We examine four situations where individuals make poor choices and review the research to show where the brain makes those decisions. In each case, we present some ideas about how to overcome the potentially suboptimal choice.
A forecasting tournament identified “superforecasters,” people who consistently make superior predictions. How they think is key: they are actively open-minded, intellectually humble, numerate, thoughtful updaters, and hard working.
We use the process of triangulation to estimate total addressable market, a vital indicator of a company’s potential. Methods discussed include an assessment of the population, product, and conversion, a diffusion model, and appropriate base rates.
We review the 2015 theme, “Attention: Pay Now or Pay Later,” and include transcripts. A key theme is how limited our attention is. The speakers offer concrete steps to address this in one’s own life and to take advantage of it in business.
The paradox of skill explains why it’s challenging to find differential skill among managers. It’s due to a surfeit, not a dearth, of skill. Making money is about proficiency and finding easy games. Use statistics that are persistent and predictive.
The quest for the Triple Crown of horse racing offers three important lessons for an investment organization: Pay attention to the results of the past, recognize the value of diversity, and value = probability x price.
We update a report from August 2014. Capital allocation is one of management’s top responsibilities, yet few are well-trained at it. We discuss uses of capital, show how to analyze them, review academic findings, and describe how to assess managers.
Intelligence quotient (IQ) is like the horsepower of an engine and rationality quotient (RQ) is like the output. We offer tips for improving rationality and we profile top forecasters. We also describe a calibration test that shows overconfidence.
Optimism and overconfidence can creep into our forecasts. Considering the results for an appropriate reference class can enhance the quality of forecasts. We provide the base rates for sales growth rates for a large sample of companies.
The fundamental law of active management reminds us success requires skill and opportunity. We examine three ways investors express skill: market timing, security selection, and portfolio construction. Measures of opportunity show 2014 was very hard.
We capture the Mr. Market metaphor, which is a powerful way to think about markets. To be an active investor, you must believe in market inefficiency to get opportunities and in market efficiency for those opportunities to turn into profits.
This report provides guidance if one of your stocks falls 10 percent or more in one day. Such drops often cause strong emotional reactions and make sound decision-making hard. We provide a checklist to help you decide whether to buy, hold, or sell.
Capital allocation is a management team’s most fundamental responsibility. We examine the sources and uses of capital for Japan, Europe, Asia/Pacific excluding Japan, and Global Emerging Markets. This extends our analysis beyond the United States.
Short-termism is widely viewed as a major problem in the investment industry, but its existence is hard to prove. Many of the perceived symptoms of short-termism don’t hold up to scrutiny, and there are some good reasons for shorter time horizons.
We review the 2014 theme, “The Art and Science of Prediction,” and include transcripts. The theme weds three ideas: how to blend the ability of humans and computers, when to rely on instincts or statistics, and how to train to make better decisions.
We relate freestyle chess to investing, where fundamental analysts are “man” and quantitative analysts are “machine.” A proper melding of fundamental and quantitative methods may well yield better results than either by itself.
Capital allocation is one of a management team’s top responsibilities, yet few are well-trained at it. We discuss seven uses of capital, show how to analyze each use, review academic findings, and describe how to assess capital allocation practices.
We describe how to properly calculate return on invested capital (ROIC), an important measure of how a company allocates capital. We link ROIC to the $1 test and to competitive strategy analysis and explain how to handle issues such as excess cash.
With corporate cash balances building, the issue of how to disburse that cash is a crucial and timely issue in determining shareholder value. We answer frequently asked questions about share buybacks and dividends, two primary methods to return cash.
Corporate longevity is an important consideration for investors as they assess valuation, position sizing, and the sustainability of competitive advantage. Turnover in the S&P 500 Index, a proxy for longevity, correlates well to M&A activity.
This report describes five common mistakes that investment firms make and offers practical guidance on how to manage each of them. The solutions rely not on getting smarter but rather on fending off poor practices that you can fix.
The price-earnings multiple is the primary method analysts use to value stocks. Yet, most don’t have a clear sense of what a specific multiple implies about a company’s future financial performance and don’t understand how multiples change over time.
Many organizations use teams and promote diversity. But without proper processes, teams may fare poorly. There are three types of diversity: social category, cognitive, and value. The best teams have high cognitive diversity and low value diversity.
Simply buying the best or worst businesses does not ensure excess shareholder returns. The market rewards improvement and punishes decline in economic returns. Focus on returns on capital first and growth second.
Outcome bias occurs when people judge outcomes without considering the quality of the decision. “The interpreter” in the brain creates a cause to explain any effect. Estimate how much luck determines a result and focus on process when luck is ample.
This report is a guide to estimating the weighted average cost of capital, with the goal of deriving a figure that is sensible from a business and economic standpoint.
Most investors know about reversion to the mean and think they take it into account as they model corporate performance, but in reality few deal with it properly. You can use the correlation coefficient to estimate the rate of reversion to the mean.
Sustainable value creation is of interest to investors who seek to anticipate expectations revisions. This report offers a framework to determine the size of a company’s moat. We cover industry analysis, firm-specific analysis, and firm interaction.
Successful investors develop proficiency and choose games with a wide dispersion in skill so as to benefit at the expense of the less skillful. The paradox of skill means that luck is often more important in shaping outcomes even as skill improves.
This report provides tools and guidance to improve decisions. Good judgment requires understanding causality, effectively incorporating information from past events to understand present prospects, and updating probabilities based on new information.