Ahead of the Curve

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Guppy Love and Investing

By Mac Greer
December 6, 2006

I'm a firm believer that wisdom resides in a motley array of places. I believe you can find timeless truths in Greek tragedies, American comedies, and "American Pie" -- both the song and the movie. I believe that your local daily newspaper contains a lifetime's worth of insight. And I believe that you can, in fact, find some of life's answers by asking Ask Yahoo! (Nasdaq: YHOO).

And while I think of myself as a relatively curious guy, I'm no match for Legg Mason Chief Investment Strategist Michael Mauboussin, the author of More Than You Know: Finding Financial Wisdom in Unconventional Places. My recent conversation with Mauboussin reminded me of a few questions I haven't asked -- or even considered. Questions like: What are the investing implications of guppy mate selection? What can slime mold teach us about the stock market? And what can investors learn from the anxiety levels of zebras?

They call it guppy love
We began our conversation by taking a trip to the aquarium. The Legg Mason strategist says investors can learn a lot from observing the behavior of frisky fish.

Mac Greer: Let's talk about a few of those unconventional places and have you tell us what they can teach us as investors. Let's begin with guppy mate selection.

Michael Mauboussin: So as it turns out, guppy females tend to have a preference for bright-colored males. But scientists, in a very sneaky experiment, set them up so the female guppies were observing other female guppies apparently choosing less bright-colored males. And rather than going with their instincts and going with bright-colored males themselves, it turns out they imitated the other females. So clearly social imitation plays a role in the animal world.

Now when you come over to the human being world, we are highly imitative animals. So ... the importance for investors is, for us to figure out what to do, what we often do is look to the left and look to the right at what other people are doing. Now, imitation is often considered a bad thing in markets, but clearly imitation is something we do a lot in life. For example, if someone knows more about wines or automobiles, you may consult them, and you are going to imitate their behaviors. In markets, it gets to be a problem, however, when everyone starts imitating one another without giving consideration to the basic underlying situation. That is what ultimately leads to booms and crashes. So the guppy mate selection is ultimately a way to discuss the idea of booms and crashes and sort of runaway social imitation.

OK -- so imitation may be the sincerest form of flattery, but when it comes to investing, it can produce some less-than-flattering results. Heed the lesson of gullible guppies and don't be afraid to swim against the tide.

Lions, tigers, and zebras, oh my!
Mac Greer: It is something that has been written about in a previous book, the fact that zebras don't get ulcers. What can that teach us as investors?

Michael Mauboussin: By the way, that is a book by Robert Sapolsky, which is just fantastic. The idea is simple. If you are an animal, what causes you stress? The answer is typically a physical stressor, so you are a zebra hanging out, a lion chases after you. Of course you start pumping blood, adrenaline rushes, and you try to get away. However, when that threat passes, you settle back down to some sort of stasis, so you kind of mellow out. The stress goes away.

Human beings have physical stressors as well, but that is really not what gives us most of our stress. Most of our stress in this day and age is psychological stress. How is my last investment going to work out? Worries about relationships, what have you. The point Sapolsky makes is that psychological stress, unlike the physical stress, never goes away. However, it does give you the same physical reactions, so people that are chronically stressed have things like problems with their stomachs, they have reproductive problems, they have elevated blood pressure. All these things are symptoms of high stress.

From an investment perspective, I think the most important thing is that stress tends to make you very short-term-oriented. If you are a zebra being chased by a lion, you are not worrying about next week. Likewise, investors that are really stressed out are saying, "Gee, I don't have the luxury to think about a three- to five-year perspective for this stock. I need to do something that works now." When you get into that mindset of trying to find things that work immediately, it often can lead to suboptimal decision-making.

OK -- so resist the temptation to focus on the short term, and practice some good financial horse sense (well, zebra sense) by setting your sights on the long-term horizon. And if you're being chased by a lion, well, try to at least outrun the zebra.

Take me out to the ball game
Mac Greer: Let's turn our attention to the world of baseball, something on our mind here as our city, Washington, D.C., just finally settled on an owner, and so I want to ask you about a great baseball player you write about, Babe Ruth. What can Babe Ruth teach us as investors?

Michael Mauboussin: Babe Ruth, as everybody knows, was a fantastic home-run hitter, but also, as many people recognize, Babe Ruth struck out a fair bit. One of the biggest kinds of canards you hear in the investment business is "Gee, if I can just be right 51% of the time, I am going to come out ahead of the game." I think there is some fundamental level [of] intuition with that. But that is simply not how it works in the world of investing.

The two dimensions you have to pay attention to [are] how often you are right, but more importantly, or as important, how much you make when you are right versus how much you lose when you are wrong. Think about a simple example: If you had four stocks, three of them went down just a bit and one went up a lot, your probability or your frequency would be poor, but your gains in the portfolio would be excellent. So we try to get people to think not only about how frequently they are right but how much they make when they are right.

The other comment I will make on that is that, because of psychological reasons, we as humans like to be right, so we often lean towards frequency bets versus expected-value bets.

OK -- so investing isn't just about the frequency of failure and success, it's about the size of your hits and misses.

Slimy business
Mac Greer: Let's talk about one more unconventional place. This may be my favorite that you write about in the book: slime mold. First of all, what is slime mold and what can that teach me as an investor?

Michael Mauboussin: It is actually one of my favorites, too, Mac. You know, slime mold, if you are walking through the woods on a fall afternoon, you see sort of that slightly yucky-looking stuff on the floor of the forest. That is going to be slime mold.

The message from slime mold, I think, is really intriguing, which is: When food is ample, slime molds tend to be independent. They go around as independent cells, amoeba-like cells. However, when food becomes scarce, what these slime molds do is they basically combine into basically blobs of up to 10,000 slime mold cells together, and then they move around together as a sort of mass. So the question is, is slime mold an "it" or is it a "they"? And the answer is, it depends solely on the circumstances.

The message of that whole story is, often in life we try and think about things in terms of attributes. For example, in investing, you would say something like, "Low P/E is an attribute that is good," or "High P/E is bad," or you might have some other way of categorizing based on attributes. What the message from the slime mold is ... it always depends. So it is very important to be very aware of the circumstances, not just the attributes of the situation.

So when we're evaluating investing metrics like P/E ratios, we need to consider the context. And if we run into some slime mold in the forest, we should probably address that slime mold as both an it and a they ... or just not address it at all.

Enjoy these previous Ahead of the Curve articles:

Michael Mauboussin is the author of More Than You Know: Finding Financial Wisdom in Unconventional Places.

Fool audio/video guru Mac Greer doesn't own any guppies, does feel stress from time to time, and thinks that the zebra is generally underrated. He does not own shares of Yahoo!. The Fool's disclosure policy is always up for pinball.