In May, I had the opportunity to hear Michael Mauboussin, chief investment strategist at Legg Mason
Impressed with his remarks, I purchased a copy. It turned out to be a wonderful investment. In July, fellow Fool David Meier interviewed Mauboussin and highlighted two parts of his book: the difference between luck and skill, and something called "the Pyramid of Numbers."
Mauboussin uniquely approaches investing from a much broader perspective than your average Wall Street jockey -- a fact reflected in the content of the book, which covers everything from ants to S-curves. In a way, this is the main point of the book.
Mauboussin argues that although trillions of dollars are exchanged in the market every day, the investment community still lacks enough knowledge to make prudent investment decisions on a consistent basis. He contends that some of these shortcomings can be overcome by approaching investing from a more multidisciplinary perspective.
He elaborates on this thesis by drawing examples and stories from a diversity of sources, including the game of chess and power laws.
I'll share a couple of insights that I gleaned from the book, and being an avid sports fan, I'll highlight some sports analogies Mauboussin uses to elucidate his arguments.
Swing for the fences like Babe Ruth
One of Mauboussin's more salient points is his emphasis on "process over outcome." He sums this up by saying, "Good decisions will sometimes lead to bad outcomes, and bad decisions will sometimes lead to good outcomes." The important thing, therefore, is to focus on process as well.
Mauboussin uses the example of a well-known company whose stock is priced for perfection, positing that the business has a 75% chance of making its earnings projection. If it succeeds, the stock price would increase by 1%. There is, however, a 25% chance that the company won't make those earnings, in which case its stock would fall by 10%.
Many investors might be inclined to hold the stock, because it has a 75% chance of success. In More Than You Know, Mauboussin says this would be a costly mistake. Although the stock offers a great probability of success, it represents a negative expected value. That is, the expected value of the increase (0.75 times 1%) is only 0.75%, while the downside is 2.5% (0.25 times 10%).
Let's say you had decided to sell Yahoo!
A corollary: When assessing a stock's performance, "the frequency of correctness does not matter; it is the magnitude of correctness that matters." Mauboussin calls this the Babe Ruth effect. He says that even though "the Bambino" struck out a lot, he was still one of baseball's greatest hitters ever, because of the extraordinary impact he had when he was successful.
... And strive to be Joe DiMaggio
The best strategy, though, is to focus on process (to maximize the impact of your hits) while being selective about the "pitches" that you're trying to hit out of the park. The combination of the two disciplines provides the average investor the best chance of consistently beating the market.
Mauboussin reminds readers that "Long streaks are, and must be, a matter of extraordinary luck imposed on great skill." While it's statistically possible that an average baseball player with a lifetime average of .250 could break Joe DiMaggio's record of a 56-game hitting streak, it's significantly less likely than it would be for a player with a lifetime average of .333.
Why? Because every time the average player steps to the plate, the odds of him getting a hit are about 8% less than the more skilled and disciplined hitter. Compound the difference over a 56-game stretch, and the number will tell you why a Derek Jeter (with a current 23-game hitting streak) is a far better bet to break DiMaggio's record than, say, a utility infielder for the Kansas City Royals.
The same logic is at work for the best investors. Those who are likely to have the longest streaks -- such as Legg Mason's Bill Miller, who has beaten the market for 15 straight years -- are likely to have investing skill and a little luck.
In truth, though, DiMaggio's record will be almost impossible to beat. As Mauboussin explains in the book, even for DiMaggio -- whose lifetime batting average is only the 27th-best in baseball history -- the likelihood of achieving the record was less than one in a million.
... But be a Tiger
Mauboussin uses this reason to argue that investors must also strive to learn from Tiger Woods. In More Than You Know, the author recounts a wonderful story about the world's top golfer. In 1997, Woods dominated the Masters, winning by a record 12 strokes. But rather than resting on his laurels, he did something amazing. He came to the startling conclusion that his swing "really sucks" and immediately set about revamping it -- changing everything from his grip to improving his strength, even though, at the time, no other professional golfer even approached his level.
As a result of his retraining, from July 1997 to February 1999, Woods suffered a serious setback, winning only one tournament. He understood that in spite of his higher scores, he was getting better as a golfer. And when asked about his slump, he simply replied that "Winning is not always a barometer of getting better."
What Tiger probably should have said was that in the short term, winning isn't always a barometer of getting better. After his new swing started to gel, he went on to win 10 of the next 14 events he entered in 1999, including eight on the PGA Tour.
If you're a golf fan, you know that Tiger hit another small slump after his 2005 Masters victory, but has once again recovered in resounding fashion. He won five tournaments in a row recently, including the British Open and the PGA Championship.
To Mauboussin, the lesson of this story is that investors must also be constantly looking for ways to challenge themselves and improve their performance. They must not be afraid to try new methods, even when things are going well.
I took this to mean that value-based investors who might share Berkshire Hathaway
The Foolish final swing
The book clearly states that there's no shortage of ways for investors to improve their game. Mauboussin says that one way to do it is to branch out into new fields of study, such as science, psychology, economics, or the arts, to pick up new pieces of information. A second method is to hone your stock-picking and selling process by applying a greater level of discipline to your trading habits; and a third is to constantly identify and accept new challenges that can take your investing to the next level.
There are many other methods as well, and More Than You Know is an excellent place to start discovering some new ones. As the book's subtitle says, investors can still find a great deal of financial wisdom in unconventional places -- including the habits of The Babe, Joltin' Joe, and Tiger.
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Fool contributor Jack Uldrich would like to think he knows More Than You Know -- but he doesn't. He does know that he doesn't own stock in any of the companies mentioned in this article, with the exception of Google. If you want to know more about the Fool's strict disclosure policy, you can read it here.