April 23, 2023
I have now read The Education of a Value Investor, by Guy Spier, several times. It’s a very honest and insightful description of Guy Spier’s evolution from arrogant and envious youth to kind, ethical, humble, and successful value investor in the mold of his heroes—including the value investors Mohnish Pabrai, Warren Buffett, and Charlie Munger.
Spier recounts how, after graduating near the top of his class at Oxford and then getting an MBA at Harvard, he decided to take a job at D. H. Blair, an ethically challenged place. Spier realized that part of his job was to dress up bad deals. Being unable to admit that he had made a mistake, Spier ended up tarnishing his reputation badly by playing along instead of quitting.
Spier’s story is about the journey “from that dark place toward the Nirvana where I now live.”
Besides the lesson that one should never do anything unethical, Spier also learned just how important the environment is:
We like to think that we change our environment, but the truth is that it changes us. So we have to be extraordinarily careful to choose the right environment….
THE PERILS OF AN ELITE EDUCATION
Spier observes that having an education from a top university often does not prevent one from making foolish and immoral decisions, especially when money or power is involved:
Our top universities mold all these brilliant minds. But these people—including me—still make foolish and often immoral choices. This also goes for my countless peers who, despite their elite training, failed to walk away from nefarious situations in other investment banks, brokerages, credit-rating agencies, bond insurance companies, and mortgage lenders.
Having stumbled quite badly, Spier felt sufficiently humbled and humiliated that he was willing to reexamine everything he believed. Thus, in the wake of the worst set of decisions of his life, Spier learned important lessons about Wall Street and about himself that he never could have learned at Oxford or Harvard.
For one thing, Spier learned that quite a few people are willing to distort the truth in order to further their “own narrow self-interest.” But having discovered Warren Buffett, who is both highly ethical and arguably the best investor ever, Spier began to see that there is another way to succeed. “This discovery changed my life.”
WHAT WOULD WARREN BUFFETT DO? WHAT WOULD CHARLIE MUNGER DO? WHAT WOULD MARCUS AURELIUS DO?
Spier argues that choosing the right heroes to emulate is very powerful:
There is a wisdom here that goes far beyond the narrow world of investing. What I’m about to tell you may be the single most important secret I’ve discovered in all my decades of studying and stumbling. If you truly apply this lesson, I’m certain that you will have a much better life, even if you ignore everything else I write…
Having found the right heroes, one can become more like them gradually if one not only studies them relentlessly, but also tries to model their behavior. For example, it is effective to ask oneself: “What would Warren Buffett do if he were in my shoes right now? What would Charlie Munger do? What would Marcus Aurelius do?”
This is a surprisingly powerful principle: modeling the right heroes. It can work just as well with eminent dead people, as Munger has pointed out. One can relentlessly study and then model Socrates or Jesus, Epictetus or Seneca, Washington or Lincoln. With enough studying and enough effort to copy / model, one’s behavior will gradually improve to be more like that of one’s chosen heroes.
ENVIRONMENT TRUMPS INTELLECT
Our minds are not strong enough on their own to overcome the environment:
… I felt that my mind was in Omaha, and I believed that I could use the force of my intellect to rise above my environment. But I was wrong: as I gradually discovered, our environment is much stronger than our intellect. Remarkably few investors—either amateur or professional—truly understand this critical point. Great investors like Warren Buffett (who left New York and returned to Omaha) and Sir John Templeton (who settled in the Bahamas) clearly grasped this idea, which took me much longer to learn.
For long-term value investors, the farther away from Wall Street one is, the easier it is to master the skills of patience, rationality, and independent thinking.
CAUSES OF MISJUDGMENT
Charlie Munger gave a talk in 1995 at Harvard on 24 causes of misjudgment. At the time, as Spier writes, this worldly wisdom—combining powerful psychology with economics and business—was not available anywhere else. Munger’s talk provides deep insight into human behavior. Link to speech: http://www.rbcpa.com/mungerspeech_june_95.pdf
Decades of experiments by Daniel Kahneman, Amos Tversky, and others have shown that humans have two mental systems: an intuitive system that operates automatically (and subconsciously) and a reasoning system that requires conscious effort. Through years of focused training involving timely feedback, some people can train themselves to regularly overcome their subconscious and automatic biases through the correct use of logic, math, or statistics.
But the biases never disappear. Even Kahneman admits that, despite his deep knowledge of biases, he is still automatically “wildly overconfident” unless he makes the conscious effort to slow down and to use his reasoning system.
