The Intuitive Investor

During their latest episode of the VALUE: After Hours Podcast, Collins, Daniel, Taylor, and Carlisle discussed The Intuitive Investor. Here’s an excerpt from the episode:

Jake: I prepared a special little piece for you, guys, specifically that’s all about intuition, because I feel like you guys have pretty amazing record of intuition of things. So, I was wondering if I could go through that now.

Vincent: Oh, God.

Jake: No, this will be good. It actually started with a conversation I was having with a quant mind and friend of mine, and he was saying that it’s almost any famous investor or a successful investment strategy can be codified into rules, and then run as a quant portfolio, and therefore, which means it’s likely to be arbitraged away at some point by computers. And so, what he was saying is that, real alpha now is when a fundamental qualitative investor actually goes against their own rules, which implies that you have to have some intuition about what causes you to deviate. And then now, it’s a skill to know when to deviate from your traditional rules. So, the first thing I would want to know, do you guys agree with that? Well, one, is intuition even a real thing that you could depend upon or is that more of like a woo-woo concept?

Porter: Well, before we get into that, look at guys like Steve Cohen. They claim on his own trading book he’s never had a down year. A lot of that’s intuition. Yes, he’s got some-

Jake: Help.

Porter: -help, whatever. He obviously has great intuition. Some people are just fabulous traders. An investor is very different than a trader. And so, I think that traders have great intuition about how to– Even if you’re a bond trader, you’re an equity trader or a commodities trader, go to commodities. Commodities are very, very– The fundamentals are more ephemeral there than they are in stocks. And so, what makes oil go up? It’s supply and demand. And so, you have to understand those dynamics pretty well, and inflection points and stuff like that.

Jake: At the end of the day, it’s really just subconscious pattern matching. There’s some studies that support this. There’s this one called the Iowa gambling task. Basically, participants are presented with four decks of cards. They draw a card and that either adds to their total or subtracts from their total, and they get paid out from it. Some of the decks have these bigger rewards in them, but they’re also more frequent penalties to the point where it’s a negative expected outcome pull on that deck. And then other ones are positive, but they tend to be smaller.

What they find is that, people usually within 40 polls to 50 polls, they’re fairly effective identifying and sticking to the good decks, and so they’re consciously they understand like, “This is the deck I want to pull from.” But what’s interesting is, they’ll galvanic skin response, which is basically like a measurement that gets at stress, and people will exhibit stress when they’re hovering over the bad deck within 10 trials. So, long before it’s any kind of conscious [Tobias laughs] sensation, their body actually starts to know that that’s a losing deck before they even know. I’m curious. Do you guys have any that Spidey sense about something and do you trust it? When do you trust it and when do you fade it?

Vincent: Yes. I think we’ve been doing this long enough to know– I know my tells. I know what I’m stressed out about certain reasons, where it’s coming from and how it manifests in my body. I could feel it. So, I do believe in the fact of intuition. If I don’t feel like our portfolio is optimal, it’s a stress factor for me. I don’t know, if a portfolio is ever optimal or you never really feel like it’s truly optimal. But when you know you’re wrong, you feel it. I feel it. I feel it all the time. So, I do believe in intuition.

Tobias: Part of the problem is that you get the best portfolio after a long period of underperformance. And so, you feel like, “Shit, but the portfolio looks really good.” And then the other way around too.

Porter: I was going touch on a slightly different angle. What we try to do is be contrarians, and try to look where other people aren’t looking. We’ve been recently pitching this stock to a couple of friends, and no one’s listening. W even pushed Eisman recently. He goes, “I can’t touch that stock.” You obviously underwrite the stock and figure out that your downside is 10% and your upside is 100%. Obviously, people won’t touch it because it’s got some hair around it or people have had bad memories with it. And so, that’s where we feel like that you got to find these idiosyncratic bets where there’s not a lot of downside, and then where you could take a big, big position in something that has 10% downside and 100% upside. That’s the way where we, you know, we try to make differentiate ourselves, I would say.

