Michael Mauboussin wears multiple hats – that of an analyst and fund manager, a writer and a teacher. Now director of research at BlueMountain Capital Management, he was the head of global financial strategies at Credit Suisse and the chief investment strategist at Legg Mason Capital Management earlier. Among the many books to his credit, three stand out — The Success Equation: Untangling Skill and Luck in Business, Sports, and Investing; Think Twice: Harnessing the Power of Counterintuition; and More Than You Know: Finding Financial Wisdom in Unconventional Places. He has been an adjunct professor of finance at Columbia Business School since 1993 and continues to be on the faculty of The Heilbrunn Center for Graham and Dodd Investing. His distinction is defined by not just the fact that he received the Dean’s Award for Teaching Excellence in 2009 and 2016, but by the progress of his students, a great example of which is none other than Todd Combs, one of the two portfolio managers handpicked by Warren Buffett. He is an authoritative voice in the world of value investing, with great work around behavioural aspects and moats to his credit. Edited excerpts. Read the full interview at www.outlookbusiness.com
You spoke about common behavioural mistakes that investors make — the base rate problem, the problem of over confidence, the idea of regression to mean or oversimplifying multiples. Can you elaborate on these?
The classic way to look at problems is to gather lots of information and combine it with one’s experience and input, and project them into the future. That’s how analysts, typically, look at a stock — they gather information, build a model and then forecast. The outside view, that is, the application of base rate, asks a much more simple question as to what happened when other companies were in similar situations before. It allows you to understand a company’s performance in a historical context. As often is the case, especially for growth companies, investors ignore the base rate and focus too much on their own information and experience. And in many cases, they tend to be too optimistic in projecting the growth rate while valuing these companies.
It ties back to one of the finer findings in finance, that is, growth stocks typically underperform value stocks. One way to think about that is, growth stocks have high expectations and value stocks have low expectations because, in both extremes, there is not enough weight placed on base rates of performance. Hence, base rates are really an important way to ground an investor’s thinking about corporate performance.
You have to understand base rates in terms of a number of important financial metrics, including sales growth rates, operating profit margins, return on invested capital patterns, earning growth rates, and so forth to see how various companies can fit into some sort of a historical context.
Does that apply to valuations also?
This story is from the May 24, 2019 edition of Outlook Business.
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This story is from the May 24, 2019 edition of Outlook Business.
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