LUNCH WITH WARREN
Guy Spier and Mohnish Pabrai had the winning bid for lunch with Warren Buffett—the proceeds go to GLIDE, a charity.
One thing Spier learned—directly and indirectly—from lunch with Warren is that the more one genuinely tries to help others, the happier life becomes. Writes Spier:
As I hope you can see from my experience, when your consciousness or mental attitude shifts, remarkable things begin to happen. That shift is the ultimate business tool and life tool.
At the lunch, Warren repeated a crucial lesson:
It’s very important always to live your life by an inner scorecard, not an outer scorecard.
In other words, it is essential to live in accord with what one knows at one’s core to be right, and never be swayed by external forces such as peer pressure. Buffett pointed out that too often people justify misguided or wrong actions by reassuring themselves that ‘everyone else is doing it.’
Moreover, Buffett said:
People will always stop you from doing the right thing if it’s unconventional.
Spier asked Buffett if it gets easier to do the right thing. After pausing for a moment, Buffett said: ‘A little.’
Buffett also stressed the virtue of patience when it comes to investing:
If you’re even a slightly above average investor who spends less than you earn, over a lifetime you cannot help but get very wealthy—if you’re patient.
Spier realized that he could learn to copy many of the successful behaviors of Warren Buffett, but that he could never be Warren Buffett. Spier observes that what he learned from Warren was to become the best and most authentic version of Guy Spier.
One effective way Spier learned to deal with adversity was by:
…studying heroes of mine who had successfully handled adversity, then imagining that they were by my side so that I could model their attitudes and behavior. One historical figure I used in this way was the Roman emperor and Stoic philosopher Marcus Aurelius. At night, I read excerpts from his Meditations. He wrote of the need to welcome adversity with gratitude as an opportunity to prove one’s courage, fortitude, and resilience. I found this particularly helpful at a time when I couldn’t allow myself to become fearful.
Moreover, Spier writes about heroes who have overcome serious mistakes:
I also tried to imagine how Sir Ernest Shackleton would have felt in my shoes. He had made grievous mistakes on his great expedition to Antarctica—for example, failing to land his ship, Endurance, when he could and then abandoning his first camp too soon. Yet he succeeded in putting these errors behind him, and he ultimately saved the lives of everyone on his team. This helped me to realize that my own mistakes were an acceptable part of the process. Indeed, how could I possibly pilot the wealth of my friends and family without making mistakes or encountering the occasional storm? Like Shackleton, I needed to see that all was not lost and to retain my belief that I would make it through to the other side.
CREATING THE IDEAL ENVIRONMENT
Overcoming our cognitive biases and irrational tendencies is not a matter of simply deciding to use one’s rational system. Rather, it requires many years of training along with specific tools or procedures that help reduce the number of mistakes:
Through painful experience… I discovered that it’s critical to banish the false assumption that I am truly capable of rational thought. Instead, I’ve found that one of my only advantages as an investor is the humble realization of just how flawed my brain really is. Once I accepted this, I could design an array of practical work-arounds based on my awareness of the minefield within my mind.
No human being is perfectly rational. Every human being has at one time or another made an irrational decision. We all have mental shortcomings:
…The truth is, all of us have mental shortcomings, though yours may be dramatically different from mine. With this in mind, I began to realize just how critical it is for investors to structure their environment to counter their mental weaknesses, idiosyncrasies, and irrational tendencies.
Spier describes how hard he worked to create an ideal environment with the absolute minimum of factors that could negatively impact his ability to think rationally:
Following my move to Zurich, I focused tremendous energy on this task of creating the ideal environment in which to invest—one in which I’d be able to act slightly more rationally. The goal isn’t to be smarter. It’s to construct an environment in which my brain isn’t subjected to quite such an extreme barrage of distractions and disturbing forces that can exacerbate my irrationality. For me, this has been a life-changing idea. I hope that I can do it justice here because it’s radically improved my approach to investing, while also bringing me a happier and calmer life.
As we shall see in a later chapter, I would also overhaul my basic habits and investment procedures to work around my irrationality. My brain would still be hopelessly imperfect. But these changes would subtly tilt the playing field to my advantage. To my mind, this is infinitely more helpful than focusing on things like analysts’ quarterly earnings reports, Tobin’s Q ratio, or pundits’ useless market predictions—the sort of noise that preoccupies most investors.
