truly understand anything. A good friend of mine told me at lunch recently that doing an hours worth of reading of a particular company’s financial statements puts an individual in the 99th percentile of those who have spent time studying a company. Myopia reigns supreme.
If anything, becoming aware that with every new investment opportunity will come the need to go through the same cycle of unconscious incompetence to unconscious competence is worth the cost of admission. Yet we live in a very unevenly distributed world. Sometimes the work necessary to make a decision is very straightforward with few extrinsic factors to consider. In other circumstances, a lifetime of dedication to a particular situation would render the same likelihood of success as having done no work at all. I am very fond of the former:
The catch is that you get paid the same for landing both.
Predictability naturally is a key element in predicting the future. This is a good point to mention that many investors allocate capital very successfully in ways that run contrary to this. An approach that lends itself to asymmetry, i.e. known downside with very unusually skewed pay offs, obviously can work very well. I’ll admit that it hasn’t worked very well for me. Personally I am a conservative investor, and minimising risk begins with exposing myself to unusually low risk business situations. Predictability goes hand in hand with this approach.
I have thought about this on the downside as well as the upside. I recently spoke to another investing friend who also acknowledged that the unusual extrinsic surprises on the upside were just as disconcerting as those on the downside. I have come to admire those who purposely decided not to invest in Covid beneficiaries - this took an amount of foresight I wish that I had.
So we look for quality - but i’ll put it to you that quality isn’t a set of financial metrics or business characteristics. It’s a set of expectations met, and often exceeded.
Another quote:
"...if you buy a 30-year government bond, it has a whole bunch of coupons attached...And the coupon says 3%, or whatever it may say. And you know that's what you're going to get between now and 30 years from now. And then they're going to give you the money back. What is a stock? A stock is the same sort of thing. It has a bunch of coupons. It's just they haven't printed the numbers on them yet. And it's your job as an investor to print those numbers on it.”
Warren Buffett
While many people might pay lip service to the primacy of the risk free rate - very few people demand bond-like characteristics out of their investments. The one thing about investment grade sovereign debt is that it (almost) always pays, and pays an amount that is known before hand. Extend that kind of thinking to your approach to investments and you’ve stumbled onto something very powerful.
Larry.
A post-script if you don’t mind the self promotion - for an extended version of my thoughts, check out a recent interview I did with fellow fintwitter Risk Biscuits.