The following is an excerpt from ValueWalk’s interview with Jim O’Shaughnessy, Chairman, Co-chief Investment Officer, and Portfolio Manager at O’Shaughnessy Asset Management. In this part, Jim discusses asking investors to show their research graveyard. Check out the full interview on ValueWalk Premium.
The Research Graveyard Is Everything You Tested
Jim O'shaughnessy: We are working on you know, better refining the way we determine what is value, what is quality, what is financial strength, etc. Through definitions and through factors, etc. But the other thing that I would say is that if you're considering becoming a partner with a quantitative investor, one of the things you want to ask them right away is you show me your data, will you show me your research graveyard?
Coho Capital 2Q20 Commentary: Podcasts, The New Talk Radio
Coho Capital commentary for the second quarter ended June 30, 2020. Q2 2020 hedge fund letters, conferences and more Dear Partners, Coho Capital returned 46.6% during the first half of the year compared to a loss of 3.1% in the S&P 500. Many of our holdings, such as Netflix, Amazon, and Spotify, were perceived beneficiaries Read More
What's that? Well, as it sounds, the research graveyard is everything you tested, that didn't work. People should have a very big research graveyard. Why? Because it demonstrates A) that they're thinking about all lot of things continually. Right. And and B) it shows that they are very open kimono about things they thought my work that didn't work.
I'll give you an example. So we had at one of our research meetings, the idea that again, on the face of it sounds reasonable, and sounds like yeah, we should look into that. One of my colleagues suggested that, hey, what do you think about this idea that companies where the founder of the company is still actively involved or owns, you know, a significant portion of that company? Do you think that intuitively, those kinds of companies might do better? And we'll talk about that for a while and we just said, Yeah, you know, that that intuitively makes sense. Right? Because if you know that's, that's their everything, right? They started it and it's probably their major source of wealth and all that you would think that those people would be almost maniacal right about the ways company gets run.
Jim O'shaughnessy On Premature Certainty
The problem is the data does not support that conclusion. We were really surprised and ended up in the in the research graveyard. But the data does not suggest that companies where the founder is still very active do materially better than companies where it's new or different professional management. You know, another one, and I'm giving examples here that make sense so that people can understand. Wow, you know, I should maybe question these things rather than just immediately going. Oh, yeah. Yeah, that makes sense. You know, one of the one of the problems that we as human beings face is what I call premature certainty. And, and that means that we become certain about something way, way too fast. And that really humbles us in terms of our the efficacy of our decision making, right? So another great example that makes intuitive sense is, what about buying companies that have the highest five year growth rate in their revenues? We talked about that. And it's like, well, that's almost kind of the definition of a growth company, right. And so we tested it, and it doesn't work. Not only does it not work over long periods of time, it struggles to even match an investment in US T-bills.
Now, why do you think that might be? Well, what happens when somebody has, you know, stratospheric growth in their revenues, everybody notices, and then everybody pours into that stock and prices it to perfection, right? So they're paying a huge premium to buy that company. And what we see historically is that perfection never happens. And and so the company has a divot, they stumble, stumble causes people to pour out of the name, rinse and repeat. Right? So the names are different, right? And the industries might be different, but the results are the same. People get inordinately excited about that. novel growth, right? They pour into the name because they think, boy, this is the greatest thing in the world. It gets very expensive, and then it stumbles.