LEARNING TO TAP DANCE
Spier, like Pabrai, believes that mastering the game of bridge improves one’s ability to think probabilistically:
Indeed, as a preparation for investing, bridge is truly the ultimate game. If I were putting together a curriculum on value investing, bridge would undoubtedly be a part of it…
For investors, the beauty of bridge lies in the fact that it involves elements of chance, probabilistic thinking, and asymmetric information. When the cards are dealt, the only ones you can look at are your own. But as the cards are played, the probabilistic and asymmetric nature of the game becomes exquisite…
With my bridge hat on, I’m always searching for the underlying truth, based on insufficient information. The game has helped me to recognize that 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.
Chess is another game that can improve one’s cognition in other areas. Spier cites the lesson given by chess champion Edward Lasker:
When you see a good move, look for a better one.
The lesson for investing:
When you see a good investment, look for a better investment.
Spier also learned, both from having fun at games such as bridge and chess, and from watching business people including Steve Jobs and Warren Buffett, that having a more playful attitude might help. More importantly, whether via meditation or via other hobbies, if one could cultivate inner peace, that could make one a better investor.
The great investor Ray Dalio has often mentioned transcendental meditation as leading to a peaceful state of mind where rationality can be maximized and emotions minimized. See: https://www.youtube.com/watch?v=zM-2hGA-k5E
To give you an analogy, when you drop a stone in a calm pond, you see the ripples. Likewise, in investing, if I want to see the big ideas, I need a peaceful and contented mind.
Having written about various ways that he has made his environment as peaceful as possible—he also has a library full of great books (1/3 of which are unread), with no internet or phone—Spier next turns to ‘rules and routines that we can apply consistently.’
In the aftermath of the financial crisis, I worked hard to establish for myself this more structured approach to investing, thereby bringing more order and predictability to my behavior while also reducing the complexity of my decision-making process. Simplifying everything makes sense, given the brain’s limited processing power…
Some of these rules are broadly applicable; others are more idiosyncratic and may work better for me than for you. What’s more, this remains a work in progress—a game plan that I keep revising as I learn from experience what works best. Still, I’m convinced that it will help you enormously if you start thinking about your own investment processes in this structured, systematic way. Pilots internalize an explicit set of rules and procedures that guide their every action and ensure the safety of themselves and their passengers. Investors who are serious about achieving good returns without undue risk should follow their example.
Here are Spier’s rules:
Rule #1—Stop Checking the Stock Price
A constantly moving stock price influences the brain—largely on a subconscious level—to want to take action. But for the long-term value investor, the best thing is almost always to do nothing at all. Thus, it is better only to check prices once per week, or even once per quarter or once per year:
Checking the stock price too frequently uses up my limited willpower since it requires me to expend unnecessary mental energy simply resisting these calls to action. Given that my mental energy is a scarce resource, I want to direct it in more constructive ways.
We also know from behavioral finance research by Daniel Kahneman and Amos Tversky that investors feel the pain of loss twice as acutely as the pleasure from gain. So I need to protect my brain from the emotional storm that occurs when I see that my stocks—or the market—are down. If there’s average volatility, the market is typically up in most years over a 20-year period. But if I check it frequently, there’s a much higher probability that it will be down at that particular moment…. Why, then, put myself in a position where I may have a negative emotional reaction to this short-term drop, which sends all the wrong signals to my brain?
… After all, Buffett didn’t make billions off companies like American Express and Coca-Cola by focusing on the meaningless movements of the stock ticker.
Rule #2—If Someone Tries to Sell You Something, Don’t Buy It
The brain will often make terrible decisions in response to detailed pitches from gifted salespeople.
Rule #3—Don’t Talk to Management
Beware of CEO’s and other top management, no matter how charismatic, persuasive, and amiable they seem. Most managers have natural biases towards their own companies.
Rule #4—Gather Investment Research in the Right Order
We know from Munger’s speech on the causes of human misjudgment that the first idea to enter the brain tends to be the one that sticks.
Spier starts with corporate filings—‘meat and vegetables’—before consuming news and other types of information.
Rule #5—Discuss Your Investment Ideas Only with People Who Have No Axe to Grind
The idea is to try to find knowledgeable people who can communicate in an objective and logical way, minimizing the influence of various biases.
Rule #6—Never Buy or Sell Stocks When the Market is Open
This again relates to the fact that flashing stock prices push the brain subconsciously towards action:
When it comes to buying and selling stocks, I need to detach myself from the price action of the market, which can stir up my emotions, stimulate my desire to act, and cloud my judgment. So I have a rule, inspired by Mohnish, that I don’t trade stocks while the market is open. Instead, I prefer to wait until trading hours have ended.
