Mental Models for Investment

[Blake Hampton]

I'm trying to conceive of a mental model for investment, my overall goal being to build my strategy around it. I've already thought of a simple model for personal finance that is earn, save, and invest. I like to occasionally break down things further so that I can focus more on specific concepts within each group. So far for my invest group I've come up with Idea generation, research and valuation, position sizing, and monitoring, I've laid them out in their general order of operations. I was curious if you guys have any similar models and also if I'm missing anything on the ones I'm working with so far.

 

Rest in peace Mr. Munger

[Blake Hampton]

Also curious on which steps in the process you guys find to be the most important

[ICUMD]

Mine:

• Use active excess cash flow to Increase net passive cash flow

[Spekulatius]

Not a mental model, but more of a checklist is what I use:

I think what’s missing is sizing though.

 

1) Is this a good business?

2) Do I understand the business?

3) Is the stock cheap?

4) Is management capable and honest?

5) Is the stock safe (balance sheet, business resilience)

6) Are there more head winds or tail winds going forward? (Elevator going up or down?)

Edited March 16 by Spekulatius

[Gregmal]

No real model. But generally speaking, what are the odds I make money, in absolute terms. I honestly have never cared or played the “will this outperform t-bills/S&P/whatever” game…that’s stupid. If I see an investment, EBay for instance…I can say that at $42 a share there’s virtually no way I lose money on it with a 3-5 year timeline. If risk is low, reward does not need to be super high…but the real gems are where you can find something with super low risks and some upside call options. Nintendo at $10, same thing. 
 

So I guess really, for the super majority of my portfolio, I look for things where at worst my money isn’t going anywhere and at best I can make a lot. Over time I’ve moved away from stuff like biotech or cigar butts where I might make a lot but I also might lose a lot. 

[brobro777]

I dunno about mental models but what works good for idea generation is to bet against dumbasses. I pay attention when these guys talk, as it's usually a good idea to take the other side. It's kind of amazing how reliably wrong these guys are - like 15 years later they're wrong yet again.

 

And I apply this to myself too. Sometimes I will look at brokerage statements from 11 years ago to remind myself how dumb I was with some industry or company and go, well, I was a moron then and I'm probably the same moron now when it comes to this industry, so I guess I'll just stay away. That saved my ass a few times over the years

 

 

[ArminvanBuyout]

One thing that's really helped for me for framing is to lean into duration as a competitive advantage, and recognize that the incremental buyer or seller today is most likely someone who works at a pod shop, and therefore has a different trading window than me. If something looks good for the a 3-5 year period, but is trading cheaply because the path to get to that point is still a bit uncertain, then I take the risk.

 

I'm effectively getting paid to take that uncertainty on, and I lean into that duration advantage (frankly one of the only advantages I have as an individual investor). 

 

This probably has higher vol than the traditional buy companies on cheap metrics, but I think open up the opportunity set to much better risk-return skews

[ArminvanBuyout]

Building on my prior response, the other model I have is thinking around where market is underpricing growth. Based on experience, market generally just seems to price in 1-2 years of earnings (based on implied DCFs). If you think growth is sustainable for longer, then you can lean into duration, and underwrite higher growth for longer. 

 

Just think of how many companies look expensive on metrics, but in hindsight, everyone should've been buying those companies regardless of NTM metrics

[ValueArb]

On 3/16/2024 at 4:41 PM, Spekulatius said:

Not a mental model, but more of a checklist is what I use:

I think what’s missing is sizing though.

 

1) Is this a good business?

2) Do I understand the business?

3) Is the stock cheap?

4) Is management capable and honest?

5) Is the stock safe (balance sheet, business resilience)

6) Are there more head winds or tail winds going forward? (Elevator going up or down?)

 

7) What is their moat? This is good to call out individually since it is an important component of 1, 2, 5 & 6. 

8 ) What is the catalyst? Once you've identified value you still need to avoid value traps. So in addition you want to identify some price influencer that will drive price towards value over time. It can be as simple as strong future earnings growth or more specific events like up-ratings, index inclusions, dividends, buybacks, sale or liquidation.

[Longnose]

I used to be all this. 

On 3/16/2024 at 5:41 PM, Spekulatius said:

Not a mental model, but more of a checklist is what I use:

I think what’s missing is sizing though.

 

1) Is this a good business?

2) Do I understand the business?

3) Is the stock cheap?

4) Is management capable and honest?

5) Is the stock safe (balance sheet, business resilience)

6) Are there more head winds or tail winds going forward? (Elevator going up or down?)

 

 

Now i much more of this. supported by the checklist verifying that the downside is actually pretty limited.

On 3/16/2024 at 6:29 PM, Gregmal said:

No real model. But generally speaking, what are the odds I make money, in absolute terms. I honestly have never cared or played the “will this outperform t-bills/S&P/whatever” game…that’s stupid. If I see an investment, EBay for instance…I can say that at $42 a share there’s virtually no way I lose money on it with a 3-5 year timeline. If risk is low, reward does not need to be super high…but the real gems are where you can find something with super low risks and some upside call options. Nintendo at $10, same thing. 
 

So I guess really, for the super majority of my portfolio, I look for things where at worst my money isn’t going anywhere and at best I can make a lot. Over time I’ve moved away from stuff like biotech or cigar butts where I might make a lot but I also might lose a lot. 

 

[Saluki]

I think it's been mentioned before but you have to trade the way that fits your personality. 

 

I was addicted to video games when I was younger so I don't want a strategy that would involve lots of trades and looking at the screen constantly.

 

Some people have all their net worth in one or two stocks, and some won't buy anything but an index fund. Both work if you know what you are doing and why, and do it consistently rather than switching strategies. "Consistency beats intensity". If you can't do Cross fit every day, then don't. Find something that works for you over time.