The amount of information that we’re exposed to now in the course of a day is as much as somebody from 15th Century was exposed to in their entire lifetime.

– Rick Smolan, The Human Face of Big Data

Engaged investors – those of us who are interested in managing a portfolio on our own or in partnership with a manager, and who watch the results with an eye toward improvement – are faced with a daily paradox in our endeavors. Information makes us more able to invest competently, but we get more of it than we can possibly manage. Not all of us can take Warren Buffett’s advice and read for 14 hours a day, we have other responsibilities. I am sure that all of us have asked if it is even worth it to try to keep up…maybe more than once.

After twenty plus years in investment banking, managing risk at hedge funds, doing third party analysis and teaching both retail and institutional investors, I have learned that effectively managing and learning from new information sets the good apart from the great. I’d like to think I have learned some lessons here myself.

The fact is that there are countless sources of “valuable data” and “expert analysis” out there. The sheer number of “breakthrough” investing newsletters combined with “free” research from the sell side (e.g., Morgan Stanley, Citi, etc.), opinions and data from third-party providers (e.g., Morningstar, YCharts), and even free resources (e.g., Google Finance, etc.) could keep a person occupied for days just looking for information on one investment idea. Forget actually looking at a company’s SEC filings. There is a salad bar feast of investing information anecdotes and statistics. Investors are faced with a virtual sea of data.

The proliferation of cheap or free data and information should make us better investors, but instead it appears to be overwhelming us. Nobel Prize winning behavioral economist Richard Thaler’s experiment on subjects managing an imaginary college endowment over a simulated 25 years showed the effects of “more data” clearly. Participants who received market information every 5 years and could only trade at that point generated returns that were more than two times those who received monthly updates and had the choice to trade more often. More data creates an illusion of more knowledge or expertise. The more data we get, the less we appear to be able to harness it properly to generate positive outcomes.

What has been our response to this ever-increasing level of data transparency? Our invested assets have rushed to passive investing strategies and roboadvisors. Our actions point to a kind of giving up.
So, is it even possible for the average person to become an institutional caliber investor without a super computer, proprietary algorithms and a team of 50 twenty-something research PhD’s who work 80 hours a week? The answer is, yes. The “how” is focus.

Based on my own investing and watching those who’ve been successful throughout my career, there are just a few rules for effectively managing investing information. We can start by getting our expectations of ourselves straight and then having an investment decision framework through which to filter information into usable knowledge.

  1. Most of us can manage only a small number of companies we understand well enough to successfully value them and them compare that value to price in order to structure successful investments (long or short). Fortunately, a small stable of good companies is plenty on which to do very well.
  2. New information is fine, if you have a filter to value it. Successful investors have an investing decision Framework on which to hang new information to see if it is even important. Said differently, they know what to look for when new information crosses their desk. For most investors, this is represented by a clear-eyed understanding of how a company turns revenues into cash profits along with how they then use those profits to drive growth.
  3. Valuable new information that passes through the filter described above is then input into the investor’s current valuation model to see if there is a meaningful change.
  4. Having a valuation history also helps because it illuminates over time what information has actually made a material change in the company’s value. So we can learn more of what to look for in new information about that company.

Warren Buffett said it best:

To invest successfully over a lifetime does not require a stratospheric IQ, unusual business strengths or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.

The figure above shows how a plan (the blueprint) drives a framework that supports a valuable outcome. Decision frameworks operate in the same way.

As outlined in my book, The Intelligent Option Investor (McGraw-Hill, 2014) and now in our investing education company’s platform, we focus students on understanding just four key drivers of value. So, we see new information through its ability to impact each of those drivers in our framework. If it misses them, the new info goes in the bin. If not, we apply the steps above. By applying this framework over and over, we come to understand how a company makes money for us as shareholders. Different companies may require us to look for different things, but simply knowing what those are makes us more efficient at managing new data.

An understanding of how companies expect to gain revenues and convert them to profits helps us understand value and by looking at that over a number of companies we get an idea of where the overall market price is relative to companies’ values. At times like this, that guidance helps us to sleep better at night because we are able to design investments that tilt the balance of risk to reward in our favor.

You can do this work yourself and become a stronger, more skilled investor – whether you work with an advisor or not. The investment industry continues to make the argument that it’s too hard and you need a “pro.” Before the democratization of information, they made that argument by telling you only they had the right information. Now they make the argument that there’s too much for you to keep track of. A sound investment decision framework has the potential to free you from this Catch-22. You can build a sound framework starting today. Your investment success will improve and you won’t be overwhelmed.

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