A Quest For a Moat

Mastering the Art of Investing

Introduction

I like reading, last year I read 45 books. Most of them either by or about extremely successful people. The two best terms I’ve heard to describe these people are ‘Serial Obsessors’ and ‘Intelligent Fanatics’. Their accomplishments and victories resulted from their ability to focus on a problem or field until they understood how things really work. Questioning tradition and behavioral biases until they were satisfied with them or had developed their own theory of how the world worked.

In order to emulate these people in my field (investing) I decided to research the best approaches to learning and implement them. What follows is the plan I have created to build my own personal ‘moat’ if you will — the ability to maintain a long-term competitive advantage which I will be documenting at this publication.

Foundation

The principles employed in the following originate from my readings of those who have studied and applied the art and science of learning. The two foundational texts are Peak by Anders Ericsson and The Art of Learning by Joshua Waitzkin. In addition, ideas from Robert Greene’s Mastery and Cal Newport’s Deep Work will also be included

Ericsson, a Swedish psychologist, is the world’s preeminent researcher in the science of elite performance across a variety of fields (music, sports, chess, memorization). He studied and branded the now famous concept of Deliberate Practice. His book Peak describes how world class performers in different fields develop their skills. Primarily through Deliberate Practice (or what Newport would call Deep Work) which develops mental structures that our unconscious mind (what Daniel Kahneman would call System 1) uses to make quick decisions and allows our cognitive capacity (System 2) to focus on more advanced and particular situations. This is the reason someone like Warren Buffett can run the most successful investment portfolio of all time with basically no staff. Responding, when asked upon the diligence performed before making an investment in Dunn and Bradstreet:

Yes. There is no staff. I make all the investment decisions, and I do all my own analysis. And basically it was an evaluation of both Dun and Bradstreet and Moody’s, but of the economics of their business. And I never met with anybody.

Buffett mastered the art of investing to such a point that his System 1 can quickly perform analysis that would take other firms hundreds of hours of System 2 processing by capable analysts to replicate. To clarify, I don’t mean that Buffett can instantly know all the research these other analysts would perform, but that he doesn’t need to. Buffett is like a Chess Grandmaster, whom research has shown examine significantly fewer possibilities at each turn than mid-level players. Both Buffett and the Grandmasters intuitively know what is likely to be important, investigate those paths, and ignore the rest.

While Ericsson has studied the science of learning, Waitzkin has practiced the Art. A chess prodigy as a child Waitzkin diverted his interest to the martial arts in his early twenties. Becoming world champion of Taiji Push Hands in 2004 and obtaining a black belt in Brazilian Jiu-Jitsu. In his book Waitzkin discusses his development in these two highly competitive fields and how he realized that what he was great at, was not chess or martial arts but rather learning.

Plan

To be precise, the skill I am trying to develop is that of:

Decision making under uncertainty with respect to investments.

Step 1

Our journey will begin by building a theoretical foundation through the reading of two legendary books. Judgement Under Uncertainty: Heuristics and Biases by Kahneman, Tversky, and Slovic will help us better understand the field of decision making under uncertainty in general. Security Analysis by Graham and Dodd will be our text for understanding investments. In a sense, here we will be learning the rules of the game.

Step 2

Our next step, following Waitzkin’s advice, will be to start with the endgame not the memorization of openings. By this we mean that our study will focus not on finding investment opportunities in the markets, but by studying the specific investment decisions made by investing luminaries.

Unlike certain disciplines like chess and music, investing has slow and noisy feedback loops. One can spend years before being able to evaluate the quality of a decision, greatly increasing the difficulty of gauging not only absolute skill but development as the theory of deliberate practice requires. Moreover, unlike the Suzuki Method in music, there is no clear path or program to learning investing.

In Peak, Ericsson discusses an approach for these types of fields. He recommends studying the masters and their decisions. This approach has had much success in chess where many Grandmasters attribute their development to studying matches between the greats. Eddie Lampert is an example of a successful investor who followed this approach. A Businessweek cover story from 2004 recounts how a young Lampert would try to reverse engineer Warren Buffett’s investment decisions. He would look for documents of the times and try to place himself in Buffett’s shoes and truly understand how he would have come to his decision (not just the why but the how). This approach will be our main didactic tool. Through the study of these decisions we will try to generate general principles that continuously show up and are useful (mental structures).

For this step we will rely on different media. Certain books have been written that discuss specific investment decisions. Inside The Investments of Warren Buffett by Yefei Lu discusses twenty different decisions made by Buffett. You Can Be a Stock Market Genius by Joel Greenblatt discusses many special situation investments he made. Fooling Some of The People All of the Time by David Einhorn discusses his short position in Allied Capital. We will also look at quarterly investment letters written by fund managers in which they discuss their positions and reasoning. Another source are videos of conferences such as the Sohn Conference where investment managers pitch their best ideas for charity. Yet another area is so called online investment clubs. The most prominent of which are Value Investor’s Club and Microcap Investor’s Club where members anonymously post investment theses and research has shown generate significant outperformance.

Step 3

Our third step will be to apply these general principles. We will randomly select companies to avoid biases and have a broad sample of businesses and analyze them. The purpose will be to start implementing our learning and keeping track of our decisions of each stock to start building a track record of our performance.

As suggested by Graham we will generate a range for the intrinsic value of a company and then come to a decision whether we should invest, pass, or short.

Step 4

Now that we have seen and analyzed a wide variety of companies and had some feedback we will start combining decisions into a portfolio. Instead of randomly selecting companies, our knowledge should guide us to where opportunities can be found.

Decision Journal

Throughout all these steps we will write down thoughts and notes in this blog. Writing about the principles he have learned from the foundational books as well as keeping a decision journal of the investment opportunities analyzed.