Why is this happening?
People overemphasize the importance of science and numbers in investment, as I mentioned in the book “The Rules of Super Growth Stocks Investing”, section 1-1. Investment is a not a science but an art in the economic field under sociology, which is more related to humanities (I think the word humanities is very appropriate; because investment is indeed more related to human nature, the masses, psychology, daily life, economic supply and demand); and it’s not that knowledge in natural disciplines such as physics, mathematics, and engineering can be verified repeatedly with mathematical formulas, 100% the same, the same, and correct answers – there is no 100% correct answer in the investment world. But most people put too much emphasis on quantification (numbers) and do not believe that in the investment world, non-quantitative (qualitative) factors are the most important ones.
- But as I mentioned on section 5-1 in my book “The Rules of Super Growth Stocks Investing”, non-quantitative factors are often the factors that determine the success or failure of an investment – that is, valuation – This is also the most difficult part of the three major factors in which stock prices will rise (see section 1-2 of my book “The Rules of Super Growth Stocks Investing” for details).
- If you have an excellent understanding of non-quantitative factors and find companies that have not yet been reflected in the stock price in time, your chances of successful investment will be far greater than others.
- In the investment world, what can be calculated is easier and even a secondary factor.
- If investors observe carefully, it is easy to find: Why are the moats of most great companies actually non-quantifiable factors? For example, the ability to manage the team, the efficiency of the enterprise, the culture of the enterprise, the design concept of the product, the brand advantage, etc., – because non-quantitative things are difficult to replicate by competitors.
But people like to think quantitatively
As for why people pay more attention to quantitative factors, I think the possible reasons are as follows:
- As mentioned earlier, quantitative factors are visible and can be expressed in numbers; people are inert.
- Education is becoming more and more popular, and everyone is doing everything possible to apply the quantitative tools such as statistics and mathematics learned in school to investment (the economist Hayek also has a similar view). The unreasonable phenomenon caused by the use for use, even if it is absurd, can be rationalized by finding reasons. This is what Buffett calls “Institutional imperative“. Charlie Munger made a thought-provoking comment on this phenomenon, “To the man with only a hammer, every problem looks like a nail.” In a 2003 speech as UCB Business School, Munger said: “But there are other factors that are terribly important, [yet] there’s no precise numbering you can put to these factors. You know they’re important, but you don’t have the numbers. Well, practically (1) everybody overweighs the stuff that can be numbered, because it yields to the statistical techniques they’re taught in academia, and (2) doesn’t mix in the hard-to-measure stuff that may be more important. That is a mistake I’ve tried all my life to avoid, and I have no regrets for having done that.”
- Non-quantitative factors are difficult to observe, not easy to obtain, and even more difficult to distinguish. They usually require a deep understanding of the company or industry, and are willing to invest a lot of time and effort. If they are not within the investor’s ability circle, it is almost difficult to identify . In addition, extraordinary insight is required, none of these conditions are indispensable. Therefore, there are considerable barriers to entry; unless you have invested heavily in investment and are willing to pay efforts, it is difficult to do so.
This is the difference between Buffett and Graham
Keynes said, “When statistics do not seem to make sense, I find it is generally wiser to prefer sense to statistics.” I mentioned it on section 2-1 of my book “The Rules of Super Growth Stocks Investing”; the simplest and most important difference between Buffett and Graham is that Graham’s investment “only” focuses on quantitative factors. At the beginning of his investment career, Buffett looked at quantitative factors in the same way as Graham, but as he ages, he pays more and more attention to non-quantitative factors and lessens the importance of quantitative factors. But the long-term results are clear – Buffett has been the world’s richest man many times. He is known to be the most successful investor in history. And his teacher, the status of investment theory is undoubtedly, won the respect of the world; but no one will include Graham among the very successful investors in history, for this reason.
How do the masters of quantitative investment theory invest?
Harry Markowitz won the Nobel Prize in Economics in 1990 for proposing the modern portfolio theory: his original average variance portfolio optimization, showing how investors should properly allocate various funds and assets to a certain degree of risk to get the most reward. You might think that Markowitz should be the richest man in the world when he retires. But instead, he simply distributed his pension equally to stocks and bonds, instead of using the complicated calculation and allocation method of modern portfolio theory that he proposed and awarded. He explained it this way: I should have calculated the historical covariance of asset classes and plotted the efficiency frontier. But I thought that if the stock market index rose but I didn’t enter the market and I didn’t have time to come out when it fell, then I must regret it. The goal is to minimize the chance of regret in the future, so I finally decided to distribute the pension equally to stocks and bonds.
How the successful cases of venture capital consider?
Putting aside the fact that the hit rate is extremely low (this is not the focus of this article), why do most people envy the lucrative profits of venture capital as high as tens, hundreds, or even thousands or tens of thousands of times? Because the factor that determines the success of venture capital is that they can see the business potential of unicorns earlier than most people in the world. The key is of course not the earning power of these unicorns when they are targeted, because no unicorn can be profitable, that is, quantitative factors are not the focus. Conversely, the focus of venture capital is on non-quantitative factors, such as:
- Complementary degree of expertise between co-founders
- Competitiveness of the company’s products
- Product acceptance in the market
- The possibility of monetization
- What is the potential for outbreak or growth
None of the above points can be quantified, but they are all crucial factors for the company’s future profitability and ability to survive.
Most successful investment gurus are non-quantitative
If investors carefully study the investment principles of all the most successful investment masters in history recognized by the public (Buffett, Peter Lynch, Keynes, Munger, Fisher, etc.,) the main investment masters investment principles, methods, strategies, and experience are all non-quantitative points, and never put forward any mathematical formulas or numbers. No, none of them. This is certainly not a coincidence, this is the consensus of these successful investment masters respected by the world!
In my book “The Rules of Super Growth Stocks Investing”, section 5-1 once listed “Use at Least 5 Questions to Screen Whether Worth Investing.” These five questions are not quantifiable, but they are extremely important for investors to evaluate whether they want to invest. These questions do not need to be calculated, and there are no figures; if you know the company well, you should know the answer immediately without consulting any information; if you cannot answer these five questions, then you really should not consider investing in this company. Because the answers to these questions determine whether this is a company worthy of your bet on a large amount of capital investment.
In the world of investment, the word “definite” does not exist. If there is a certain thing, there will be formulas. For this reason, investment is an art, not a science. Therefore, what investors should pursue is to increase the probability of investment success, that is, the possibility of things happening.
Quantitative factors are priced in the stock price
The important thing is: usually quantitative factors have been reflected in the stock price. Non-quantitative factors are usually difficult to reflect in a timely manner, as long as they are reflected, it will cause extremely large rises and falls in stock price. In fact, this is to find out the “intrinsic value” that others have not yet seen. The market will eventually reflect the reasonable intrinsic value of the company. The content of my book “The Rules of Super Growth Stocks Investing” section 1-2 mentioned the third most important factor among the three factors affecting the stock market. So investors want to make a lot of money and get excess returns; please focus on non-quantifiable factors. It is of course difficult to gain insight into non-quantitative factors (this is what Howard Marks called the second layer of thinking), but it is worth it.
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