Seeking Perfection

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Perfection is an aspiration. It is something to strive for, an ideal so high that its nigh on impossible to achieve. Perfectionists are those that seek flawless outcomes, sublime achievements and impeccable results. And the reality is that if you're seeking perfection in Investment, you'll never get there.

The stock market is a complex system where an almost infinite number of variables can influence stock prices in any multitude of ways. Information is often ambiguous, participants are often irrational and those variables are in a state of flux. The future is unknown. In this environment you can’t possibly expect to know all the information that will impact a company or it's share price. Even the company CEO cannot know everything going on in a company.  And even if she could, to profit from it, she would then need to be able to understand how that information will impact market participants. 

Complex systems are full of interdependencies—hard to detect—and nonlinear responses. In such an environment, simple causal associations are misplaced; it is hard to see how things work by looking at single parts. Man-made complex systems tend to develop cascades and runaway chains of reactions that decrease, even eliminate, predictability and cause outsized events.” Nassim Nicholas Taleb

"The stock market, at least in the short run, responds to many factors besides profits and dividends. Inflation and interest rates, the supply of new stock underwritings, the money supply, investor confidence, government actions, and international events are all factors that interact with one another in subtle, changing and unpredictable ways. What we have, really, is a complex system with lags and multiple feedback loops. All such systems share certain characteristics that hinder predictive accuracy." Ralph Wanger

I remember working with a highly intelligent junior analyst who was always seeking more information about the companies we were analysing. He had come from a corporate finance background where he was used to having an abundance of information to prepare corporate documents and forecasts - company budgets, management accounts, debt schedules, contracts, etc. When it came to the markets and stock ideas, and he was confronted with having much less available information, he became paralyzed by the absence of data and was unable to make recommendations on the basis of probabilities.

And this is a common trend. Yet, accepting that we cannot know everything is an essential psychological mindset for successful investment. One of my favourite books “The Art of Learning” by the US Chess Master, Josh Waitzkin, highlights the need to be able to operate without perfection..

“We must be prepared for imperfection. If we rely on having no nerves, on not being thrown off by a big miss, or on the exact replication of a certain mindset, then when the pressure is high enough, or when the pain is too piercing to ignore, our ideal state will shatter” Josh Waitzkin

The current breed of 'Rocket Scientists' created by the Financial Industry want to set standards for Investment that are impossibly high. They want to have a 'clean sheet', an investment record so perfect that the Masters of the Finance Game bow in homage to it. But they're focusing on 'doing things right', rather than 'knowing the right things'; even the Investment Masters understand that striving for perfection is a futile exercise..

Perfection doesn’t exist in this world. All of my choices involve various degrees of compromise and tradeoffsThomas Gayner

"Trying to be right 100% of the time leads to paralysis" Sam Zell

“You can’t be 100% certain but try to look for weaknesses in your thinking” Walter Schloss

"I’ve never been 100% certain and I’m never seeking to be stubborn. There are many possible outcomes, and there’s a large range of profitable outcomes" Bruce Berkowitz

“Investing is about predicting the future, and the future is inherently unpredictable. Therefore the only way you can do better is to assess all the facts and truly know what you know and know what you don’t know. That’s your probability edge. Nothing is 100%, but if you always swing when you have an overwhelming better edge, then over time, you will do very well” Li Lu

“I am always searching for the underlying truth, based on insufficient information.. it’s simply not possible to have a complete understanding of anything. We’re never truly going to get to the bottom of what’s going on inside a company, so we have to make probabilistic inferences” Guy Spier

“One of the things I do very well in investing is, I gather a lot of information but I never know the whole picture. I have a lot of inputs but never everything and I have to make a decision on incomplete information" James Dinan

“Any time you’re investing, pretty much any style of investing, there is no such thing as a 100% sure bet. You can always have the asteroid come and take everything out – everything is probabilitiesMohnish Pabrai

“My conclusions are the result of my reasoning, applied with the benefit of my experience, but I never consider them 100% likely to be correct, or even 80%. I think they’re right, of course, but I always make my recommendations with trepidation” Howard Marks

Many investors and analysts rely on financial and mental models to understand and predict how a company operates and how it may perform in the future. But models are exactly that, models - they are not reality. Even the best models are imperfect.

“All models are wrong, some are useful” George Box

“Every scientific law, every scientific principle, every statement of the results of an observation is some kind of a summary which leaves out details, because nothing can be stated precisely”  Richard Feynman

"No model captures the richness of human nature. Models are supposed to simplify things, which is why even the best models are flawed” Philip Tetlock

"All models have an inherent limitation on their validity" Ralph Wanger

Models, including financial models, work only because they shed certain information in order to highlight or analyze other information. This is necessarily true. A great physicist once summed up the situation: "To build a perfect model of the universe would require all the matter and energy in the universe because the only perfect model, the only model that sheds no information and made no compromises in order to achieve its object, would be the universe itself." This is the virtue of models: They exclude information not directly relevant to the question under consideration, allowing us to focus on the significance of particular variables. This is also the vice of models: If the discarded information proves decisive to the issue being analyzed, the model will fail. If the model fails in a critical situation, and the people using the model cannot recover or even identify the critical lost information, they may not be able to react rationally to events; they may panic” Andy Redleaf

While models can’t possibly include all the variables that may impact a company, what's important is that they do consider the limited number of critical factors that are key to a company’s performance.

