One of the most frequently asked questions among aspiring value investors and seasoned fund managers is, “What’s the most effective way to become a better investor?” This is of course, is a vastly broad question, with answers all over the map. Yet, there’s a fundamental common thread among the top practitioners of the value investing philosophy, that’s worth highlighting here.
The clip below is from our interview with Robert Hagstrom, Chief Investment Strategist and Managing Director of Legg Mason Investment Counsel, and author of several notable value investing books, including: Investing: The Last Liberal Art and The Warren Buffett Way. In the interview, Hagstrom attributes some of Buffett’s titanic success to him being a “great business historian”. That is, researching, reading, and understanding the nuances of the companies he buys to a degree of prodigious fluency.
“There is an art side to it,” says Hagstrom. And, like any skill that gets refined into an art, you get better the more you practice. Take for example the story about the British cycling coach, Dave Brailsford. In 2010, Dave was tasked with the job of coaching the British Cycling Team in the Tour de France, a race no British cyclist had yet won. In only two years, Brailsford team achieved victory in 2012, again in 2013, and once again 2015. The secret? Dedication to marginal improvement.
In making daily 1% improvements to the performance and strategies of his riders, the British team compounded a significant advantage over their competition. In just one year, consistent 1% daily improvements creates a 37X result. This is a calculation Buffett no doubt knows all too well, and one he’s applied throughout his business career. How exactly did Buffett develop his business thinking prowess?
Developing the Business Mind
On this subject, Buffett often says, “I’m a better businessman because I’m an investor, and being an investor, makes me a better businessman.” If you’ve read Alice Schroeder’s biography of Buffett, The Snowball, then you might already be familiar with this concept and some of the entertaining stories that exemplify Buffett’s business acumen.
From a very early age, Buffett’s business prowess was off the charts. Look back at the newspaper routes, the pinball machines, collecting and cashing in discarded ticket stubs from betting tracks, and his golf ball recycling business–all of which are evidence of Warren’s unusually sharp eye for profit.
Perhaps the best example of Buffett’s love and appreciation for business fundamentals is his decision in 1966 to acquire Associated Cotton Shops, then owned by retailer Ben Rosner. As the story goes, upon hearing Ben once counted out all 500 sheets of toilet paper to ensure he wasn’t being short-changed from his suppliers, Buffett knew he wanted to work with him. You could also argue, Buffett’s decision to acquire Rose Blumkin’s Nebraska Furniture Mart was made on similar principles.
Creating a Latticework of Mental Models
The name for this blog, comes from one of Charlie Munger’s recommendations to become a better investor, which is, to create for yourself a latticework of mental models. If you’re already familiar with this concept, then you might enjoy taking this as an opportunity to perform a new assessment of your models. If you’re just discovering this idea for the first time, than you’re in for a treat.
In the world, you have a broad array of disciplines: Physics, Biology, Psychology, Mathematics, Philosophy, etc. Mastering one such discipline in your life would be worthy of recognition. What Charlie points out however, is that you can learn the 20% of the core concepts that provide 80% of the value, without dedicating your life to the field. In his brilliant 2007 commencement speech to USC, Munger says the following:
“You have to learn these things in such a way that they’re in a mental latticework in your head and you automatically use them for the rest of your life. If you do that I solemnly promise you that one day you’ll be walking down the street and look to your right and left and think, “my heavenly days! I’m now one of the few most competent people of my whole age forward. If you don’t do it, many of the brightest of you will live in the middle ranks or in the shallows.”
In a followup interview with Robert, he discusses how you can become a better investor via the latticework of mental models.
You don’t have to see the markets as an equilibrium-based system, says Hagstrom. You can look at markets from a biological perspective, which explains some of the non-linear behavior, that would otherwise be unexplainable. Essentially, what Robert is getting at, is that understanding the principle ideas from different mental models will help you be a more prepared investor. Instead of panicking when things start behaving in an unusual manner, you have a different way of thinking about investing that restores rationality.
There’s a tremendous amount of quality knowledge resources and recommendations on how you can become a better investor. Yet, the underlying thread among the most brilliant investing minds like Buffett and Munger, is an understanding and fluency of business fundamentals. No matter if you’re just beginning your investing career or are already an experienced portfolio manager, you don’t need to be a world class investor to grasp business fundamentals, but you must understand business to be a world class investor.
The Snowball by Alice Schroeder
7 Steps To Becoming A Great Stock Investor by Earl Jordan Yaokasin, CFA
Simon Caufield on The Genius of Warren Buffett
An Introduction of Mental Models by Farnam Street Blog