The Intuitive Investor: Why Intuition Is Important
Over the course of my investment career, I used several unconventional tools to improve the results of the fund I co-managed, but none was more powerful than intuition. In fact, there is a growing regard for intuition as many successful investors, including George Soros, attribute their success to intuition. A recent Wall Street Journal article said of executive decision making, “The potential conclusion is that people who are good at strategy are better at sensing or feeling their way through strategies, rather than relying only on logic and being rational.” Even the author of My Life as a Quant, Emanuel Derman, has a deep-seated research interest in intuition.
In this, the first in a regular series on the importance of intuition in investing, I will weigh in on the burgeoning discussion about intuition.
Why Intuition Is Important
As I discuss in my book, The Intuitive Investor, it is intuition that allows investors to identify what unique data are relevant from a nearly infinite sea of information. Likewise, intuition helps to identify nonstandard risks when evaluating a business for possible investment. Intuition allows for an evaluation of perennially difficult factors that are used to inform our buy and sell decisions, including: future competitiveness of businesses; the likely success of new product offerings; the character or personality nuances of executives; and even the choices made in financial modeling, such as next year’s gross margins.
Furthermore, in an age in which many active investors fret that computer trading algorithms are poised to bleed all alpha away from human beings and turn investing into adventures in beta, it is important to remember what human beings can do that machines cannot do. Take the following as an example of the unassailable powers of the human over the machine, courtesy of intuition, creativity, curiosity, and of course, intellect.
The Power of Intuition
Here is an example of intuition in action, drawn from my own experience:
Arriving at the single gate airport in Santa Fe in late summer 1999, I see a 20-something Adonis clad in a bespoke suit and wearing dress shoes with square toes.
I take a moment to assess the situation. I do this to allow the powers of my intellect to assess the overwhelming sense my intuition is providing me: “This guy is unique.”
I then walk up to the young man and ask, “How was that drive up from Albuquerque?” He looks at me quizzically and replies of the 59.7 mile drive, “Windy.”
Without hesitation I say to him, “You are a health care investment banker for UBS Warburg,” and then ask, “What Genzyme deal are you working on?”
Shocked, the nearly speechless young man mumbles, “Er, uh, how did you know that? And who the hell are you?”
Shortly after this encounter there is, in fact, an investment banking deal led by UBS Warburg between Genzyme and Genesys announced on 18 October 1999.
This is the power of intuition when combined with the intellect — namely, the ability to see in the world what no one else is seeing. Keep reading to hear how I did what I did on that day in 1999.
Intuition Is the Partner of Intellect
Intuition is the hidden and more powerful partner of the intellect in investing. I want to emphasize the word “partner,” because what I really advocate is that investors use the entirety of their information-discovery apparatus — their consciousness — which includes both the intellect and intuition. But because financial analysis is typically thought of as, well, analytical and rational, and intuition is thought of as the opposite, irrational, most investors do not look to their intuition’s power for solutions. Worse still, they actively try and eliminate intuition from their processes. This is why I think intuition is more powerful than the intellect: Neglect of intuition by most leads to opportunity for those who use it.
What Is Intuition?
I think intuition’s power is further underappreciated because it is conceived of incorrectly. Intuition is not about being female. Intuition is not the same thing as gut instinct. Nor is intuition an uninformed guess. So what is it?
According to the Oxford English Dictionary, intuition is:
a. The immediate apprehension of an object by the mind without the intervention of any reasoning process; a particular act of such apprehension.
b. Immediate apprehension by the intellect alone; a particular act of such apprehension.
c. Immediate apprehension by sense; a particular act of such apprehension.
I agree with all the above definitions and believe that taken as a whole, they capture the essence of intuition. In a companion piece that accompanies this post, I discuss the definition of intuition very thoroughly. In particular, I counter the growing tendency of behavioral economists to slight intuition. Daniel Kahneman, for example, incorrectly associates his System 1 thinking with intuition, when in reality, I think he means instinct.
Intuition in Action
So in answer to the UBS Warburg investment banker’s question (“Er, uh, how did you know that?”), let me explain how my intuition and intellect worked together to reveal a piece of information that would have remained otherwise hidden were it not for intuition and creativity.