"In my early years, I ended up too much in the weeds. I had to know everything about a company and its industry. I’ve since learned that knowing less is okay as long as you have identified the one to three things that will drive the company. We believe exactness offers little so we prefer to establish a potential range of outcomes instead. We’d rather be directionally right rather than precisely wrong. " Steven Romick

"I believe that there's no need to know every detail, rather there's a need to understand the three, four or five factors affecting the company" Charles De Vaulx

"If you are an investment analyst or investment manager, to be successful and to do well, a couple of things have to happen. Number one, in most businesses, the results are driven by three or four factors that control let’s say 80 percent of the outcome and most entrepreneurs are honed in on those three or four factors. They understand those factors and they focus on those factors. If the factors you focus on do not match the factors that the guy running the business is focused on, you’ve not understood the business and there’s a problem over there." Mohnish Pabrai

“Every company has 100 things about them you could study and learn. But you have to understand the differences between data and knowledge, and between knowledge and wisdom. Warren Buffett is remarkable in his ability to cut right through. He sees very clearly the three or four or five critical factors that determine whether a company succeeds or fails. It’s not about encyclopedic knowledge, it’s about zeroing in on what truly matters and assessing that. There’s no substitute for that in this business." Howard Marks

Investment mistakes are usually caused by failures of analysis, not failures of collection. In lieu of time spent collecting all the available information, time is better spent on thinking and the reasoning processes.  Is the information collected practically useful? What psychological biases could be at play? Have competitors/customers/suppliers been consulted? Has the idea been tested? What assumptions are being relied upon? Can they be disproved? Can you imagine alternative scenarios? What could have been missed? What don't we know?  

"There are only a few things you have to get right about a company for it to be successful investment. Our view is that if you can get 85% of the way there by answering the big questions, don't waste your time on the last 15% because the marginal utility isn't worth it" Steve Morrow

“The value of in-depth fundamental analysis is subject to diminishing marginal returns” Seth Klarman

By focusing on the things that matter as opposed to seeking every last detail means you’re less prone to over-confidence and confirmation bias

Information tends to beget information, as users become addicts. “Perfect information”, the saying goes, “leads to perfect decisions.” But more and more information gathered in the name of the wrong context leads to worse and worse decisions”.  ‘Ceo’s and the CIA: Lessons Learned’  Inferential Focus 1998

“Investment experts continue to be convinced that their major problems could have been handled if only those extra few necessary facts had been available. They thus tend to overload themselves with information, which usually does not improve their decisions but only makes them more confident and more vulnerable to serious errors” Dave Dreman

"When forecasters have too much information, they often become even more inaccurate than when there is too little" Bennett Goodspeed

"Once an experienced analyst has the minimum information necessary to make an informed judgement, obtaining additional information generally does not improve the accuracy of his or her forecasts. Additional information does, however, lead the analyst to become more confident in the judgement, to the point of over-confidence" Richards Heuer

Although the ability to collect all the information will always remain elusive, investors can still achieve solid returns even if mistakes are made. You don’t need a perfect batting average.

“I am a professional mistake maker. One third of my trades are probably wrong” Ray Dalio

“If you’re terrific in this business, you’re right six out of 10Peter Lynch

“If an investor is right 2 out of 3 times in the investment decisions they make, they would hit the ball so far out of the park, it would be amazing” Mohnish Pabrai

The important thing is not to dwell on mistakes. Learn from them and move on.

“To others, being wrong is a source of shame; to me, recognizing my mistakes is a source of pride.  Once we realize that imperfect understanding is the human condition there is no shame in being wrong, only in failing to correct our mistakesGeorge Soros

“Since actual perfection and 100% satisfaction with a position are impossible, we must learn from results and not dwell on past outcomes, either good or bad. Moving forward, even from large errors, is required.” Paul Singer

“I may try to minimise my errors, but I'm not one to dwell on them.  It isn't worth it. You have to put mistakes behind you and not look back.  Tomorrow is another day.  Just go on to the next thing and strive to do your best." Warren Buffett

Remaining open-minded, accepting and learning from mistakes and adopting a sense of humility by acknowledging you can't know everything will improve investment results in an environment of impossible perfection. 

“The humility required for good judgment is not self-doubt—the sense that you are untalented, unintelligent, or unworthy. It is intellectual humility. It is a recognition that reality is profoundly complex, that seeing things clearly is a constant struggle, when it can be done at all, and that human judgment must therefore be riddled with mistakes.Philip Tetlock

"The more you learn, the more you will realize how little you know - and armed with this humility, you will never lose sight of the distance that separates self-confidence and self-importance" Jim Rogers

Even the Investment Masters make mistakes. It's human nature. And whilst perfectionism is also a fundamental human behaviour, striving for it in Investment is a mistake. We can learn from our mistakes, whereas if we are always seeking that perfect 'batting average', the chances of learning and adapting are minimal indeed. So before you buy your next stock, keep open the possibility you may be wrong ...