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Does Good Investment Require Good Research?


spartansaver
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Great question to ask here.

 

My feeling about CoBF modus operandi is that "you need great research to have great returns". I somewhat agree. :) But then I also come from the fields where great research is rewarded. You don't get a name in math or physics or theoretical computer science without doing great research... ;) Not sure if this applies to investing though.

 

Personally, I don't do great research, but my returns are also not great, so ...

 

There are people who disagree with "you need great research to have great returns". The ones I know somewhat have had better results in the past than in couple last years though.

 

....

 

There is also an issue that last 5 (or more?) years have not been kind to value investors. So you can look at a lot of "great" investors and they have been underperforming. Almost (?) irrespective if they did great research or not.

 

Related to above the "easy" solutions for outperforming without research: buying BRK or FRFHF/FFH - these have not worked well recently.

 

....

 

Edit:

Arguments for in depth research:

- You have to know the industry well. You have to know company well. You have to know the sales, the products, the margins, the capex, the nuts and bolts, etc. to understand where company is and where it is going and what kind of sales/earnings/FCF/returns it will offer. This requires in depth research

- You have to know management well. Same as above

 

Arguments for shallow research:

- "Buffetty" argument. Selecting a good business is more important than details. If you get the gist of Google, buy it while it's small, then hold forever, done. Don't sweat the details. Being able to hold is more important than being able to do great research.

- "Quantitative" argument ("Grahamy"?). Just look at valuation, don't bother much about business, buy cheap, sell when not cheap, repeat.

 

---------------------

 

So no real answer to your question. Let's see what others will say. :)

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To quote Charlie Munger: "The world is not yet a crazy enough place to reward a whole bunch of undeserving people." 

 

I'd say that more effort (hours) does not necessarily translate into more (higher) returns.  What is required is better insight, and the way to better insight is better thinking.  But of course effort is required, "how could it be otherwise"?

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As I've said somewhere else, investing is a very bad field to work in. You have a no-effort, no-cost, no-brainer baseline that outperforms >99% of investors and probably over 90% of smart investors. Think what would happen if we had this in other fields. You get sick and there's no-effort, no-cost, no-brainer approach that outperforms 99% of doctors. You want food and there's no-effort, no-cost, no-brainer approach that outperforms 99% of chefs. You want a haircut and there's no-effort, no-cost, no-brainer approach that outperforms 99% of stylists. Would anyone go to become doctor, or chef or stylist or whatever?

 

So to paraphrase Buffett "when an investor with a reputation for brilliance tackles investing business with a reputation for being very hard to outperform, it is the reputation of the business that remains intact."

 

And yet so many people continue trying. Me, myself, and I included.  :-\

 

But perhaps this is OT.

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What is great research? I'm guessing there are a handful of people on this board who are marvellous experts in SHLD but what returns have that earned them? Maybe that's a cheap shot, but there is a lot of navel-gazing research going around and I don't know that it is that great.

 

Turning over a lot of stones and finding simple investments may on the other hand be great. Or just being better at keeping emotions in check, something I guess people have been reminded of the value of these last few weeks.

 

Personally, I think it's a question of identifying key drivers of an investment. If you need thousands of hours to do that in a single name, then maybe either you are a bit thick or you are confused and think your name is Warren and have only 50 companies in the world to choose from, none of which offers the kind of returns we potentially could have.

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As I've said somewhere else, investing is a very bad field to work in. You have a no-effort, no-cost, no-brainer baseline that outperforms >99% of investors and probably over 90% of smart investors. Think what would happen if we had this in other fields. You get sick and there's no-effort, no-cost, no-brainer approach that outperforms 99% of doctors. You want food and there's no-effort, no-cost, no-brainer approach that outperforms 99% of chefs. You want a haircut and there's no-effort, no-cost, no-brainer approach that outperforms 99% of stylists. Would anyone go to become doctor, or chef or stylist or whatever?

 

So to paraphrase Buffett "when an investor with a reputation for brilliance tackles investing business with a reputation for being very hard to outperform, it is the reputation of the business that remains intact."

 

And yet so many people continue trying. Me, myself, and I included.  :-\

 

But perhaps this is OT.

 

What other profession offers gambling without damaging one's reputation? What other profession offers allows a person to claim credit for dumb luck? Other than lottery, what other activity offers instant gratification?

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Interesting question. First of all, how do you define 'average research'? Is that sell-side research promoting Enron right until it blew up? Or retail people buying TSLA because 'they have cool cars'? Or on the other end: David Einhorn studying Allied Capital? Assuming that you mean with average that you read a few 10K's, make a simple model for the business, have a target price and follow the news then I am inclined to think that yes, you can outperform. Or at least, that is what I hope.

 

How? I think one way is to by exploiting retail and/or professional biases. In no way is this easy because you have to overcome your own biases as well. For example, I think a lot of mechanical strategies could could work quite well (NCAV portfolio, low p/b stocks, magic formula) but nobody does it (because it is boring?). Or people think they can 'improve' strategies manually while in fact they are doing the opposite.

