Investing is as much about psychology and intellect as it is reading financial statements. David describes three kinds of thinking that investors can use to get an edge.
Rule Breaker Investing
How Investors Should Think About Thinking
It's the Rule Breaker Investing Podcast with Motley Fool Co-Founder, David Gardner. And welcome back to Rule Breaker Investing, a delight to have you join in with me this week. And before I start, I want to go back and look backward briefly. So over the last four weeks, let's briefly cover the four things that we've talked about that we've learned together. Four weeks ago, we talked about multiple futures versus one future. If you've not already listened to that, it was podcast number 12. I recommend it to your attention, thinking in terms of which companies have many potential different futures and which companies just have likely very one single future. Number two, the week after that, podcast number 13 of Killers and Kings, exploring how our misleading tendency to make binary assumptions driven by a media that loves headlines about Killers or Kings can lead you down the wrong path with both your perceptions and sometimes with your investing too. The week after that, the tale of Spiffy Pop, I wanted to make sure that everybody listening to Rule Breaker Investing knows what my screen name on the Motley Fool website, TMF Spiffy Pop, means. And more specifically, I wanted to make sure that you start to aim for Spiffy Pop's in your investing life. And then last week, we talked about technology accelerating, that's podcast number 15. Ray Kurzweil talking about how the world is speeding up, innovations are happening faster than ever before and what are the implications then for our investing. And as I look back over these four, two quick thoughts to share, the first is, I'm reminded that we used to do this in my Shakespeare English class in college. The late great professor, Darryl Glass at the University of North Carolina, himself a Rhodes Scholar, one of my favorite professors in my four years in Chapel Hill. And Darryl would always start every class by having one student picked at random, have to review what we covered last class. And what he was doing for us is he was reviewing and saying in the active review, this is when we really learn. I think studies sometimes, I remember him quoting studies saying that you have to really hear something six times, let's say a name. So it's really good with phone numbers, but a phone number, six times your credit card number if you like to memorize it, six times before you really know it. And so he would start to vote the first five minutes of every class simply to reviewing what was covered last class. So that's thought number one, that's what I'm doing here. It's a tribute to Darryl, but I also just think it's good to remember where we've come from and remind ourselves and relearn those lessons. And then the second thought about that is a little bit deeper, a little bit more broadly, Rule Breaker Investing, this podcast, I mean, as I think about those four topics, I mean, are those about investing or hardcore stock market stuff? Not really. Not really. In fact, when I think about what we covered and I think about our podcast overall, I would say we're not really about investing. Have you noticed? I mean, yes, ultimately we're trying to translate this into making better money, making more dependable money, making money as investors on the stock market, but really what this podcast is about is we're about thinking, thinking different, thinking better, certainly an aim for all of us at all times, thinking leading to action. It is, in fact, this love of thinking, about thinking how to think, the metagame of thought that I want to spend a little bit of time this week. Specifically, I want to review three types of thinking and illustrate them for you each. Three of my favorites. By no means am I a student, I did take Shakespeare in college. I mentioned that I never took any class on cognition. So please don't view me as anything more than a fellow noob, a fellow traveler on the path of life, just trying to figure out how things work. But I've definitely started to aggregate my thoughts around three buckets of standard forms of thinking that I find very helpful for me as an investor. And so let's cover the first one right now. The first one is systems thinking. There's a wonderful book called Thinking in Systems, written by Danella Meadows, kind of regarded as one of the forerunners of the whole systems thinking movement. She wrote the book, she was an MIT systems professor in the 1990s, she wrote the book partly back then, but died suddenly, unfortunately, in 2001, never finished her book. And then an associate started to get all the rest of her thought together and compiled it into this book, which was published in 2008, so a little storytelling around Danella Meadows's book. But systems thinking, something that you may have heard about, something you might well do, sometimes subconsciously, sometimes very consciously, I bet some of you know a lot more about systems thinking than I do, but let me give a couple of examples of systems thinking. First of all, just to define this one, because this is a little bit more technical than my other two, Danella Meadows defined it as a system is an interconnected set of elements that is coherently organized in a way that achieves something. So that was her definition of a system, an interconnected set of elements that is coherently organized in a way that achieves