For an investor to be successful over many years and decades, a lot of things need to happen. For starters, they must pick the right stocks to buy. Businesses with competitive advantages and sizable growth runways can be fruitful investments. Additionally, it is helpful to have the right emotional makeup -- otherwise, they are liable to let emotional decision-making become the biggest impediment to their achieving good returns.
Related to that last point, one key insight might completely change how you view your investing actions. And it connects to an incredibly simple trick that can make you a better investor and boost your investing returns.
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Ignore the noise
A 1973 study done by psychologist Paul Slovic, and discussed in a recent Wall Street Journal article, analyzed horse racing handicappers based on how much information they had access to. With just five pieces of information about the horses, their accuracy at picking winners was 17%. When they were allowed to ask for 10, 20, or even 40 data points, their accuracy remained at 17%. The downside, however, was that their confidence in their predictions nearly doubled.
While predicting horse races isn't quite the same as investing in publicly traded companies, this valuable insight helps demonstrate why more information can be a bad thing.
One reason is that having access to more information may increase an investor's confidence, which could lead to riskier behavior. They might over-concentrate in a single stock or buy and sell too frequently simply because they think they have a better understanding. And this could lead to financial ruin.
Another reason is that if you're paying attention to more data points than you really need, you might end up giving too much weight to a factor that isn't so important.
Take streaming pioneer Netflix (NFLX -0.20%). While there is no shortage of opinions about this company, I see three things as mattering most to the investing thesis: the number of subscribers it can add over time, its ability to raise subscription prices (especially in the U.S. and Canada), and its generation of consistent free cash flow (FCF).
Being able to charge a growing number of customers more money is a sign of pricing power, a wonderful competitive edge. And generating positive free cash flow that it can use to reinvest in its business means Netflix has reached a scale that allows it to benefit from favorable economics. Looking out five years into the future, I'm almost certain that Netflix's share price will be much higher than it is now if the company is able to capitalize on those three critical factors.
Focus on what matters
Many of the largest asset managers and hedge funds maintain huge research budgets so they can try to uncover hidden insights about different companies and predict where their prices will go next. In other words, they try to collect as much information as they can. There's no way retail investors can compete with those operations.
But do we have to? Think of the information sources we have for free: SEC filings, companies' investor relations sites, certain industry-specific publications, earnings call transcripts, interviews with management, and more. That's more than enough to learn how a company makes money, what its biggest expenses are, and how it's trying to grow its value over time.
Some of the world's greatest investors, such as Warren Buffett, Dan Loeb, and Stanley Druckenmiller, advise people to focus on the few key variables that drive a business and a stock. Everything else is just noise.
To be clear, this doesn't guarantee better portfolio performance. But what it does do is ensure that one is disciplined enough to focus on the things that matter most to a stock and a company. And by identifying how the companies you invest in become more and more valuable, you'll be more likely to ride out the ups and downs long enough to earn long-term gains.
