I am a big fan of Joachim Klement, physicist and mathematician turned investment strategist and author. And recently have been binge reading his writings (so expect more on this front).
I found some fascinating perspectives on what makes an investor great. So I have reproduced his views below and mentioned the source at the end.
What makes an investor great?
Research analysts and fund managers typically have been trained in finance and learned everything about financial statement analysis and how to calculate valuation ratios, etc. They know every little detail about the companies they cover, from the dividend coverage ratio to the amount of earnings growth expected in each of the next five fiscal years. And while that knowledge may be impressive, it does not make them great investors.
Think of the great investors in history. What differentiates them from the run-of-the-mill? How do people like Warren Buffett and George Soros, Seth Klarman and Howard Marks, Benjamin Graham and Peter Lynch, stand out? While all of them have different investing styles and approaches, they all have one thing in common: They are investment philosophers.
Look at the typical fund manager interviewed on television or in the papers. They usually share their “wisdom” about why they love growth or income stocks or why they think the Bank of England will hike rates or not. Put another way, they talk their book.
Now listen to Buffett or Soros: They don’t talk about any of these technical details. Instead, they focus on the big themes and trends that drive markets today and will continue to in the years to come. They think about the fundamental drivers, not about the recent data flow, and they have developed investment techniques that can adapt to a broad range of problems to understand the underlying market dynamics.
Graham’s Intelligent Investor and Security Analysis, with David L. Dodd; Marks’s The Most Important Thing; or Klarman’s Margin of Safety are timeless.
Some of these titles may be decades old, but they are still as relevant today as they were when they were first published. Why? Because they don’t focus on technicalities but on how to assess investments in a fundamental and informative way.
Mathematician Carl Jacobi advocated: “Invert, always invert.”
Jacobi argued that many complex problems can be solved if you invert them and think about the solution you want to find and then work backwards to your current situation. When you do that, you often find the quickest and most effective solution to seemingly intractable problems. In mathematics and physics, this inversion technique is applied all the time, and I use it again and again at work when assessing market developments or investment opportunities. To me, it’s just common sense.
So, in the spirit of “Invert, always invert,” to become a great investor or research analyst, become an investment philosopher. Hone your skills in understanding market dynamics instead of memorizing data points or performing the DuPont analysis of return on equity. To be sure, you will need such expertise to become a great investor, but once you grasp the technique and how to calculate the elements, there is little added value in doing it over and over again or to an ever more sophisticated level. That may keep you busy, but it won’t make you better, and it won’t make you a great investor.
- By teasing out from market prices the assumptions needed to justify these prices, you can learn a lot about these prices.
How can it be that during the tech bubble, for example, analysts on both the sell and buy side assumed technology companies would grow their earnings by 20% or more per year into eternity? Making that assumption may give you a fair value in your discounted cash flow (DCF) model that is in the vicinity of a company’s current market valuation. But if earnings grow at 20% indefinitely, the company would soon own the world.
I have seen analysts estimate long-term earnings growth for Amazon at 36.8% per year. Assuming Amazon’s PE ratio stays constant, this means that in 2050 the company’s market cap would exceed U.S. GDP. Research analysts who cover Amazon and fund managers who invest in it tend to know many details about the company, how it makes money, and where and how it can grow in the future. Yet all their technical expertise makes them miss the forest for the trees.
Once you have an idea to investigate, use data and academic studies to verify or falsify it. Keep an open mind and reject the thesis if the data does not support it. Learn to be resilient in dealing with such failures.
Don’t rely on secondary sources like other research analysts or media reports. It is amazing how unreliable some this of research, particularly sell-side research, can be. Focus on the original sources, peer-reviewed academic studies, and your own models and analysis.
- Don’t stick to your narrow area of expertise
Venture into history, psychology, neuroscience, and other disciplines to inform your work. Novel ideas often develop by connecting existing ideas and techniques from different fields rather than genuinely new insights.
Keep some loose ends that you can pick up at a later stage to create a network of interconnected ideas that form your “world view” over time.
- Practice, Patience, Predisposition
Investment success takes time, so impatience is probably detrimental to long-term success. Good investors also need resilience when investments turn out poorly. Both patience and resilience are to some extent pre-determined by our genes. In our youth and through adulthood, we learn how to deal with disappointments and failures. Exposing children to difficult challenges and then teaching them how to respond when they come up short is a vital ingredient to future success.
To be good investors or research analysts, we need the right genetic predisposition and then must create the right circumstances to practice and hone these skills. It’s practice that makes us better analysts and investors and amplifies the small initial differences.
Think of Warren Buffett and other great investors. They started to invest very early in life and turned investing into more than just a profession: It became a lifestyle. They always try to learn new things about investments and reflect on past mistakes — something Buffett does in his annual letter to shareholders.
The combination of talent with experience and the ability to constantly look beyond the immediate task at hand and broaden the horizon seems to create these exceptional investors and researchers.
All the above content has been sourced from