something. It's more than the sum of its parts. So for example, a body is a system versus just the individual cells, a university, the system more than the sum of its parts, its individual students, an ecosystem versus an individual plant or animal, a living being is a system, she would say, but it loses its systemness when it dies. So that's a little bit about what a system is. And when you start thinking in systems, it involves largely trying to get up above what you're looking at and seeing how those cogwheels are spinning and what they're striking and how the whole thing works. And while it's easy often for us to do this in our professional or hobby lives about things that we know really well, sometimes we get so inured to how things are or we get so down in the weeds that it's hard for us to get up above and see the system. And I think that I'm a systems thinker. Again, I'm not a practiced particularly or a certainly studied systems thinker, but I think some of the things that we do with this podcast in our investment approach indicate systems thinking. So two quick examples, I would say the very concept of rule breaker, like the very name of this podcast, really our investment approach, that is a system, right? We're looking at how the world works and we're saying, here's the story of business. I sometimes say every great company starts, it needs to provide a better solution, maybe a better product or service. Usually it comes along and disrupts the status quo. We call those the rule breakers, they're breaking the rules of how things are done. And in time, they hope one day to move from breaking the rules to making the rules rule breaker to rule maker. That's a narrative. I just gave you a story. It's in my head. It's a model. Maybe you see it, maybe you agree with it, maybe you don't. But I think we can both agree that's kind of a system that we have in place, the very concept of being opposed to the majority in a self-conscious way and asking, why will that be valuable? If everybody's doing one thing, we're going to do something else. That system's thinking inherently. And then let me give a second example, which goes back to one of my earliest podcasts when I was talking about the six signs of rule breaking and the sixth sign in particular, which is that we're looking for our stocks to be called overvalued. We want there to be a general perception, even better if it's on the headline of business week or a big Wall Street Journal article taking down this company, calling it out whatever it is as overvalued, we want that. Why do we want that? Well, that means that there's a lot of money on the sidelines, probably a little bit more scared money as big negative articles written about how overvalued that stock is, if the perception is that something is dramatically overvalued, then of course, most people aren't going to be investing in it. Their money stays outside it. But usually, in my experience, things are called overvalued because they're really good. It's just that people think it's trading for way too much. There's no profits yet. How could Google hasn't even figured out how to make money yet was one of the big arguments about Google back in the day. How's that company ever going to make money so as people don't invest in it? But if that excellent thing is truly excellent and continues to perform over time, what naturally happens is converts start showing up. And they start saying, "Well, you know, I missed it early, but I'm going to buy some shares now." And that's what ultimately drives stock market pricing and great stocks over time. That's more systems thinking, right? That's looking specifically for an attribute based on how we see the system functioning. All right, systems thinking, we've covered it. I don't have that much more to say about it because as I said, I never really studied it, but I do admire it and I do look to cultivate it and I do like to talk about it. That's form of thinking number one, form of thinking number two, pattern recognition. So this one's a little bit quicker and easier. By the way, for each of these, I'm going to mention how practicing this form of thinking will make you more awesome. And I meant to close my systems thinking one by saying that if you can do this well, what you're going to be able to start doing is playing things forward, right? If you're looking at the system and you can see the full manufacturing, right, from the start of the conveyor belt right to the end, you're able to look about it, you're going to be able to predict what things are going to look like at the end because you're able to see the system and you just play it forward. And most people don't do that very well or aren't even looking to do that. So you can get a little edge here by playing things forward with your systems thinking. That's your slightly more awesome superhero power you'll be gaining from form of thought. Number one, form of thought number two, pattern recognition. I'll say right up front, how you'll become more awesome with pattern recognition. That is you'll just make quicker and more confident decisions. That's my experience when you start recognizing patterns. Now we all do this all the time and there is some relationship between pattern recognition and systems thinking. To me, systems thinking is more complex. It requires deeper knowledge and you really have to get in and see all those cog wheels and understand which direction they're spinning and what's going to happen. But pattern recognition, well, what's a good example of