By Todd Massedge, bio at bottom
“Invert, always invert”
-Charlie MungerAs Hedge Funds Dive Into Private Equity, Tiger Global Leads The Way
Assets in private equity and venture capital strategies have seen significant growth in recent years. In comparison, assets in the hedge fund industry have experienced slowing growth rates. Q2 2021 hedge fund letters, conferences and more Over the six years to the end of 2020, hedge fund assets increased at a compound annual growth rate Read More
Have you ever noticed that some of the world’s most successful and brilliant people are dyslexic?
Ben Franklin, Einstein, Charles Schwab, and Churchill were all believed to be dyslexic.
People with dyslexia tend to struggle in school, especially when it comes to reading, mainly because they flip-flop words in their heads. Dyslexia forces them to view the world from a different perspective, but is that an entirely bad thing?
When you have dyslexia, you often have to develop creative ways to become successful. Additionally, dyslexia can result in the development of excellent problem solving skills.
So how does this relate to investing?
In Charlie Munger’s famous speech to the 1986 graduating class of the Harvard business school, he quoted the famous mathematician Jacobi who said “Invert, always Invert”. The idea behind that? Do things a bit backwards.
Instead of focusing on ways to do something successfully, focus on things like are likely to fail and avoid them.
Munger explains that more:
“It is in the nature of things, as Jacobi knew, that many hard problems are best solved only when they are addressed backward. For instance, when almost everyone else was trying to revise the electromagnetic laws of Maxwell to be consistent with the motion laws of Newton, Einstein discovered special relativity as he made a 180 degree turn and revised Newton’s laws to fit Maxwell’s. It is my opinion, as a certified biography nut, that Charles Robert Darwin would have ranked near the middle of the Harvard School graduating class of 1986. Yet he is now famous in the history of science. This is precisely the type of example you should learn nothing from if bent on minimizing your results from your own endowment. Darwin’s result was due in large measure to his working method, which violated all my rules for misery and particularly emphasized a backward twist in that he always gave priority attention to evidence tending to disconfirm whatever cherished and hard-won theory he already had. In contrast, most people early achieve and later intensify a tendency to process new and disconfirming information so that any original conclusion remains intact. They become people of whom Philip Wylie observed: ‘You couldn’t squeeze a dime between what they already know and what they will never learn.’
The life of Darwin demonstrates how a turtle may outrun the hares, aided by extreme objectivity, which helps the objective person end up like the only player without blindfold in a game of pin-the-donkey. If you minimize objectivity, you ignore not only a lesson from Darwin but also one from Einstein. Einstein said that his successful theories came from: ‘Curiosity, concentration, perseverance and self-criticism. And by self-criticism he meant the testing and destruction of his own well-loved ideas.’”
Here’s how you can tie that into your investing process:
#1) Actively Focus On What Can Go Wrong, Not What Can Go Right
“All I want to know is where I’m going to die so I’ll never go there”
Ever get that rush anytime you find a new idea?
It’s a thrill.
You start to see the potential. You start to see the upside.
The growth is going to take off. Margins are about to dramatically improve. The company is going to get sold at a massive premium. Management is going to do a huge buyback. A positive here, a positive there. I’m sure you’ve heard all of those before.
You dig deeper, and deeper. Sometimes you get so into the weeds and spend so much time on a name that you just get desperate to be right. Confirmation bias starts to enter in the equation.
Maybe that’s exactly the problem.
Want to save yourself a bunch of future headaches? Focus on the wrong, not the right.
Be picky. Be skeptical. Doubt everything.
As an investor, learn to ignore the positives and focus on the potential issues that may arise. Watch how many potential ‘good’ ideas of yours don’t look so good anymore.
#2) Valuation Last, Business First
There’s a problem with using stock screeners when trying to find ideas:
It causes you to get hung up on valuation before you even know anything about the company. That’s a problem.
Try flipping the situation: Don’t even think about valuation until you’ve thoroughly vetted an idea. Develop your own idea funnel where valuation is the last thing you think about. Something like this:
People tout the Margin of Safety all the time, but seeing those same people actually use it in practice is a totally different story.
Don’t get hung up on a potential triple if it’s just as likely to go to zero.
Your potential upside means nothing if you can’t fully comprehend all the risks and the potential downside.
#3) Argue The Opposite Thesis
“The first principle is that you must not fool yourself – and you are the easiest person to fool”
Want to make sure your thesis is really bulletproof? Try and argue the other side.
Does this sound ridiculous? Maybe, but it’ll help you avoid confirmation bias.
Sometimes investors get so attached to a certain thesis that they become blind to any potential holes in their thesis. Don’t be that guy.
Figure out everything you possibly can about the people on the other side of your trade.
Why are they long/short? What does the market think? Is it over-selling by inexperienced retail investors? How much lower/higher can this thing go?
For example, Guy Spier once recommended Farmer Mac as a long idea to Whitney Tilson back before the crisis. Tilson, intrigued by the idea, recommended it to Bill Ackman to check out. What did Ackman think?
He saw it as a no-brainer short and Tilson ended up changing his mind and going short. Ackman ended up being right.
Always, always, always analyze the other side of your thesis. You may even end up changing your mind.
Even very smart people can be stupid.
I’m Todd Massedge, founder of the AlphaTree Group and the Invest Like the Street Program (https://ilts.alphatreegroup.com). I teach college students and recent graduates about investing to help them land better jobs on of school and manage some of my family’s manage on the side. Prior to that I worked on the buy-side for a value-based fund in California. Before that I was a high-yield credit analyst at Moody’s in the healthcare space.