Investing Tips From Bugs Looking for some fresh ideas? Market strategist Michael Mauboussin gleans financial lessons from the oddest places
(MONEY Magazine) – What can ants, Babe Ruth or Social Security's troubles tell us about investing? A lot, says top market strategist Michael Mauboussin, who in February resigned from Credit Suisse First Boston to join Legg Mason. Just like biology or baseball, the stock market is a complex, ever-changing system governed by probabilities.
Mauboussin's CSFB newsletter, the Consilient Observer, enjoyed an elite subscriber list, including Amazon.com's Jeff Bezos and, perhaps not coincidentally, Legg Mason's Bill Miller. (You can find archived issues at expectationsinvesting.com.) There's not a stock tip to be found in the Observer--sample title: "Integrating the Outliers: Two Lessons from the St. Petersburg Paradox"--but Mauboussin has plenty of advice on how to think more clearly about chance, risk and the way businesses really work. Here are four of his most useful lessons.
--Strike out more often. Babe Ruth is known for his batting prowess, but he struck out nearly twice as often as he hit homers. Likewise, in investing it's not how many times you're right but how right you are. A portfolio in which seven out of 10 stocks fall could still post a terrific return if the three that rise go high enough. But most of us tend to want to be right all of the time. "How often we're right is how we tend to keep score," says Mauboussin. That can lead us to sell our winners too early, so that we can lock in a "right" answer, and hold our losers too long in hopes that they'll recover and make us right. Higher tolerance for mistakes could improve your stock picking in the long run.
--Why Intel is like the common fruit fly. A tortoise can live 100 years, but the fruit fly's entire life lasts weeks. Businesses too can have vastly different life cycles. So where are the market's fruit flies? MIT professor Charles Fine ranks industries according to "clockspeed" and says that makers of personal computers, semiconductors, and toys and games have the shortest cycles. Their assets don't last as long as most companies', and their product cycles are shorter. Investors need to think differently about how to value such high-clockspeed stocks, Mauboussin says. For one thing, their five-year earnings growth rate won't be a useful guide to their future.
--The world changes and so should your assumptions. When the government created Social Security in 1937, it designated 65 as the retirement age on the assumption that retirees would die soon enough that the program could be sustained without burdensome taxes. Today, of course, most of us can expect to live way, way past 65, and the Social Security system is woefully under funded. The lesson: When the world changes, you're in trouble if you rely on old information. For example, we shouldn't use past price/earnings multiples to understand today's stock market, Mauboussin says. Over the past 130 years, the average P/E of the stock market is just 15, compared with north of 20 today. But that alone doesn't mean that stocks are too expensive. Changes in tax rates and inflation-- among other things--all mean that stocks probably deserve a higher P/E today than in times past. Conversely, a stock that trades at a steep discount to its long-term historical P/E may not be a bargain if its underlying business is shrinking.
--Be an ant--seek diversity. When ants discover food, they leave chemical trails on the way back to their nest to help them find the food again. That's pretty smart for a bug. Here's what's even smarter: Ants periodically break from the path and begin a random search all over again--a survival strategy that keeps them on the lookout for the next food source. Investors too should break from their patterns and seek out diverse sources of ideas. Try switching newspapers every once in a while. Or ask your broker what stock ideas he's been giving to his other clients, who may have a different investing profile than you do. Says Mauboussin: "When you get too close or too comfortable, you don't get good perspective." --LISA GIBBS