But when the researchers studied the ants, they realised that some of them wandered off the trail from time to time. That didn’t seem to make sense, especially if there was a good food source.
As they studied it in more depth, they realised there was a mathematical probability an ant would leave the trail, and that the probability was somewhat related to how likely it was that another food source would appear. So the colonies were adept at exploiting and exploring. And the point of exploring is that it might be where the next great idea comes from. It’s like corporate research and development.
The lesson for investors is that you should be allocating some percentage of your time to non-traditional information because if you’re doing what everybody else is doing you’re unlikely to have results much different from them.
Your books stress on the importance of diverse thinking to profit in constantly changing financial markets...
My inspiration here is Charlie Munger, the vice chairman of Berkshire Hathaway and Warren Buffett’s partner. Munger talks a lot about the mental models approach. The basic point is that you should strive to understand the big ideas from many different disciplines, because those ideas will come in handy when you’re solving problems. He’s fond of the saying, “To a person with a hammer, every problem looks like a nail.” If you don’t have many tools in your mental toolbox, you won’t be effective.
So how do you develop your mental models? The main way I know is to read. Most of the great investors I have known read constantly—hours and hours a day. They are reading plenty of traditional material, but also carve out time to learn about ideas that are off the beaten path. The problem with the mental models approach is that it is hard, time consuming, and leads you down many intellectual cul-de-sacs. The benefit is that flash of insight that comes with recognising how to solve a seemingly difficult problem in a way that others have not thought of.
What are the four-five points which investors should keep in mind while investing in stocks?
First, it is essential to always differentiate between fundamentals and expectations. Perhaps the biggest and most consistent mistake in the investment world is a failure to separate those two factors. For the stock market, fundamentals are the future financial performance of the business—it’s sales growth, cash flows, and return on invested capital. The expectations are the stock price. It is possible to reverse engineer the expectations in the stock to understand what is implied about future financial performance. It is a vital task, and few investors do it with discipline.
Next, I’d say stay steadfastly focused on process. Because investing is probabilistic, outcomes can be very noisy, especially in the short-term. Process includes finding securities that are mispriced and constructing a portfolio that takes advantage of that edge via position sizing while being mindful of risk.
I’d also echo another Buffett and Munger theme and say to identify and stay within your circle of competence. It’s a big world out there and it is unlikely that you’ll be able to find investment edge everywhere you go. So recognise what you’re good at and stick to it. This means there will be times when other people seem to be making much more money or having much more fun. You have to have persistence and stay the course.
Finally, I’d recommend that investors keep track of their decisions. Create an investment journal. Write down what you decide, what you expect to happen, and why. Perhaps make note of how you feelphysically and emotionally. A journal is one of the few ways you can provide yourself with honest and clear feedback.
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