Credit Suisse’s strategist Michael Mauboussin, just published a research report entitled Thirty Years: Reflections on the Ten Attributes of Great Investors. I skimmed through the ten attributes and found myself nodding in agreement at each one, and am happy and proud to say that IOI’s training courses very thoroughly covers all the attributes he mentions here (and then some). If you are your family’s Chief Investment Officer, you owe it to yourself and your family to read through this piece!
As terrific as this report is, the one thing that I think Mauboussin could have done better is to talk too about “process.” All of his ten attributes are indeed very important ones, but he addresses them in a way that highlights them as one-offs rather than as interconnected elements of a coherent process.
For example, it is certainly important to understand value (Mauboussin’s Attribute 2), but without understanding the behavioral biases and structural factors that push prices away from value, it is hard to find good investing opportunities. And yes, it’s important to understand accounting (Mauboussin’s Attribute 1), but there are plenty of accountants who couldn’t invest their way out of a wet paper sack; not because of a lack of knowledge of accounting rules, but because of the lack of training in how to apply that knowledge to assess value.
Great investors have a thorough understanding of the tools of the trade (including theoretical tools, like discounted cash flow) as well as a sensible process for applying those tools to actual problems. Teaching this is precisely what the IOI training courses are designed to do.
Here are the ten attributes Mauboussin proposes, with my notes included.
- Be numerate (and understand accounting): Both IOI’s course on Valuation (IOI 102) and our complementary mini-course on accounting will help here. We also talk about common mistakes people make when analyzing numbers and how to avoid them in IOI 101 (Behavioral Biases and Structural Factors).
- Understand value (the present value of free cash flow): Doing this is precisely what we teach in the IOI 102 course on Valuation! “Discounted Cash Flow” or “DCF” valuations make certain assumptions, and it is important that you understand what those are and what dependencies they have.
- Properly assess strategy (or how a business makes money): The defining feature of IOI analyses is that we step back to take a simple look at the sources of cash flow: revenue growth, profitability, and investment level. Looking at these elements allow an investor a terrific opportunity to do what Mauboussin calls “properly assessing strategy.” We cover this in IOI 102 and in much more depth in Valuation master classes.
- Compare effectively: Mauboussin’s title here is a bit misleading, but what he describes is distinguishing between present fundamentals and future expectations. IOI’s way of focusing on growth and thinking carefully about what medium- and long-term growth rates we can expect is a great way to view expectations in a transparent way. We talk more about this in IOI 102.
- Think probabilistically (there are few sure things): Of course, valuation ranges and valuation scenarios are a key defining element of the IOI valuation process and of our IOI 102 course. Looking at valuations as a probabilistic range does two things: a) allows an investor to avoid a pervasive and dangerous behavioral bias called “anchoring” and b) allows an investor to have a much more useful and transparent view of the balance of risk and return. For investors that incorporate options into their portfolios, thinking in probabilistic terms makes it much easier to see which option strategies are most attractive.
- Update your views effectively (beliefs are hypotheses to be tested, not treasures to be protected): One reason that we have so many scientists and engineers who enroll in IOI training courses is because we approach valuation from just this scientific perspective. Observation and a keen focus on what valuation scenarios are tied back to what unambiguous operational data is an integral part of this process.
- Beware of behavioral biases (minimizing constraints to good thinking): This is such an important element to successful investing that we focus on this (as well as “structural factors”) for an entire course – IOI 101. We couldn’t agree with this point more!
- Know the difference between information and influence. This title is a little deceptive as well, but what he’s talking about here is having a clear, testable framework for assessing value, so that you’re not pulled this way and that by “social” (i.e., behavioral) pressures.
- Position sizing (maximizing the payoff from edge). For those of you who have seen our recently published 1H 2016 recommendation performance review, you’ll get a very strong sense of the importance of position sizing using IOI’s process. Where we don’t have much of an edge (“Recycled Income” investments), we keep sizing small and asset selection very diversified. For “Researched Income” investments, we have more of an edge and thus are willing to commit more capital. “Conviction Growth” are sized in proportion to our conviction in the investment.
- Read (and keep an open mind): I read a phenomenal amount every day. About a wide set of topics ranging from Bronze Age Mediterranean culture (here’s a site I recently found that has put my reading of The Iliad into context for me) to scientific papers from various specialties (economics, psychology, medicine, climatology) to social and investing news (favorite outlets are The Financial Times, The New York Times, and The Economist). Follow me on Twitter to get links to articles, etc. I find that reading a wide range of things helps me think more creatively and make connections that I wouldn’t be if I only had my head down in financial statements all the time!