Practical analysis for investment professionals
09 May 2019

What Makes a Great Investor?

Think back to your education. Remember your university or secondary school days. What did you learn then that you still use today? Does any of it help you in your professional life? And before you moan about how nothing you learned in school has any application in real life, let me assure you that this is not true. All of us are shaped by our education and we all picked up things in school that we still use today. So, try again and think about what you learned.

In my case, the big lesson I took from university was how to solve problems. In a previous incarnation, I was a physicist and mathematician. This meant solving integrals of complex functions or calculating the polarization of sodium D1 and D2 lines in the solar spectrum. In other words, don’t ask.

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After roughly two decades in finance, I could claim that nothing I learned at university helps me do my job. After all, what does calculating the polarization of sodium D1 have to do with investing? But in truth, every day at work I use the problem-solving skills I developed at university. While I may be a bit rusty at solving integrals these days, I’ve improved as a problem solver because I applied what I learned in school to an ever-widening set of problems.

One simple example is that I employ the approach advocated by mathematician Carl Jacobi: “Invert, always invert.” Jacobi argued that many complex problems can be solved if you invert them and think about the solution you want to find and then work backwards to your current situation. When you do that, you often find the quickest and most effective solution to seemingly intractable problems. In mathematics and physics, this inversion technique is applied all the time, and I use it again and again at work when assessing market developments or investment opportunities. To me, it’s just common sense.

But when I look around the investment world, I see too many research analysts, fund managers, and investors who can — to stick with my example from above — solve integrals at incredible speed, but can’t solve any problem they have not encountered before.

Research analysts and fund managers typically have been trained in finance and learned everything about financial statement analysis and how to calculate valuation ratios, etc. They know every little detail about the companies they cover, from the dividend coverage ratio to the amount of earnings growth expected in each of the next five fiscal years. And while that knowledge may be impressive, it does not make them great investors.

How can it be that during the tech bubble, for example, analysts on both the sell and buy side assumed technology companies would grow their earnings by 20% or more per year into eternity? Making that assumption may give you a fair value in your discounted cash flow (DCF) model that is in the vicinity of a company’s current market valuation. But if earnings grow at 20% indefinitely, the company would soon own the world. Heck, analysts currently estimate long-term earnings growth for Amazon at 36.8% per year. Assuming Amazon’s PE ratio stays constant, this means that in 2050 the company’s market cap would exceed US GDP. Research analysts who cover Amazon and fund managers who invest in it tend to know many details about the company, how it makes money, and where and how it can grow in the future. Yet all their technical expertise makes them miss the forest for the trees.

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Invert, Always Invert

Now think of the great investors in history. What differentiates them from the run-of-the-mill? How do people like Warren Buffett and George Soros, Seth Klarman and Howard Marks, CFA, Benjamin Graham and Peter Lynch, stand out? While all of them have different investing styles and approaches, they all have one thing in common: They are investment philosophers.

Look at the typical fund manager interviewed on television or in the papers. They usually share their “wisdom” about why they love growth or income stocks or why they think the Bank of England (BOE) will hike rates or not. Put another way, they talk their book. Now listen to Buffett or Soros: They don’t talk about any of these technical details. Instead, they focus on the big themes and trends that drive markets today and will continue to in the years to come. They think about the fundamental drivers, not about the recent data flow, and they have developed investment techniques that can adapt to a broad range of problems to understand the underlying market dynamics.

Graham’s Intelligent Investor and Security Analysis, with David L. Dodd; Marks’s The Most Important Thing; or Klarman’s Margin of Safety are timeless. Some of these titles may be decades old, but they are still as relevant today as they were when they were first published. Why? Because they don’t focus on technicalities but on how to assess investments in a fundamental and informative way.

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So, in the spirit of “Invert, always invert,” to become a great investor or research analyst, become an investment philosopher. Hone your skills in understanding market dynamics instead of memorizing data points or performing the DuPont analysis of return on equity. To be sure, you will need these expertise to become a great investor, but once you grasp the technique and how to calculate the elements, there is little added value in doing it over and over again or to an ever more sophisticated level.

That may keep you busy, but it won’t make you better, and it won’t make you a great investor.

For more from Joachim Klement, CFA, don’t miss Risk Profiling and Tolerance and 7 Mistakes Every Investor Makes (and How to Avoid Them) and sign up for his regular commentary at Klement on Investing.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©Getty Images/ToniFlap

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About the Author(s)
Joachim Klement, CFA

Joachim Klement, CFA, offers regular commentary at Klement on Investing. Previously, he was CIO at Wellershoff & Partners Ltd., and before that, head of the UBS Wealth Management Strategic Research team and head of equity strategy for UBS Wealth Management. Klement studied mathematics and physics at the Swiss Federal Institute of Technology (ETH), Zurich, Switzerland, and Madrid, Spain, and graduated with a master’s degree in mathematics. In addition, he holds a master’s degree in economics and finance.

