One of Charlie Munger's favorite sayings is that "to a man with a hammer, everything looks like a nail." In other words, an analyst or investor who specializes excessively in one particular field may apply the rules of that field to everything he or she sees and thereby run the risk of missing extremely important developments elsewhere. For example, someone too narrowly focused on newspaper companies such as New York Times
One of the books on Munger's list of recommended reading is Richard Dawkins' The Selfish Gene. After reading it, I attempted to apply an evolutionary framework to investing in an attempt to learn how to become a better investor. I believe investors should consider a trio of fundamental concepts from this book.
1. Good genes get passed on.
If an organism has good genes in, say, strength or intelligence, then these extra skills give the organism a better chance of survival and of reproducing. A company's genes are its culture and its management. Talented people attract other talented people, and a good culture helps companies retain talented people.
As an analyst, I often focus too much on the numbers and not enough on the culture and management team. I believe this to be a crucial mistake, because identifying which companies have great cultures and management teams can be very profitable. For example, Goldman Sachs
Good genes get passed on, and so does good management.
2. Invest at the top of the food chain.
Would you rather have lunch or be lunch? I remember visiting the local Ikea to get some furniture before moving into my college dorm room. The store was located in a furniture plaza, with one huge Ikea and a multitude of smaller adjacent mom-and-pop furniture stores. I vividly remember that virtually every single mom-and-pop store was conducting a going-out-of-business sale. At that point, I realized that in life, there are predators, and there are prey, and it's better to eat than be eaten.
When looking at Warren Buffett's core holdings, such as Coca-Cola, Gillette (which was acquired by Procter & Gamble), and American Express
Many industries exhibit power-law market-share distribution. This means that the top player's market share is exponentially larger than the second-largest player's share, and so on, and profit margins are distributed accordingly. Thus, the predators at the top usually stay at the top. After all, when was the last time you saw a rabbit eat a fox? Of course, sometimes in the business world, the fox ends up buying the rabbit out at a 20% premium, but in most cases, such as with Ikea, the dominant companies end up putting the smaller companies out of business.
3. Invest in industries that operate in a stable environment.
Whereas some environments may change dramatically as time goes on, other environments are extremely stable. For example, rainforests and coastal areas are extremely unstable because of the instability of the environment. However, other environments operate under more stable conditions of temperature, food sources, and population.
Likewise, some companies operate in stable industries, and others exist in more chaotic sectors. For example, it doesn't take psychic powers to know that Wells Fargo
In short .
Keep your eyes open for good management, top players in an industry, and a strong, reliable business sector, and your portfolio is likely to live at or near the top of the food chain.
Fool contributor Emil Lee is an analyst and a disciple of value investing. He doesn't own shares in any of the above-mentioned companies and appreciates hearing about your comments, concerns, and complaints. The Motley Fool has a disclosure policy.