FOOL ON THE HILL: An Investment Opinion
I Think, Therefore I Invest

With volumes of information to parse, sound investing requires investors to think for themselves. How do you do that? One method involves asking lots of dumb questions, then asking follow-up questions -- until your questions and the answers get better.

By Richard McCaffery (TMF Gibson)
September 7, 2000

The more I contemplate investing, the more I prize folks who think independently and encourage others to do the same.

Sounds pretty trite, I know. Who doesn't prize independent thinking? But, it's worth mentioning, since I'm talking about a specific method for getting there.

Independent thinking doesn't have to mean brand-new ideas. For entrepreneurs, it often involves taking old ideas and applying them in new places, in new combinations, or in ways other people didn't think would work. That's what Michael Dell did when he pioneered the direct model in the computer industry and drove Dell Computer's (Nasdaq: DELL) sales to $25.3 billion in 1999 from $2.9 billion in 1994.

This wasn't a new idea -- just a new application of an old idea. Berkshire Hathaway's (NYSE: BRK.A) GEICO unit has used the direct sales model to sell insurance since Leo Goodwin founded it in 1936. He had a simple idea: Sell insurance to low-risk clients and reduce expenses by cutting out the middle man, namely insurance agents. Voila, a low-cost competitor.

These simple applications of old ideas created companies with unique competitive advantages that look sustainable over the long term. After all, executing the direct model is the real challenge, not just applying the concept. It's the difference between playing the game and watching film.

For investors, I see a lot of independent thinking in people who ask a lot of questions. I warm quickly to folks who favor this approach, since I've been a reporter for a while now. What little I've learned has come from asking lots of dumb questions -- I mean really dumb questions -- and repeating the answers right back to the person I'm interviewing, or writing them down. Through this process, I formulate new and better questions and always get better answers -- or a clear sense that the person I'm talking to won't, or can't, be candid.

One mark of independent thinking is the ability to think counter-intuitively. For example, Motley Fool Research Analyst Zeke Ashton applied a little counterintuitive thinking when he wrote about Yahoo! (Nasdaq: YHOO) and Lycos (Nasdaq: LCOS) in a recent story.

His theory goes like this: Seeing Yahoo! rival Lycos succeed isn't a bad thing for Yahoo! investors. Rather, it's useful, since it helps validate an emerging industry and puts Yahoo!'s enormous lead in relief.

For me, the lesson here is useful. When thinking about a complex system like investing, every question has to be put in context. It's a mistake to automatically assume the success of Lycos is a threat to Yahoo! merely because the two compete. A better question would be, what does Lycos' success mean for Yahoo!?

For me, counterintuitive and independent thinking often means asking a follow-up question, and then another. It's often that simple. Here's an example. Growth is good, right? Now the follow-up: What kind of growth are you talking about? Is some growth better than others? You bet.

Adrian Slywotzky points out in his book The Profit Zone that for many years corporations pursued sales and market growth as a kind of Holy Grail. Of course, a seasoned company that's growing unprofitably is destroying value, not creating it. Therefore, growth isn't a universal good. It has to be put into the context of profitability. If your favorite investment increases earnings per share every year, but continues to leverage the balance sheet and eat cash, well, that's lousy growth.

For years the business press has criticized General Motors (NYSE: GM) for losing market share. But, does it make sense for the company to grab market share if it's spending more than it's making? I'd rather see GM focus on profitability than selling more cars. (Nasdaq: AMZN), on the other hand, is in a different position. Jeff Bezos made the decision to eschew profitability and pursue growth -- a viable strategy over the short term, and one that worked well for Amazon up to this point.

I run across a lot of fresh-air, independent thinking in the Outstanding Investor Digest, especially in interviews with Berkshire Hathaway Chairman Warren Buffett, and Vice Chairman Charlie Munger. Both men are cut from the same cloth, but Munger in particular is articulate about the value of independent thinking.

Here's an example of Munger thinking counterintuitively. In a discussion about the Internet and the investment possibilities it created, he said, "It's not the bad ideas that do you in, but the good ones." He credits investor Benjamin Graham with saying this, but Munger gets credit for taking an old idea and applying it in a new place, the Internet. His point is pretty simple: The Internet will spawn a few great companies, and hundreds that are terrible. Buyer beware.

Here's another: "Good businesses can survive a little bad management." You can learn a lot watching a business wrestle trouble. That's the feeling I've had watching Gap (NYSE: GPS) this year. The company slipped off the beam with its fashions, and recently had problems getting back-to-school inventory into stores. It's also seeing Old Navy stumble for the first time, after five years of amazing growth. I'm eager to see how CEO Millard Drexler will right the ship, and how the company will assess 2000 in hindsight. My guess is Gap is good enough to take a direct hit and that it will emerge a stronger company.

Part of the difficulty of investing is parsing all the information -- the numbers, the ratios, the endless partnerships and product announcements. I separate the fact from the fluff by asking questions. I've never been able to ask a good follow-up question without trying to understand what I've just been told. I ask the easy question that's gnawing at me, take time to think it through, then ask a follow-up... and so on, and so on.

Great investors aren't all rocket scientists. Many whom I admire are folks like Philip Fisher, author of Common Stocks and Uncommon Profits, who wasn't afraid to ask basic questions over and over, always checking his assumptions, and working his way toward better questions and a better understanding of the business.

Have a great day.