9 thoughts on “What Makes a Great Investor?”

  1. Max says:

    This picture seems to be from Buenos Aires.

  2. Brian Kehm says:

    Thanks for your insight… Invert, always invert reminds me of reverse engineering… and if your problem is unique, find similar solutions. It’s also important to learn cross-disciplinary concepts. Great investors have ingrained timeless mental models and have learned to ignore the noise. Charlie Munger is another great investor of our time.

  3. Cornelius Chan says:

    Thanks for sharing your opinion. It is so true. I read Howard Mark’s The Most Important Thing and it really changed my way of thinking not only in finance and investment but to a certain extent life in general as well.

  4. Good investors know the inherent risk in investing. They understand their plans and analyze their expected returns. Being risk averse is a quality shaped by experience, knowledge and confidence over the above mentioned key characteristics.

  5. Kirk Cornwell says:

    First, luck — second, patience. The ability to read a balance sheet and some cash to start with are helpful. An ability to see emerging trends often is a factor. I bought and sold Apple in the mid-1980s.

  6. LEON SPIES says:

    With regards to the remark that Amazon’s expected earnings annual growth rate of 36,8% will grow the company’s market cap to exceed the GDP of the US in 2050, one has to keep in mind that everything is relative and that the US GDP will also grow. It is a moving target in other words.

  7. The photo depicts the Congress Park in Buenos Aires, Argentina. The Thinker (French: Le Penseur) is a bronze sculpture by Auguste Rodin.

  8. this article is too generic to make an invetors know what skill he need.

    we need how long the growth could be to give a stock its valuation. to know how long it grows, know how long it compete with other companies successfully. to do so, we need to realize competitive advantages a company have.

    a strategic perspective which includes competitive dynamics and the trend of customer demand is needed for an investor. the financial numbers partly help investors realize the competitive dynamics. but the view on future demand is also importan. future must be different from the past and this is why our society develop. internal combustion car will disappear and electric cars will appear. so, dont follow and buy the internal combustion car with good financial ratio. buy the electric car companies which will be profitable in the future and which could have bad financial ratio or in the red.

    how do we know the electric car companies which could make huge profit while at present is in the red. answer is simple. which companies is most competitive though they could also be in the red. most electric car companies are in the red. but which one will become a business empire and which one disappear. we need to know about competitive advantage. read strategic and competition books.

    if doing business is calculating the financial numbers, computers do business faster than we do. computer can not have strategic perspective like us. we win but not computers

  9. Be like a commercial credit professional. They make good self-directed investors in corporate stocks because they understand that companies who do not make profits are risks. They see the purpose of a company is to make a profit not to be bait for stock speculators.
    Their decisions of whether to grant credit or not are based on the historical and current factual information that they are able to gather on companies. Unfortunately, few of the risks they must assess are public companies who are traded on stock exchanges and must report audited financial information on a regular basis. Credit Managers must dig for historical trade payment information, the absence of presence of public legal records like writs, judgments, security registrations, etc.
    They are used to taking chances on newly formed small companies. Very rarely do they see a financial statement from a long-established financially strong company.
    Thus, when out of the 25,000,000 companies in North America having to determine the degree of risk with a few thousand publicly traded companies on the major stock exchanges is easy. Every public company has a financial statement. In a few seconds you can not only see they are profitable, but you can see if their ever-increasing share prices and dividend payouts stretch back for decades.
    Having dealt with deadbeats and shysters on a regular basis they are not impressed with the “potential profitability” of a hot stock being pushed by stock promoters. Unlike most speculators they want to see the financial facts that confirm before they invest that they will not lose money. However, they will also spread their risk among several stocks knowing that there is always the potential for a few unexpected losses within their portfolio.

    Thus, when I set out to build stock scoring software it was so much easier than when I had had to build a commercial credit scoring platform. All the information I needed on the few thousand publicly traded companies was instantly available and constantly updated.
    I decided to supply my stock scoring software with all six of my investment books, including my two latest “New York Stock Exchange’s 106 Best High Dividend Stocks” and “Canadian High Dividend Investing – 215 Scored Stocks”. Now, no one needs to be intimidated by the idea of investing in the stock market. Those who have lost money in the stock market often fail to recognize that stock investing is just another form of commercial risk.
    If you treat a stock like any commercial risk. it is not difficult to achieve a safe, reliable dividend income while watching your portfolio grow in value and keep you ahead of inflation for the rest of your life.

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