Michael Mauboussin: What Distinguishes A Great Investor From A Good Investor

Johnny HopkinsMichael MauboussinLeave a Comment

In his recent interview with RIAIntel, Michael Mauboussin discussed a number of topics including what distinguishes a great investor from a good investor. Here are some excerpts from the interview:

What distinguishes a good from a great investor?

This difference rarely has to do with the tools they’re using but rather relates to their skills in decision-making — especially during challenging and stressful situations. The main way to improve outcomes is to enhance the process of decision-making.

Your work focuses on equities. To help identify promising investments, you have a deep faith in fundamental metrics such as discounted cash flow. How has that approach been dovetailing with what’s been happening in markets since Covid struck?

First, it’s important to distinguish between investors and speculators. Investors are buying partial stakes in companies. They need to ground their thinking in cash flow models. Speculators, in contrast, are trying to find stocks that go up. While there are pockets of speculation (e.g., meme stocks), I think for the most part markets have been acting very sensibly. My faith in fundamental analysis has not been shaken by market behavior over the past 18 months. I don’t see the markets being broadly mispriced.

Beyond DCF, what other metrics do you advise investors pay close attention to?

The spread between the return on invested capital and the cost of capital, the trajectory of sales growth, and the strategic positioning of the business. Many folks are concerned about macroeconomic conditions. It’s essential to be aware of potential macro-outcomes. I try to be macro aware but am macro agnostic. I’m honestly skeptical macro analysis can add value for most fundamentally driven investors.

Investors should focus first and foremost on a firm’s economic returns. A simple proxy for that is return on invested capital. Growth amplifies economic returns. If a business earns its cost of capital, you’re essentially on an economic treadmill. Whether it’s growing fast or slow, you’re not creating value. If your return on capital is high, growth is positive. The faster a firm grows, the more wealth gets created.

However, if returns are below the cost of capital, increasing growth destroys more value. Bottom line: consider economic returns first and growth second. Doing this demands an understanding of a firm’s strategic positioning and competitive advantage within its industry. If a company has such an advantage today, the next question is how sustainable it is?

You can read the entire interview here:

Michael Mauboussin Is Unshaken (RIAIntel)

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