that? How about our stock pick of Mercado Libre, where from the earliest write up, I think, we were saying things like, it's the Amazon and eBay of Latin America, or sometimes you'll hear people say that's, you know, he or she, he in this case, is the Elvis of Mexico. Whenever you hear people, I think Americans do this more often to relate the rest of the world to America. We tend to say the Elvis of Mexico, or I just read an article this week on Twitter about the buffet of Canada. And apparently, there's now three or four people that are regularly called the buffet of Canada. So as investors, maybe especially as those of us who are Americans, I know I'm happy to say I have a lot of people outside of America who listen to Rule Breaker Investing, but maybe it's a particularly American phenomenon that we tend to do that. But anyway, pattern recognition, right? You've seen it before and you've seen it enough times before that you now see, again, this thing happening and it helps you be quicker and make better decisions. Let me give a quick additional example and we'll talk about it in another Rule Breaker Investing podcast. I haven't got to this one yet. So in future, we'll talk about the hype cycle. I know many of you will probably know Gartner, the consulting firm, developed this framework to describe the five stages of hype. And usually these are around things like new technology or you could apply it to a stock or the stock market overall. Anytime you see hype, there's a cycle there. And once you've seen it enough times, you know which of the five stages, if you agree with the framework, if you agree with the pattern being recognized, you can sort of see which of the five stages we find ourselves in, whether it's with 3D printing as a technology or with GoPro as a company or a stock. So it's pattern recognition and this is something where you have to let enough time play out that you gain this recognition over time. I'm not one of those people who thinks that we always get wiser as we get older. I think there's a lot of merit to say that a lot of the real geniuses show up before the age of 25 and they're often starting the companies that end up being worth billions of dollars later. I think there's a lot to be said for youth. But I do think that, especially with pattern recognition, this is something that probably comes better to us as time passes. So that's form of thought number two. And then helpful form of thought number three this week is associative thinking. So those of us who were alive in the 1970s will probably remember, I think it was Reese's. Yep, Reese's Peanut Butter Cups. There was a, their regular television advertisement at the time had somebody who was eating chocolate bump in by mistake, thoughtlessly to somebody who was eating peanut butter. And of course he or she would stick their chocolate bar by mistake in the peanut butter jar of the other person and angrily say, you just got chocolate on my peanut butter. Well you just got peanut butter on my chocolate and they, then they both take a bite and they go, wow, that, that, that's really good. And that was of course a good ad for Reese's Peanut Butter Cups. You got peanut butter in my chocolate. Associated thinking when you pull something from one context completely out of that context and relate it to another context and have a discovery. What is the slightly more awesome you that you become once you start to get better and better at associative thinking? But for this I think you're going to come up with more novel, creative and interesting ideas as a consequence of getting better at associative thinking. I'm going to give a stock market example and a sec, but let me mention a book. I mentioned Danella Meadows's book if you want to get better at thinking and systems. Read the book by that name. There's a wonderful book in 2004 called The Medici Effect, which I'm sure some of you have read. It was a business bestseller that year. And it's all about how, well, using Renaissance Italy as its metaphor, how important it was at that time to have people from completely different cultures, completely different religious, cultural, business practices, all congregating and smashing up against each other like atoms that throw off sparks and create all kinds of new ideas and possibilities, really the life of the Renaissance and specifically if you think about Florence and you think about Italy, kind of the heart of it. So what that meant for art and music and thought and commerce, really important. And the Medici Effect therefore was, you know, the Medici Family dominant in Florence at the time, but it was, it was really that all of the commercial gains since this was a business book possible when you invited many different viewpoints and many different possibilities. So, so that's the Medici Effect, a very good book on associative thinking. And I think you'll enjoy it if you haven't read it. Let me give a couple quick examples to close. One is Warren Buffett's great line. And we have this line as the single largest quote I think that you'll see if you ever come visit us at Foolhead Quarters. It's Buffett. It's my favorite Buffett line. I'm a better investor because I'm a businessman and a better businessman because I'm an investor. Let me explain why I think that's such a great quote and it's pure associative thinking. I'm a better investor because I'm a businessman. Well, we all know Warren Buffett is a businessman. He is the founder, CEO, I think still. But anyway, Berkshire Hathaway, a company that is an