Rule #7—If a Stock Tumbles after You Buy It, Don’t Sell It for Two Years
When you’ve lost a lot of money, many negative emotions occur.
Mohnish developed a rule to deal with the psychological forces aroused in these situations: if he buys a stock and it goes down, he won’t allow himself to sell it for two years.
…Once again, it acts as a circuit breaker, a way to slow me down and improve my odds of making rational decisions. Even more important, it forces me to be more careful before buying a stock since I know that I’ll have to live with my mistake for at least two years. That knowledge helps me to avoid a lot of bad investments. In fact, before buying a stock, I consciously assume that the price will immediately fall by 50 percent, and I ask myself if I’ll be able to live through it. I then buy only the amount that I could handle emotionally if this were to happen.
Mohnish’s rule is a variation on an important idea that Buffett has often shared with students:
I could improve your ultimate financial welfare by giving you a ticket with only 20 slots in it, so that you had 20 punches—representing investments that you got to make in a lifetime. And once you’d punched through the card, you couldn’t make any more investments at all. Under those rules, you’d really think carefully about what you did, and you’d be forced to load up on what you’d really thought about. So you’d do much better.
Rule #8—Don’t Talk about Your Current Investments
Once we’ve made a public statement, it’s psychologically difficult to back away from what we’ve said. The automatic intuitive system in our brains tries to quickly remove doubt by jumping to conclusions. This system also tries to eliminate any apparent inconsistencies in order to maintain a coherent—albeit highly simplified—story about the world.
But it’s not just our intuitive system that focuses on confirming evidence. Even our logical system—the system that can do math and statistics—uses a positive test strategy: When testing a given hypothesis, our logical system looks for confirming evidence rather than disconfirming evidence. This is the opposite of what works best in science.
Thus, once we express a view, our brain tends to see all the reasons why the view must be correct and our brain tends to be blind to reasons why the view might be wrong.
AN INVESTOR’S CHECKLIST
Atul Gawande, a former Rhodes scholar, is a surgeon at Brigham and Women’s Hospital in Boston, a professor of surgery at Harvard Medical School, and a renowned author. He’s ‘a remarkable blend of practitioner and thinker, and also an exceptionally nice guy.’ In December 2007, Gawande published a story in The New Yorker entitled “The Checklist”: http://www.newyorker.com/magazine/2007/12/10/the-checklist
One of Gawande’s main points is that ‘intensive-care medicine has grown so far beyond ordinary complexity that avoiding daily mistakes is proving impossible even for our super-specialists.’
Gawande then described the work of Peter Pronovost, a critical-care specialist at Johns Hopkins Hospital. Pronovost designed a checklist after a particular patient nearly died:
Pronovost took a single sheet of paper and listed all of the steps required to avoid the infection that had almost killed the man. These steps were all ‘no-brainers,’ yet it turned out that doctors skipped at least one step with over a third of their patients. When the hospital began to use checklists, numerous deaths were prevented. This was partly because checklists helped with memory recall, ‘especially with mundane matters that are easily overlooked,’ and partly because they made explicit the importance of certain precautions. Other hospitals followed suit, adopting checklists as a pragmatic way of coping with complexity.
Mohnish Pabrai and Guy Spier, following Charlie Munger, realized that they could develop a useful checklist for value investing. The checklist makes sense as a way to overcome the subconscious biases of the human intuitive system. Moreover, humans have what Spier calls “cocaine brain”:
the intoxicating prospect of making money can arouse the same reward circuits in the brain that are stimulated by drugs, making the rational mind ignore supposedly extraneous details that are actually very relevant. Needless to say, this mental state is not the best condition in which to conduct a cool and dispassionate analysis of investment risk.
An effective investor’s checklist is based on a careful analysis of past mistakes, both by oneself and by others.
My own checklist, which borrows shamelessly from [Mohnish Pabrai’s], includes about 70 items, but it continues to evolve. Before pulling the trigger on any investment, I pull out the checklist from my computer or the filing cabinet near my desk to see what I might be missing. Sometimes, this takes me as little as 15 minutes, but it’s led me to abandon literally dozens of investments that I might otherwise have made…
As I’ve discovered from having ADD, the mind has a way of skipping over certain pieces of information—including rudimentary stuff like where I’ve left my keys. This also happens during the investment process. The checklist is invaluable because it redirects and challenges the investor’s wandering attention in a systematic manner…
That said, it’s important to recognize that my checklist should not be your checklist. This isn’t something you can outsource since your checklist has to reflect your own unique experience, knowledge, and previous mistakes. It’s critical to go through the arduous process of analyzing where things have gone wrong for you in the past so you can see if there are any recurring patterns or particular areas of vulnerability.
