Source: Qile Club
Author: Michael Mauboussin
The author of this article, Michael Mauboussin, currently serves as the Head of Consilient Research at Morgan Stanley Investment Management and is the honorary chairman of the board of the Santa Fe Institute, a pioneer in multidisciplinary research on complex systems theory.
He has worked at several renowned institutions, including Credit Suisse and Legg Mason (where he was a colleague of Bill Miller, responsible for organizing forums on cutting-edge ideas). He has taught Security Analysis at Columbia Business School for over two decades.
In this article, he summarizes the ten characteristics of great investors. We categorize them into several aspects: sensitivity to numbers, understanding that investing is a discipline of comparison and probabilistic activity, and continuous evolution through reading, among others.
01. Successful investors must be sensitive to numbers.
Although investment decisions rarely involve complex calculations, successful investors possess a 'sense' for numbers and probabilities.
Proficiency in financial statements is one of the key manifestations of being sensitive to numbers. Great investors are adept at handling financial reports, distinguishing between profit growth and value growth. If a company underinvests in the future or its investments fail to yield 'appropriate' returns, the company can destroy value while increasing earnings.
Therefore, astute investors generally focus more on the present value of future free cash flows as a representation of a company's value rather than its current earnings performance.
At the same time, financial statements can help understand the connection between a company’s strategy and value creation. By comparing how different companies in the same industry allocate resources, one can assess competitive advantages and strategic superiority. Companies with higher profit margins and lower capital velocity adopt a differentiation strategy, while those with lower profit margins and higher capital velocity pursue a price-based strategy.
Thus, evaluating a company's ability to generate profits essentially amounts to assessing how long the company can sustain its current competitive advantage.
02. Understanding Value
For most listed companies, the investable period is not very long, roughly about a decade, yet numerous uncertainties exist, such as technological changes, shifts in consumer preferences, and competitive environments. What remains constant is that the present value of future free cash flow determines the value of financial assets.
Therefore, great investors are fully aware that superficial indicators such as price-to-earnings ratios and enterprise value multiples do not directly represent the value of a company; they are merely simplified tools used during the valuation process, helping to save time but also having limitations. “Cash is the truth, while profit is just an ‘opinion’.”
03. Evaluating Corporate Strategy Correctly
At the micro level, great investors have a clear understanding of how a company generates profits and are fully informed about changes in the drivers of profitability.
At the macro level, great investors can understand the unique position of the companies they invest in within their industries and assess whether their competitive advantages are sustainable. Strategy and valuation influence and interact with each other.
04. Investment Is a Discipline of Comparison
What particularly distinguishes ordinary investors from great ones is whether they can compare fundamentals with expectations or, in other words, identify “errors” in market expectation pricing.
Take horse racing as an example: the bets placed on a horse reflect its odds, which can be viewed as expectations, while fundamentals refer to how fast the horse can run. As Munger said, “We need to find a horse with a 1/2 chance of winning but offers odds of three to one.”
Humans tend to think by analogy. We find it relatively easy to understand relative value and rank things according to our preferences, but it is difficult to truly comprehend the absolute value of a company. If comparisons are confined to specific attributes while ignoring external conditions, the possibility of gaining insight may be lost.
Excellent investors know how to speculate on what lies behind appearances when comparing expectations with fundamentals. Take the example of birds flying: having wings and feathers is an apparent connection to flight, but flapping wings generates lift through aerodynamic principles, which is the intrinsic reason why both birds and airplanes can fly in the sky.
Similarly, great investors, when comparing the present situation with history, seek to understand the underlying driving factors that shaped that history rather than merely comparing prices or other superficial aspects, thus avoiding cognitive pitfalls.
05. Learn to think in terms of probability.
Investing is an art of probabilities. The entire thinking framework of great investors is built on probabilities, and they look for investment opportunities created by mismatches between price and probability in the market.
Outstanding investors continuously seek their own edge while paying more attention to the process than the outcome. Because of the existence of probabilities, good decisions sometimes lead to bad outcomes, and bad decisions can also lead to good outcomes.
Over the long term, if one possesses a correct decision-making process, even if bad outcomes occasionally occur, the overall 'investment performance' will still be satisfactory, requiring sufficient time and a large enough number of investment decisions for probabilities to take effect.
Buffett once summarized that he has always strived to 'maximize the probability of being correct multiplied by the potential profit of being correct, and minimize the probability of being wrong multiplied by the potential loss of being wrong.'