Vincent: There’s good news, bad news to that, which is, to me, the good news is, because of all of the dynamics of the plumbing of the market, I feel like the market levels of inefficiency is probably close to its all-time high.

Porter: Right.

Vincent: It’s inefficiently too expensive in many names. It’s inefficiently too cheap in a bunch of other names. The problem is is that the majority of publicly traded capital being run are long-term, short-term momentum. So, being a contrarian, I think it’s extremely difficult to scale to a massive size. You need super patient outside capital to deal with, like you said, Tobias, that your portfolio probably feels at its best after you’ve had three months of getting punched in the face. That’s hard for any outside manager to tolerate and take. That said, there’s probably some of the best opportunities, as we know, are names that no one wants touch, if you have some patience and duration.

Jake: So, this is this book, The Emotionally Intelligent Investor by this guy Ravee Mehta. In it, he talks about six items that will help you to determine when you can trust your intuition and when you shouldn’t. And his list is, number one, it’s only valuable if it concerns something in which you have ample experience. So, you guys have so much experience that you can start to trust it. And actually, in Howard Mark’s latest memo that came out this week, he was talking about how he’s made five market calls over 50 years. They don’t start until the year 2000, and even though he’d been doing it for 30 years at that point. And so, he had seen enough patterns to be able to match where your brain can recognize the pattern at that point. This is Buffett’s basic circle of competence.

Porter: You know those inflection points you’re like, “That’s going to move that stock.” I’m confident that, if X, Y, Z happens, this stock is going to go and go whole lot.

Jake: Yeah.

Vincent: It’s funny. You just brought up Buffett. So, of course, my head went to a tangent of what he’s been doing recently. You talk about energy, Tobias, that you’re knee deep in energy. Everyone doesn’t want touch it. They’re worried about a recession, but here’s the goat, right?

Jake: Yeah.

Vincent: Just made a second acquisition in energy in an LNG facility. I don’t know, I would pay attention to what he’s doing. God, I wish someone knocked us on the head when he started buying Japanese commodity.

Tobias: Oh, yeah.

Porter: We did look at it. We owned the Japanese banks in the very, very early parts of the bull market, but we didn’t trust that one. 30 years of really awful performance is hard to get behind.

Jake: Yeah. [laughs]

Vincent: Yeah. Financials are an interesting breed. There’s such a different characteristics. We just happen to know them fairly well, and perhaps, maybe too well when it came to Japan. But I just found it interesting. He keeps buying Oxy, and he just made another acquisition. What does he say?

Tobias: Not much though. $3.3 billion. Obviously, I agree with thesis, but it’s just– For him, it’s not a huge position.

Vincent: Yeah.

Jake: So, a couple other things on this. Number two, remind yourself of your emotional biases. Number three, ask whether the investment reminds you of a previous situation where you’ve been successful. So, the more explicit you can be about the pattern match, probably the better. Number four, know the security and understand your risk reward. Like what you were saying, Porter, you know it’s a 10% downside, 100% upside. You still have to do the work, right?

Porter: Yes.

Jake: Number five, bounce ideas off of someone else. So, that’s courting the outside view, to use Kahneman’s term. And then the last one, maintain freedom to change your mind. So, set up trip wires in advance. That would be like, “Okay, if this happens, that destroys my thesis on this and we have to change our mind.”

Porter: When we were bouncing this idea of off Eisman off different guys, and a lot of people were like, “Oh, I can’t touch this thing. It’s too small.” We heard all the downsides. We’re like, “Okay, we got it. We know we’re talking about. We got our risk and we’re fine.” Yeah, those are great, by the way.

Vincent: Yeah, I loved all of them. I feel like, whenever we’re super successful on name-by-name basis, we probably employ the majority of those in some way, shape, or form or even better. There were a few things that you said where you avoid. Some of the names that you’ve been involved in, or if you see common characteristics of names that you’ve had mistakes on, you say, “All right, get out now.”

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