It is very important to note that there are at least four categories of investment mistakes, all of which must be identified, studied, and learned from:
- A mistake where the investment does poorly because the intrinsic value of the business in question turns out to be lower than one thought;
- A mistake of omission, where one fails to invest in a stock that one knows is cheap;
- A mistake of selling the stock too soon. Often a value investment will fail to move for years. When it finally does move, many value investors will sell far too soon, sometimes missing out on an additional 300-500% return (or even more). Value investors Peter Cundill and Robert Robotti have discussed this mistake.
- A mistake where the investment does well, but one realizes that the good outcome was due to luck and that one’s analysis was incorrect. It is often difficult to identify this type of mistake because the outcome of the investment is good, but it’s crucial to do so, otherwise one’s future results will be penalized.
Here is the value investor Chris Davis talking about how he and his colleagues frame their mistakes on the wall in order never to forget the lessons: http://davisfunds.com/document/video/mistake_wall
Davis points out that, as an investor, one should always be improving with age. As Buffett and Munger say, lifelong learning is a key to success, especially in investing, where all knowledge is cumulative. Frequently one’s current decisions are better and more profitable as a result of having learned the right lessons from past mistakes.
DOING BUSINESS THE BUFFETT-PABRAI WAY
Hang out with people better than you, and you cannot help but improve.
Pabrai likes to quote Ronald Reagan:
There’s no limit to what you can do if you don’t mind who gets the credit.
Buffett also talks about the central importance of treating others as one wishes to be treated:
The more love you give, the more love you get.
Spier says that this may be the most important lesson of all. The key is to value each person as an end rather than a means. It helps to remember that one is a work in progress and also that one is mortal. Pabrai:
I am but ashes and dust.
Spier explains that he tries to do things for people he meets. Over time, he has learned to distinguish givers from takers.
The crazy thing is that, when you start to live this way, everything becomes so much more joyful. There is a sense of flow and alignment with the universe that I never felt when everything was about what I could take for myself…
I’m not telling you this to be self-congratulatory as there are countless people who do so much more good than I do. The point is simply that life has improved immeasurably since I began to live this way. In truth, I’ve become increasingly addicted to the positive emotions awakened in me by these activities… One thing is for sure: I receive way more by giving than I ever did by taking. So, paradoxically, my attempts at selflessness may actually be pretty selfish.
THE QUEST FOR TRUE VALUE
Buffett calls it the inner scorecard and Spier calls it the inner journey:
The inner journey is that path to becoming the best version of ourselves that we can be, and this strikes me as the only true path in life. It involves asking questions such as: What is my wealth for? What give my life meaning? And how can I use my gifts to help others?
Templeton also devoted much of his life to the inner journey. Indeed, his greatest legacy is his charitable foundation, which explores ‘the Big Questions of human purpose and ultimate reality,’ including complexity, evolution, infinity, creativity, forgiveness, love, gratitude, and free will. The foundation’s motto is ‘How little we know, how eager to learn.’
In my experience, the inner journey is not only more fulfilling but is also a key to becoming a better investor. If I don’t understand my inner landscape—including my fears, insecurities, desires, biases, and attitude to money—I’m likely to be mugged by reality. This happened early in my career, when my greed and arrogance led me to D. H. Blair…. [also later in New York with envy]
By embarking on the inner journey, I became more self-aware and began to see these flaws more clearly. I could work to overcome them only once I acknowledged them. But these traits were so deepseated that I also had to find practical ways to navigate around them.
The important thing is to understand not only human biases in general, but also one’s own unique brain. Also, some lessons can only be learned through difficult experiences—including mistakes:
Adversity may, in fact, be the best teacher of all. The only trouble is that it takes a long time to live through our mistakes and then learn from them, and it’s a painful process.
It doesn’t matter exactly how you do the inner journey, just that you do it.
[The] real reward of this inner transformation is not just enduring investment success. It’s the gift of becoming the best person we can be. That, surely, is the ultimate prize.
BOOLE MICROCAP FUND
An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time. See the historical chart here: https://boolefund.com/best-performers-microcap-stocks/
This outperformance increases significantly by focusing on cheap micro caps. Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals. We rank microcap stocks based on these and similar criteria.
There are roughly 10-20 positions in the portfolio. The size of each position is determined by its rank. Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost). Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.
The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods. We also aim to outpace the Russell Microcap Index by at least 2% per year (net). The Boole Fund has low fees.
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Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.