This is a VIP content that I’d like to share with you from Michael J. Mauboussin.
In case you don’t know Mauboussin, writes some of the best newsletters from Credit Suisse. There’s research, opinions and lessons in all of his letters.
Q1 hedge fund letters, conference, scoops etc, Also read Lear Capital: Financial Products You Should Avoid?
This was from a couple of years ago, on Mauboussin's 30 year anniversary on Wall Street, and the 10 attributes he found in great fundamental investors. This is my quick summary. Full PDF is available at the end.
10 Attributes of Great Fundamental Investors
1. Be numerate (and understand accounting).
Accounting is the language of business. You won't encounter many complex calculations all the time, but you need to have a feel for figures, percentages, and probabilities.
2. Understand value (the present value of free cash flow).
Great fundamental investors have a deep understanding of free cash flow.
- The average half-life of a public company is about 10 years. Much of things are mutable and in flux.
- Great fundamental investors also know the limitation of valuation techniques like price/earnings and enterprise value/EBITDA multiples.
- Shorthands are useful as it saves you time, but they come with blindspots.
3. Properly assess strategy (or how a business makes money).
This attribute has two dimensions.
- Fundamental understanding of how a company makes money.
- The second dimension is gaining a grasp of a company’s sustainable competitive advantage.
4. Compare effectively (expectations versus fundamentals).
Investors compare all day: stocks versus bonds, active versus passive, value versus growth, stock A versus stock B, and now versus later. Humans are quick to compare but not very good at it.
- Fundamentals - captures a sense of a company's future financial performance.
- Expectations - reflects the financial performance implied by the stock price.
5. Think probabilistically (there are few sure things).
Great investors find an edge. Edge for investors is the process of making good decisions.
There are 3 ways to come up with probabilities.
- subjective probability
b. propensity based on physical properties of the system
c. frequency, which considers the outcomes of a proper reference class given the situation under deliberation.
6. Update your views effectively (beliefs are hypotheses to be tested, not treasures to be protected).
Great investors seek information or views that are different than their own and they update their beliefs when the evidence suggests they should.
7. Beware of behavioral biases (minimizing constraints to good thinking).
You can have average IQ but you can cultivate your RQ (rationality quotient).
“I always look at IQ and talent as representing the horsepower of the motor, but that the output—the efficiency with which that motor works—depends on rationality. A lot of people start out with 400-horsepower motors but only get a hundred horsepower of output. It’s way better to have a 200-horsepower motor and get it all into output.” - Warren Buffet
Don't get caught up thinking value investors are better at understanding behavioral biases. Value investors are just as bad as we think "we know it all" and fail to get out of our own value investing biases.
8. Know the difference between information and influence.
Information is fact. Influence is bandwagon thinking.
Great investors don’t get sucked into the vortex of influence. This requires the trait of not caring what others think of you, which is not natural for humans.
9. Position sizing (maximizing the payoff from edge).
Have you read the recent position sizing article? This can make or break investors.
Mauboussin gives examples of how a data driven method to position sizing has worked.
"Almost all investment firms focus on edge, while position sizing generally gets much less attention."
Every article on the internet will focus on what to buy or sell. Not how much to position.
- Successful investing is about finding edge and fully taking advantage of it through proper position sizing.
10. Read (and keep an open mind).
Charlie Munger said that he really liked Albert Einstein’s point that “success comes from curiosity, concentration, perseverance and self-criticism. And by self-criticism, he meant the ability to change his mind so that he destroyed his own best-loved ideas.”
Reading fosters this idea.
Click here to download the complete PDF version
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