Investment Theory #7: Michael Mauboussin

Michael J. Mauboussin is managing director and head of Global Financial Strategies at Credit Suisse, where he advises clients on valuation and portfolio positioning, capital markets theory, competitive strategy analysis, and decision-making. He is also an adjunct professor of finance at the Columbia Business School and chairman of the Board of Trustees at Santa Fe Institute.

Mauboussin started his career at Drexel Burnham Lambert of Michael Milken fame. He was trained to be a financial advisor and in his own words was an abject failure. Armed with the knowledge of what he wasn’t good at, he set out to find a job in equity research. He eventually landed a job as a packaged food analyst at First Boston, which later merged with Credit Suisse. He has been there ever since.

Mauboussin recently published a reflection on his last 30 years in the investment industry. I recommend you read the article in its entirety. He ends with an exploration of the top 10 attributes of a great investor. This post contains my brief notes regarding his insights.

Understand Numeracy and Accounting

Accounting is the language of business and investors need to be fluent in it. To perform financial statement analysis, we combine this fluency with numeracy and calculate things like free cash flow, return on invested capital, and relative performance.

Understand Value

The only constant in investing is that the value of a financial asset is the present value of its future free cash flows. As investors, we need to focus on the sustainability and magnitude of those cash flows.

Understand how a Business Makes Money

At the micro scale, we need to know how a company generates a sale and the economics of the transaction. At the macro scale, we need to understand a company’s competitive position.

Understand Expectations versus Fundamentals

There is no money to be made in what is already priced in. Instead, we need to find the companies that are mispriced relative to how they will actually perform. For example, a company that is sure to win will be a good bet if it is priced to lose and a bad bet if it is priced to win twice.

Understand Probability

More things can happen than will. As investors, we need to have an understanding of the probability distribution of future outcomes and bet heavily when the odds are in our favor. In the short run, a good decision can lead to a bad outcome and a bad decision can lead to a good outcome, but in the long run good decisions will maximize our chance of good outcomes.

Understand Bayesian Updating

When the facts change, we should change our thinking. As investors, we should actively seek out both confirming and dis-confirming information and update our views as appropriate. The only constant is change.

Understand Behavior biases

We have a genetic predisposition for certain ways of thinking. Historically, if there was a deer (gain) and a lion (loss) in the same location, we would flee. This would be rational, as the loss in this situation would be our life and the gain would only be a meal. That way of thinking has stuck with us, and we suffer from loss aversion in instances where we shouldn’t. As investors, we need to understand our biases and work to correct them.

Understand Information versus Influence

Prices can be a product of information or a product of influence. When markets are efficient, they price in the available information on the company. When markets are in a state of panic or irrational exuberance, they price in the influence of the crowd.

Understand Position Sizing

It isn’t about being right or wrong, it’s about how much you make when you’re right versus how much you lose when you are wrong. The Kelly Criterion provides us with a model for optimal position sizing.

Always be Learning and Reading

As Charlie Munger has said:

In my whole life, I have known no wise people who didn’t read all the time-none, zero.

Conclusion

There is plenty of wisdom to be gained by studying Mauboussin’s life work. For more reading, consider his books:

I’ll leave you with some of my favorite Mauboussin quotes:

“Sustainable value creation has two dimensions—how much economic profit a company earns and how long it can earn excess returns.”

“Humans have a strong desire to be part of a group. That desire makes us susceptible to fads, fashions, and idea contagions.”

“Success in a probabilistic field requires weighing probabilities and outcomes—that is, an expected value mindset.”

“We have a natural sort of module in our brain that associates good results with skill. We know it’s not always the case for the future, but once it’s done, our minds want to think about it that way.”

“When you see something occur in a complex adaptive system, your mind is going to create a narrative to explain what happened—even though cause and effect are not comprehensible in that kind of system.”

“The plural on anecdote is not evidence.”

“Perhaps the single greatest error in the investment business is a failure to distinguish between the knowledge of a company’s fundamentals and the expectations implied by the market price.”

References:
https://en.wikipedia.org/wiki/Michael_J._Mauboussinhttps://doc.research-and-analytics.csfb.com/docView?language=ENG&format=PDF&source_id=em&document_id=1063945621&serialid=1wRGyN6EnJdsEAzicRfCQyDmuExS84d2HcYRBRMNZJ8%3D

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Author: David Shahrestani

"I have the strength of a bear, that has the strength of TWO bears."

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