06. Update your views.
Views are hypotheses to be tested, not immutable principles. Many people tend to hold on to consistent viewpoints, and we always hope others remain consistent as well. This desire for 'consistency' grows stronger with age.
Great investors do two things differently from us: they actively seek out information and perspectives that differ from their own; and as soon as they find evidence that they are wrong, they update their views and take action accordingly.
Research indicates that individuals who actively seek out arguments opposing their own viewpoints tend to excel in forecasting. This effort, which goes against human nature, can offset the inherent bias of protecting one's own perspective. The most accomplished investors understand that the surrounding world is constantly evolving and that their perspectives should reflect this fluidity.
07. Develop a Clear Awareness of Behavioral Biases
If IQ represents cognitive ability and RQ (Rationality Quotient) denotes decision-making capability, the overlap between the two is actually lower than commonly perceived. Importantly, we should focus on cultivating our RQ.
Buffett once made an insightful analogy: 'I’ve always believed that IQ and talent represent the horsepower of an engine, while RQ represents its output. Many people start with an engine that has 400 horsepower but only achieve 100 horsepower in actual output, which is far less effective than fully utilizing 200 horsepower.'
Decision-making ability essentially reflects how well your beliefs align with the world. One way to enhance decision-making skills is to evaluate yourself. The capacity to avoid behavioral biases may partly stem from personality, partly from training, and partly from the environment. Exceptional investors recognize biases and know how to address them, placing themselves in a work environment that fosters thoughtful consideration.
08. Distinguish Between Information Itself and Its Impact
Take price as an example: Price is highly valuable information in financial markets. However, due to the social nature of investment activities, price can shift from being merely an information source to becoming an influence driver.
For instance, during the Internet bubble, rising stock prices increased investors’ paper wealth, influencing those who were not invested. Many eventually began purchasing, fueling the bubble. Negative feedback gave way to positive feedback (buying as prices rose and selling as they fell), causing the system to deviate further from its original trajectory.
Exceptional investors possess the ability to resist such influences, which requires disregarding others’ opinions about them—a trait inherently contrary to human nature. Successful investment decisions involve synthesizing various perspectives to form a well-considered viewpoint that diverges from consensus.
Collective wisdom is often correct, but when errors occur, you need strong mental fortitude to act against the trend. The reason it’s easier said than done is that it often entails risking one’s career.
09. Dare to make bold bets based on strengths.
Almost all investment institutions focus on developing their strengths, but they often pay insufficient attention to position allocation.
The establishment of a general investment portfolio typically follows this process: clarifying the strategy implementation method; identifying a combination of investment opportunities; and fully considering various constraints the portfolio must face (liquidity, potential cash withdrawals during the investment period, leverage, etc.).
Only after fully answering the above three questions can positions be allocated effectively. The most common methods are mean-variance optimization (maximizing returns for a given level of risk) and the Kelly Criterion (maximizing the expected geometric return of the portfolio).
The choice of method depends on how investment objectives, opportunities, and constraints are analyzed. This is also an important distinction between mediocre investors and great ones. The difference between long-term profitable investors and average investors lies in the former’s understanding that proper position allocation is as crucial as identifying investment opportunities for achieving sustained profitability.
10. The Importance of Reading
Students from Columbia Business School, as alumni, have the opportunity each year to visit Buffett and his colleagues, such as Todd Combs.
As a teacher, I am always curious about what they gain. Students were most surprised by the suggestion to read 500 pages per day. We are constantly overwhelmed by meetings, emails, and other tasks, making such a reading volume hard to imagine.
Munger once said his favorite quote from Einstein is: 'Success comes from curiosity, focus, perseverance, and self-criticism, with self-criticism referring to the ability to change one's own ingrained ideas, even those most cherished.'
Reading is a key way to cultivate these qualities. Munger also said: 'Among all the smart people I know, not one is not an avid reader—without exception.'
Great investors have three major reading habits:
First, always prioritize reading.
Buffett says he spends 80% of his workday reading.
Second, be all-encompassing.
Do not limit yourself to business and finance but let your curiosity guide your reading choices. Ideas or information from other fields can sometimes unexpectedly become excellent investment references.
Third, maintain a critical mindset.
Do not only seek opinions that align with your own. By reading, carefully understand the perspectives of those who hold differing, yet equally well-thought-out views. This helps maintain an open mind. Reading is especially crucial for investors because investing requires synthesizing information and ideas from various fields to continuously identify profitable opportunities.
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Editor /rice