One of the most important things that any of us can do to improve the quality of our lives is to improve the quality of our decisions. This principal applies to our personal life, our professional life, and our investments. What the notion of Value Investing really boils down to is using structured analysis to make better decisions.
When engaging in a deeper analysis of our decisions, the first and most important thing that we must understand is the difference between decisions and outcomes. The reason for this is because good decisions can sometimes result in bad outcomes, and bad decisions can sometimes result in good outcomes.
Ignorant observers who only look at outcomes (or “results” is corporate speak) can wrongfully assume that whatever produces good results is a good decision. This is how people get involved in speculative bubbles, Ponzi schemes, fix and flip pyramiding, and other strategies that led to inevitable collapse. What ultimately happens with every bull market is that the early movers or “smart money” players come in at the beginning when everybody else is afraid. As the market begins to recover, more people are attracted to invest and prices rise. Eventually, the rise in prices attract “dumb money” that only chases returns, and does not understand what drives those returns. This is typically the point where the bubble collapses.
As astute investors, we need to understand where exceptional returns come from, and by extension what makes for good decisions. Put another way, the “Smart Money” is interested in making good decisions, and the “Dumb Money” is interested in getting good results. This distinction is critically important to understand, since chasing results typically results in chasing fads. Chasing fads is how you end up buying at the top, only to watch your capital erode until you finally sell.
By understanding what assets are worth, it will prepare us to make informed decisions about when to buy, and when to sell. When market forces push prices below the intrinsic value of the assets, astute value-based investors buy. Similarly, when market forces push prices above the intrinsic value of the assets, value-based investors should start looking to sell. However, we should avoid trying to time the top or bottom of speculative bubbles. Any market can shoot higher or plunge lower than can be justified by any sane analysis.
| GOOD DECISIONS | BAD DECISIONS |
GOOD OUTCOMES | Desired Situation Consistent Success Comes From Here | Lucky Breaks Cannot Depend on This Long-Term |
BAD OUTCOMES | Sometimes Happens Will Not Always Happen | Natural Result of Bad Decisions This is How “Gamblers” Go Broke |
What this ultimately means is that value-based investors will frequently buy an under-valued asset only to see the price continue to go down before it goes back up. Similarly, value investors will often sell only to see the price continue escalating in a speculative bubble. As disciplined investors, we must learn to let go of the “ghost returns” that we could have made if we guessed the market correctly. Guessing is a game for gamblers, and we are not interesting in gambling.
Intelligent decisions should be based on insightful analysis. As astute investors, we need to use our knowledge of what drives the market, and what constitutes fair value to drive our buying and selling decisions. Discipline is required in order to stick to a winning system during the times when it is being “outperformed” by the good outcomes of other people’s bad decisions.
Good decisions and good luck are entirely different things … decisions are completely within our control, and luck is completely out of our control. There is no guarantee that all of your good decisions will end up producing good results. Sometimes a lucky idiot will create unbelievable profits by simply being at the right place in the right time, and being too ignorant to understand the risks that they are taking. None of us are interested in striking a future as a lucky idiot.
The most consistent path to success is through consistently making quality decisions. Over time, the impact of luck will tend to dissipate, as things go your way in some cases, and don’t go your way in others. However, quality decisions are not solely dependent on luck to generate success since they are based on fundamentals. This means that good decisions will have a long-term advantage in generating good results. This advantage will not always be apparent in the short-term, but is the source of long-term wealth that nearly every successful investor has learned to harness.