- I was in Santa Fe, New Mexico, USA, a small town of around 60,000 people. This is a factual piece of knowledge, and I therefore attribute this to my intellect.
- People in Santa Fe hardly ever wear suits — and never wear bespoke suits. This is an anecdotal piece of observational evidence, as I did not quiz Santa Fe residents about their dress. I attribute this to my intuition, which had highlighted for me years earlier the contrast between how people dress in other cities relative to how they dress in Santa Fe.
- I knew how to spot a bespoke suit. This is a factual piece of evidence, and I attribute this to my intellect.
- I knew that bespoke suits were very expensive. Intellect.
- I observed years prior that many investment bankers seem to look like male models. Again, this is an anecdotal piece of evidence, so, yes, I attribute this to intellect but more so to my intuition.
- I observed that New Yorkers are among the trendiest people on the planet, concerned about this season’s latest fashion as few other cultures are. Ditto the above.
- When I had been in New York City earlier in 1999, I had noticed that the “in” thing for men was square-toed dress shoes. Ditto the above.
- Thus, when I found myself “arriving at the single gate airport in Santa Fe in late summer 1999 [and saw] a 20-something Adonis clad in a bespoke suit and wearing dress shoes with square toes,” I said to myself, that is an investment banker from New York City. How else to explain someone so young, handsome, ignorant of local dress norms, and with a high income in the hamlet of Santa Fe?
- So now I knew I was seeing an investment banker. My intuition told me I was right. This felt like alignment with the truth — a feeling I believe most of us have felt.
- But why was the investment banker in Santa Fe? Was he on vacation or here working? Using my intellect and my intuitive sense of appropriateness, I concluded that the probability was that he was in Santa Fe working and not on vacation. Otherwise, he would know that people in Santa Fe do not wear suits, or he would prefer not to be wearing a suit at all.
- But how did I know he worked for UBS Warburg and not some other firm? Did I guess? Absolutely not. I knew that New Mexico only had two firms in the entire state that were publicly traded and both were health care companies, one in Albuquerque and the other in Santa Fe. Intellect.
- I knew that in a famous mutiny Smith Barney’s Benjamin Lorello had taken Wall Street’s largest health care banking team to UBS Warburg earlier in 1999 for a reported three-year contract worth a whopping $70 million. Only UBS Warburg could afford to cover such remote territory as New Mexico. Again, a combo of intellect and intuition. Once more I got that tingly “you’ve got it right” feeling associated with coming into accord with reality.
- I now knew that he was likely an investment banker for UBS Warburg, but from which of the two companies was a deal likely forthcoming? I surmised using a combination of intellect and intuition that it was the company he had spent more time with on his visit.
- Next, I knew that it would be too expensive even for UBS Warburg to pay for a car service to take the banker from Albuquerque the 60 miles up to Santa Fe. So the banker had probably driven a rental car. That was when my intuition and creativity led to a question that would help me resolve the dilemma: “How was that drive up from Albuquerque?”
- See, I knew it had been very windy the afternoon of the day prior, whereas today it was summer-comfortable. That suggested to me that he had likely flown in the day before and spent time in Albuquerque making a “Hey, we are now UBS Warburg, not Salomon Brothers”-type of check-in with a health care company. This guy wanted to finish his trip with his real interest: Genzyme.
- Most importantly, this entire process was guided by my creative and intuitive faculties. Put another way, I believe my intellect was in service to a higher form of consciousness.
Although this is a dramatic story of intuition’s power, when coupled appropriately with intellect, it is not unique. Better still, in the coming months I will share with you some of the secrets of how to tap your intuition and to deploy it as you see fit, whether it is to uncover an investment banking deal simply from momentary observation of an out-of-place character in Santa Fe or how much top-line revenue growth to assume in your discounted cash flow model.
I would love to hear from you about your stories and thoughts about intuition. Feel free to leave a comment below, or reach out to me at firstname.lastname@example.org and please put the word “intuition” in your subject line.
Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.
Photo credit: ©iStockphoto.com/retrorocket