 

A couple of things that I think you could potentially exploit / use to improve your performance:

 

- Large cap vs. micro cap: Buffett is not going to invest in the OTC-market. Prices there might be more inefficient.

- Value tilt: low p/b & p/e stocks outperform in the long run. So buy cheap stuff - don't try to predict the successor of Facebook.

- Liquidity premium: illiquid stocks outperform. Buy them.

- Overconfidence bias: don't think your Valeant analysis is so impressive that you can put 200% of your portfolio in it. Always be skeptical of your own work. Always look for contrary evidence. Diversify.

- Holding term arbitrage: don't try to time the market. Don't focus too much on quarterly earnings. Have a very long term perspective.

- Ignore the crowd: Do your own work. Mostly ignore any idea that has a >10 page CoBF thread. So many people are looking at it, what's your edge?

- Activity bias: the best performing brokerage accounts are from deceased people. So trade like them.

- Mathemathics: try not to permanently lose capital. It sucks when you want to compound your savings. Look for a margin of safety.

 

Basically, do all the boring stuff that other people don't want to do. Don't spend all your time in the oil macro-, european bank macro- and ZINC thread. Instead, research 100 boring stocks nobody has ever heard of and buy the cheapest 10. Or, buy a couple of global ETF's and don't open your account the next 10 years.

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Pretty good answers.  There is diminishing returns to research.  One certainly needs to know things such as the primary risk factors for a business, from a macro perspective - I have more than proven that with oil last year. 

 

One also needs to know the debt levels, cash flows, etc. in order to gauge the solvency of an investment or ability to meet its demands, since we often engage in buying less than savory morsels. 

 

But does it really pay to know BACs in depth to the 1000 page of its filings.  Obviously the CEOs of these companies dont even know this.  You could have known everything you wanted to know about BAC and still been killed this year by the spector of negative interest rates.  Similarly, with Pennwest - they were on the right track and profitable even down into the 60s to 70s per barrel and then whoomph, the oil price tanks to levels way below production cost.  What can you do?

 

Knowing Shld in depth didn't help anyone.  Knowing Horsehead in depth didn't save anyone. 

 

I guess one has to determine where their skill lies.  Mine does not lie in doing deep research into companies... it has never paid off.  A wide view has always worked best for me.

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I think what most of you are proposing is a corollary to the idea that A stock doesn't know you own it; which is that A stock doesn't know how much research you've performed on it. You're either right or wrong. Research is a means to an end.

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Great topic/question.

 

My sense of COBF, (check out the investment ideas page) is that a lot of "research" here nicely fits the "precisely wrong" adjective. Then there is the Berkshire Hathaway thread, there we have pages and pages of "precisely wrong" research as well, (check out the BV discussions ...is IV 1.22 or 1.35x BV etc. ). "BV understates IV by a wide margin" is a vaguely correct statement that does it, for me.

 

Munger has mentioned that if an idea they are seeking to put money in requires significant calcs (DCF etc.) it is most likely "too hard". Find something else. 

 

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Depends on the definition of good research. Researching what is relevant is good. Looking at every number and sentence from every 10-k from the last 10 years is not relevant, therefore not good but rather wasteful.

 

Having an understanding of the big picture = good research. Doing excess projections and discounting = not good.

 

Just imagine you owned a business. Imagine what you'd be thinking about as the owner, and equally importantly- what you couldn't care less about. That's the best way to go about it.

 

I don't think reading hundreds of pages of documents is what you'd be doing or need to be doing if you owned a business.

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The increasing circles of competence requiring shallow research:

 

Level 1) Dollar-coast average the Vanguard 500 ETF

Level 2) Dollar-cost average into BRK, being more aggressive when price is near 1.2x BV

Level 3) Clone the high-convictions holdings of the buy-and-hold fund managers which qualify at least by some value criteria spread over 20 holdings or so (though as noted above, this may not have worked spectacularly the last few years) and requires more work/nerves

 

Intermediated

-value weighted basket by EV/EBITDA

 

Advanced:

-buying baskets of spinoffs

-baskets of net-nets

 

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Q: Does Good Investment Require Good Research?

A: No.

 

Forget value investing, become a trend follower of the broad markets. The easiest way to add alpha is to side step big drawdowns. Trend following is supposed to do just that with very little research.

 

One model I'm intrigued about is dead simple. Do this once a month:

 

Check 12-month trailing returns for VTI and VEA.

If VTI > 0 and VTI > VEA invest 100% in VTI.

If VTI > 0 but VTI < VEA invest 100% in VEA.

If VTI and VEA are both negative, go 100% cash or short term bonds.

 

The back-tested results are amazing.

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One of the greatest ironies of all is that the father of security analysis, Ben Graham advocated simple selection of baskets of stocks by low PE ratios toward the end of his life. (This was the inspiration for Greenblatt's Magic Formula).

 

Talk about an about-face.

 

Alas, we would do well to remember what Pascal said - "All men's miseries derive from not being able to sit in a quiet room alone."

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Considering how difficult it is to make good investment (to Charlie Munger), naturally one has to assume that good investment requires many things - luck, luck, luck, diligence, patience, philosophy, method, execution, many more, and surely good insight and research.