amazing company, great stock, owns many other great companies. He is definitely a businessman, but what he's saying is he's a better investor because he's a businessman. Well, you can imagine why because there's no substitute for being an entrepreneur or trying to run or work within a business to get you to realize what's working and what's not. It gives you insight into when you're starting to pick stocks. Do I admire this or that aspect of that company based on my own knowledge of my industry or the culture of my company? You are a better investor because you are a businessman and to reverse it, he also says I'm a better businessman because I'm an investor. Let's think about that for a sec. Well, the very act of picking stocks has you constantly, at least me, constantly looking for best practices, who's winning out there, who do I think's going to win, you're constantly looking and trying to find excellence. And to complete the circle here, I would hope that you'd start trying to pull some of that excellence into your own business. Again, whether you are an entrepreneur of a small business, we have many listening to this podcast. We have a lot of small business owners who are motley, fool, fans and followers. But we also have many other people who just work within businesses. And I'm speaking to all of you, we as investors should be learning and studying the best and then influencing those around us to pull those things into our company. In fact, one of the best things we did the Motley Fool in the last five years is we had an all-company challenge a few years back where teams of eight to 10 fools were sent out actually by their own autonomous choice somewhere in the greater Washington DC area where we work and to find a company and to spend a little time with that company's permission and learning about them and to learn something awesome that they do at that company, whichever one it was, and we covered about 50 companies, that we could try at our company. And as a consequence, a few years later, we're a much better company as a consequence of that. We are better businessmen because we are investors. So that's great associative thinking and I want to close with an example about a stock that I once picked. And it's Martha Stewart Omnimedia. This is a stock I picked more than a decade ago in Motley Fool's stock advisor. I'm hoping some of you were there with me buying along with us at the time. But what was funny, the associative thinking for me is normally I would never have invested in Martha Stewart Omnimedia. It was a beaten up stock and I prefer winning companies that are doing well and adding lots of value to the world. And no question my mind, Martha Stewart has added value to our world, but at the time, she was under fire for the insider trading. I'm sure a lot of us remember that and her stock had absolutely tanked. And I decided I was going to recommend it. And in fact, I think it was Holbert or a Wall Street Journal article mentioned six months later that of all the stock pickers in their database, there was only one that was long Martha Stewart Omnimedia and it was the Motley Fool's stock advisor. I'm happy to say that one worked out pretty well for us. But my experience that I'd had just before picking that was to play a board game. And we have actually a board game called the Motley Fool's By Low Sell High. I think you can find it on Amazon. I'm definitely not here to peddle it. We don't make much money from sales and board games, I assure you. But the experience of that game has you looking for things that have just been crushed, which is not even my own investment strategy. That's not what we talk about in rule breaker investing, but the way to play that game is when everyone else has given up on one of the three stocks that you can buy in the game, that's the time to start buying. And I translate that experience associatively, the Medici effect here, directly to deciding to step out of my own normal comfort zone and pick Martha Stewart Omnimedia, which did end up being a wonderful stock pick because we truly did find Martha at the darkest time for that company and the stock did pretty well in the succeeding couple of years, although I wish we'd continue holding it. We sold it a little early. Anyway, associative thinking. So there we have it this week. Three forms of thought that any one of which you should get better at. I'm trying to get better at. I'm showing you all three of them because I try to use them intentionally and actively and become a better student of them, systems thinking, pattern recognition, and associative thinking. Well, thus much for rule breaker investing this week. I think my podcast always is ably edited by my friend Rick Engdahl and I never know how long it's going to be exactly, but my guess is this is a slightly longer one than some of the others. And if so, darn it, I think that's good because this time we were thinking about thinking and I can think of few better things to improve your investing than that metagame of thinking. Thanks a lot for joining us on Rule Breaker Investing this week. Next week, since I earlier talked about the hype cycle, next week, let's talk about the hype cycle. We'll go over the hype cycle and anything else that pops into my head. In the meantime, happy investing. Fool on. As always, people on this program may have interest in the stocks they talk about and the Molly Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. Learn more about rule breaker investing at rbi.fool.com. [MUSIC] [BLANK_AUDIO]