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When Less Research Is More

By Rupert Hargreaves. Originally published at ValueWalk.

During June, value Mohnish Pabrai gave a talk at Google in which he touted the benefits of doing as little research as possible when evaluating a potential investment. This advice might seem misleading at first, but the reasoning behind Pabrai’s guidance contains a vital lesson for investors conducting securities research.

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Charlie Munger: Less securities research is better for investors

It is vital to research a potential investment before you take the plunge. However, too much securities research can be damaging. Spending hours trawling over numbers, forecasts and spreadsheets only increase the likelihood that you will reach a positive conclusion. Therefore, Pabrai argues that best investment ideas are obvious from the start and if an idea requires extended, in-depth securities research, it should be avoided. To hammer this point home, Pabrai recites a story from Charlie Munger:

A few years back, I had dinner at Charlie Munger’s house with a small group of people. He posed the question to the group; he said that the Capital Group, a few years back, had set up a best ideas fund. They had asked each of their portfolio managers to give one stock, their highest-conviction idea, and then they created a best ideas fund, which was taking one pick from each of the managers. Charlie went on to say that this fund did not do well, it underperformed its benchmark and the S&P 500. He was asking the group why this was.

They tried setting up the best ideas fund multiple times, and each time it failed. He said, ‘Before I answer the question why it failed, I want to give you a story from my days at Harvard Law School.’ He said that sometimes when they had classes at Harvard Law, the professor would bring up a case where the facts were such where it wasn’t obvious which side was in the right. Then they would divide the class into two halves randomly. One half would argue for the defendant, and the other would argue against the defendant. The two sides went off and studied the facts and made their arguments. After all of that was done, when they surveyed the entire class, overwhelmingly the students who had argued for the motion believed strongly that they were right, and the people who had argued against the motion believe strongly that they were right. Before they had studied the facts, they did not have a leaning one way or the other. Charlie said the best ideas fund was simply a fund full of ideas which managers had spent the most time on, the ideas they were most excited about.”

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Put simply, an investment plan should be simple, and the more time you spend on it, the more likely it is you will ignore the fundamentals. This isn’t the first time Pabrai has argued for the need for a simplified investment process. On the topic of simplicity, during a talk at Google in July 2014, he said:

“The most important thing is that, before you invest, you should be able to explain the thesis without a spreadsheet within four or five sentences. Typically I write down those sentences before I invest, so if I have a conversation with someone you could very quickly explain why this investment makes sense.”

Benjamin Graham: Less securities research will help you outperform

The notion that simple is best in investing has been around for decades, but Wall Street is not interested. It would be difficult to justify investment banks’ multi-million dollar fees and investment advisers’ commissions if they just picked the easiest investment they could find.

The godfather of value investing, Benjamin Graham himself actually advocated this approach. Between September 1946 and February 1947, Benjamin Graham presented a series of lectures entitled, Current Problems In Security Analysis at the New York Institute of Finance. Throughout the series, he covered various topics including estimating a company’s future earnings power and placing an appropriate multiple on the shares based on this assessment. After warning students about the dangers of placing a high multiple on the company’s shares just because they like the business more than its peers, Graham went on to warn against spending too much time researching a company and its prospects due to the problems of forecasting:

“A thing I would like to warn you against is spending a lot of time on over-detailed analyses of the company’s and the industry’s position, including counting the last bathtub that has been or will be produced; because you get yourself into the feeling that, since you have studied this thing so long and gathered together so many figures, your estimates are bound to be highly accurate. But they won’t be. They are only very rough estimates, and I think I could have given, and probably you could have given me, these estimates in American Radiator in half an hour, without spending perhaps the days, or even weeks, of studying the industry.”

The post When Less Research Is More appeared first on ValueWalk.

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