 

In terms of research, good is not enough. One needs "better" research. Unless you call the S&P "good", good investment surely requires superior research/insight.

 

WEB has not deteriorated in his investing talent; he probably got better. I think the average result of BRK in recent years is due only partly to size. What has changed is competition. Competition in investing is higher than ever.

 

The only time when you have good investment but not good research is when you have lots of luck.

 

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I've been doing the investing thing for ten years now. I first started like Buffett, trying to find the tiny undiscovered needles of gold in the haystack, looking at micro/nano-caps to try and discover the cheapest stocks. I was lucky, because when I started in 2006/2007, the market was ready to go straight into the ditch and very quickly, I was able to discover cheap stocks (on my own, and through here too). A few stocks ended up going to zero, a few went nowhere, a few doubled/tripled, one or two went up 5x. It was a strategy that made money, but in hindsight, it wasn't really necessary to go sifting through so many awful companies to find a few gems. If I had just bought the best insurance company (Beazley Group), the best bank (Hingham Institution), the best conglomerate (Berkshire), the best retailer (Walmart) and a basket of long-term consumer stocks (Coke, J&J, Procter, etc.) I would have probably performed even better with about 10% of the effort.

 

I couldn't be bothered with the first strategy anymore. Too much work, too many headaches, too much stress when you could achieve superior results with less effort by just buying quality when it comes down in price.

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As I've said somewhere else, investing is a very bad field to work in. You have a no-effort, no-cost, no-brainer baseline that outperforms >99% of investors and probably over 90% of smart investors. Think what would happen if we had this in other fields. You get sick and there's no-effort, no-cost, no-brainer approach that outperforms 99% of doctors. You want food and there's no-effort, no-cost, no-brainer approach that outperforms 99% of chefs. You want a haircut and there's no-effort, no-cost, no-brainer approach that outperforms 99% of stylists. Would anyone go to become doctor, or chef or stylist or whatever?

 

So to paraphrase Buffett "when an investor with a reputation for brilliance tackles investing business with a reputation for being very hard to outperform, it is the reputation of the business that remains intact."

 

And yet so many people continue trying. Me, myself, and I included.  :-\

 

But perhaps this is OT.

 

What other profession offers gambling without damaging one's reputation? What other profession offers allows a person to claim credit for dumb luck? Other than lottery, what other activity offers instant gratification?

 

Do you seriously think investing is the only occupation where the answer to one or all of your questions is yes?

 

Were you running money in the Great Depression or something?

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If good is better than market average returns then historically (empirically) no.  One could check out Fama and French or pretty much any of the other research on mechanical value portfolios or read pretty much anything else about the value anomaly.  200 slide presentations built on excruciating research wouldn't help you much in a quest to stay in bidness after getting smoked by the FANG/MoMo the last 3 years. 

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I've been doing the investing thing for ten years now. I first started like Buffett, trying to find the tiny undiscovered needles of gold in the haystack, looking at micro/nano-caps to try and discover the cheapest stocks. I was lucky, because when I started in 2006/2007, the market was ready to go straight into the ditch and very quickly, I was able to discover cheap stocks (on my own, and through here too). A few stocks ended up going to zero, a few went nowhere, a few doubled/tripled, one or two went up 5x. It was a strategy that made money, but in hindsight, it wasn't really necessary to go sifting through so many awful companies to find a few gems. If I had just bought the best insurance company (Beazley Group), the best bank (Hingham Institution), the best conglomerate (Berkshire), the best retailer (Walmart) and a basket of long-term consumer stocks (Coke, J&J, Procter, etc.) I would have probably performed even better with about 10% of the effort.

 

I couldn't be bothered with the first strategy anymore. Too much work, too many headaches, too much stress when you could achieve superior results with less effort by just buying quality when it comes down in price.

 

What are you thoughts on Hingham?  Why's it the best bank?

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What I find interesting is that WEB says that if he were starting out today he would do things the same way as he did back in the 50s/60s - looking for little pockets of value.

 

Though I agree buy and sit on your ass approach is much less work (albeit a more cerebral, qualitative kind of work).

 

The cigar-butt approach is more quantitative, requires more activity, vigilance, and nerves of steel.

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I think everyone would agree it helps, If you are limited on time, and I think most of are. We don't have the time and/or passion to put in Buffetesque amounts of time reading and pondering. I think you have to go with the advantages you have. Most of us possess the ability to understand a section of the market, whether it's pharma, banks, or fast casual restaurants. We can have a niche. I think someone putting in 4 hours a week could be an absolute expert on a small area and recognize values in that area especially amongst smaller caps. It still takes the right temperament, the ability to learn from mistakes, and patience. I think Oddball is a good example of this with small cap bank stocks.

 

That would be my advice to a new investor who like most of us has limited time. Put most your money in index funds or a few BRK style stocks, and learn with a 10-20% slice, starting with a small pool.

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"In any sort of contest financial, mental, or physical its an enormous advantage to have opponents who have been taught that its useless to even try. From a selfish point of view, Grahamites should probably endow chairs to ensure the perpetual teaching of EMT"

-WEB

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