Does Good Investment Require Good Research?

spartansaver · February 24, 2016

I have been pondering today whether a person who does average research can achieve above average results? Do the great investors of our day know companies better than others through in depth research, or is it their inherent investment skills that make them above average?

Jurgis · February 24, 2016

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.

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

TREVNI · February 24, 2016

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"?

Jurgis · February 24, 2016

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.

alwaysinvert · February 24, 2016

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.

Vish_ram · February 24, 2016

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?

premfan · February 24, 2016

Don't listen to me I'm average in the public markets. That said, its all about conviction and timing. Its all subjective except timing. First gain conviction and fuck timing. Conviction and timing are also interconnected which is paradoxical.

writser · February 24, 2016

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.

Uccmal · February 24, 2016

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.

coc · February 24, 2016

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.

February 25, 2016

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.

Mephistopheles · February 25, 2016

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.

dabuff · February 25, 2016

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