Michael Mauboussin – Common Mistakes Even Smart Investors Make

Michael Mauboussin - The Success Equation

One of our favorite investors here at The Acquirer’s Multiple – Stock Screener is Michael Mauboussin.

Mauboussin is the Managing Director and Head of Global Financial Strategies at Credit Suisse. He’s also written three books, he’s been an adjunct professor of finance at Columbia Business School since 1993, and received the Dean’s Award for Teaching Excellence in 2009.

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One of my favorite Mauboussin interviews was one he did with Barbara Kiviat at Time back in 2009 where he discusses how investors, like any other group of people, are prone to make mistakes that stem from faulty approaches to decision-making.

Here's an excerpt from that article:

Barbara Kiviat (BK): You just wrote an entire book about how smart people make bad decisions. Maybe you could shed some light on the financial meltdown.

Michael Mauboussin (MM): Increasingly, we as human beings create systems that are more complex than we can comprehend. If you're designing an airplane you create redundancies to try to mitigate bad outcomes, but as we saw earlier this year with Air France 447, when certain cascading events line up, they can lead to a disaster that you just can't anticipate. In the realm of the social, we create institutions like global, interconnected markets. By and large when investors are operating with some degree of diversity, when they're thinking about things differently — time horizons, trading strategies — the markets are basically efficient. But what we know is that people episodically coordinate their behavior. They all become optimistic or pessimistic, and that leads to extremes. Even with the best of intentions, you can't anticipate all the things that are going to happen.

..............

BK: Speaking of which, you write that money management is one of the best examples of the illusion of control in the professional world ...

MM: I was hoping no one would read that. Well, honesty never goes unpunished. Could you give me a good reason then why investors wouldn't be better off with index funds?" By and large, investors would be better off with index funds. The question to me is, if you are an active manager, what makes you think you can do better than others over time?

We like to think about four distinct building blocks.

One is thinking about capital markets more properly. Sometimes markets are efficient and sometimes they aren't. The insight is knowing what mechanisms lead you from efficiency to inefficiency.

The second is being very disciplined in valuation, in figuring out if there are differences between fundamentals and expectations.

The third thing is competitive strategy work, being able to apply tools from microeconomics and strategy to figure out which companies are going to do better or worse down the road.

And then finally there is all this stuff on decision-making. Very few people are willing to allocate the time to grasp the things they need to know to make good decisions consistently.

BK: You talk about how winning strategies aren't transitive. What's the lesson for managers?

MM: One mistake managers make is they'll read a book that says: Here are the eight things great managers do. They figure if they just live up to those attributes then they'll succeed. Well, no. It's not the attributes that matter, it's the circumstances — what's going on around them. Almost all successful strategies are circumstance-based, not attribute-based.

Boeing, for instance, a very smart company, had outsourced a lot of their products, but then they outsourced the design of the 787 and it was a complete disaster. The attribute was "outsourcing is good," but in this case, the circumstances didn't serve it well. The key was that you should only outsource when your product is modularized, when you can take the components and click them together.

 

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The Acquirer's Multiple
The Acquirer’s Multiple® is the valuation ratio used to find attractive takeover candidates. It examines several financial statement items that other multiples like the price-to-earnings ratio do not, including debt, preferred stock, and minority interests; and interest, tax, depreciation, amortization. The Acquirer’s Multiple® is calculated as follows: Enterprise Value / Operating Earnings* It is based on the investment strategy described in the book Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations, written by Tobias Carlisle, founder of acquirersmultiple.com. The Acquirer’s Multiple® differs from The Magic Formula® Earnings Yield because The Acquirer’s Multiple® uses operating earnings in place of EBIT. Operating earnings is constructed from the top of the income statement down, where EBIT is constructed from the bottom up. Calculating operating earnings from the top down standardizes the metric, making a comparison across companies, industries and sectors possible, and, by excluding special items–earnings that a company does not expect to recur in future years–ensures that these earnings are related only to operations. Similarly, The Acquirer’s Multiple® differs from the ordinary enterprise multiple because it uses operating earnings in place of EBITDA, which is also constructed from the bottom up. Tobias Carlisle is also the Chief Investment Officer of Carbon Beach Asset Management LLC. He's best known as the author of the well regarded Deep Value website Greenbackd, the book Deep Value: Why Activists Investors and Other Contrarians Battle for Control of Losing Corporations (2014, Wiley Finance), and Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors (2012, Wiley Finance). He has extensive experience in investment management, business valuation, public company corporate governance, and corporate law. Articles written for Seeking Alpha are provided by the team of analysts at acquirersmultiple.com, home of The Acquirer's Multiple Deep Value Stock Screener. All metrics use trailing twelve month or most recent quarter data. * The screener uses the CRSP/Compustat merged database “OIADP” line item defined as “Operating Income After Depreciation.”

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