“Too much time is spent trying to find out more and more about less and less, until we know everything about nothing. Rarely, if ever, do we stop and ask what we actually need to know!” —James Montier, Value Investing: Tools and Techniques for Intelligent Investment
In chapter 19—Keep it simple—of James Montier’s Value Investing book the topic of information overload is discussed. When is enough information really enough? The following is the introductory summary of the chapter.
Our industry is obsessed with the minutia of detail. Analysts are often petrified of saying ‘I don’t know’. Something I personally have never had any issue with! It is a common misunderstanding that in order to make good decisions we need masses of information.
However, nothing could be further from the truth.
• A new paper by Tsai et al. examines the confidence and accuracy of American football fans trying to predict the outcome of games. They found that people were just as accurate if they had six items of information as when they had 30! However, confidence (which exceeded accuracy at all levels of information) increased massively as the amount of information increased.
• This inability to process large amounts of information represents a cognitive constraint embedded within our brains. The simple truth is that our brains aren’t supercomputers with limitless computational power. Rather than crashing mindlessly into our cognitive bounds, we should seek to exploit our natural endowment. So, rather than collecting endless amounts of information, we should spend more time working out what is actually important, and focusing upon that.
• When it comes to information overload, parallels exist between medicine and investing. For instance, in a certain hospital in Michigan, doctors were sending around 90% of all patients with severe chest pains to the cardiac care unit. However, they were admitting 90% of those who needed to be admitted, and 90% of those who didn’t! They were doing no better than chance.
• The key reason for this seems to have been that the doctors were looking at the wrong information – effectively they were looking at a wide range of ‘risk’ factors such as age, gender, weight, smoking, etc. While these factors can define our probability of having a heart attack, they aren’t good diagnostic tools to tell if you are actually having a heart attack.
• A complex set of statistical tables were introduced to help doctors to make better decisions. However, when these were removed, the doctors still made good decisions. They had learned to look at the correct information cues to make the best decision. Doctors using a very simple decision tree diagram delivered the best results. Similar devices could easily be deployed in the world of investing. As Warren Buffett says, ‘investing is simple but not easy’.
Seth Klarman also discusses the topic of information gathering and analysis as part of the investment process in his Margin of Safety.
How Much Research and Analysis Are Sufficient?
Some investors insist on trying to obtain perfect knowledge about their impending investments, researching companies until they think they know everything there is to know about them. They study the industry and the competition, contact former employees, industry consultants, and analysts, and become personally acquainted with top management. They analyze financial statements for the past decade and stock price trends for even longer. This diligence is admirable, but it has two shortcomings. First, no matter how much research is performed, some information always remains elusive; investors have to learn to live with less than complete information. Second, even if an investor could know all the facts about an investment, he or she would not necessarily profit.
This is not to say that fundamental analysis is not useful. It certainly is. But information generally follows the well-known 80/20 rule: the first 80 percent of the available information is gathered in the first 20 percent of the time spent. The value of in-depth fundamental analysis is subject to diminishing marginal returns.
Information is not always easy to obtain. Some companies actually impede its flow. Understandably, proprietary information must be kept confidential. The requirement that all investors be kept on an equal footing is another reason for the limited dissemination of information; information limited to a privileged few might be construed as inside information. Restrictions on the dissemination of information can complicate investors’ quest for knowledge nevertheless.
Moreover, business information is highly perishable. Economic conditions change, industries are transformed, and business results are volatile. The effort to acquire current, let alone complete information is never-ending. Meanwhile, other market participants are also gathering and updating information, thereby diminishing any investor’s informational advantage.
David Dreman recounts “the story of an analyst so knowledgeable about Clorox that ‘he could recite bleach shares by brand in every small town in the Southwest and tell you the production levels of Clorox’s line number 2, plant number 3. But somehow, when the company began to develop massive problems, he missed the signs….’ The stock fell from a high of 53 to 11.”
Although many Wall Street analysts have excellent insight into industries and individual companies, the results of investors who follow their recommendations may be less than stellar. In part this is due to the pressure placed on these analysts to recommend frequently rather than wisely, but it also exemplifies the difficulty of translating information into profits. Industry analysts are not well positioned to evaluate the stocks they follow in the context of competing investment alternatives. Merrill Lynch’s pharmaceutical analyst may know everything there is to know about Merck and Pfizer, but he or she knows virtually nothing about General Motors, Treasury bond yields, and Jones & Laughlin Steel first-mortgage bonds.
Most investors strive fruitlessly for certainty and precision, avoiding situations in which information is difficult to obtain. Yet high uncertainty is frequently accompanied by low prices. By the time the uncertainty is resolved, prices are likely to have risen. Investors frequently benefit from making investment decisions with less than perfect knowledge and are well rewarded for bearing the risk of uncertainty. The time other investors spend delving into the last unanswered detail may cost them the chance to buy in at prices so low that they offer a margin of safety despite the incomplete information.
The Information Bias: If You Have an Enemy, Give Him Information
One of the heuristics, or biases, discussed Rolf Dobelli in The Art of Thinking Clearly is “the information bias, the delusion that more information guarantees better decisions.”
Doctors are not the only professionals with a penchant for surplus information. Managers and investors are almost addicted to it. How often are studies commissioned one after the other, even though the critical facts are readily available? Additional information not only wastes time and money, it can also put you at a disadvantage. Consider this question: which city has more inhabitants – San Diego or San Antonio? Gerd Gigerenzer of the Max Planck Institute in Germany put this question to students in the Universities of Chicago and Munich. Sixty-two per cent of Chicago students guessed right: San Diego has more. But, astonishingly, every single German student answered correctly. The reason: all of them had heard of San Diego, but not necessarily of San Antonio, so they opted for the more familiar city. For the Chicagoans, however, both cities were household names. They had more information and it misled them.
Or, consider the hundreds of thousands of economists – in the service of banks, think tanks, hedge funds and governments – and all the white papers they have published from 2005 to 2007, the vast library of research reports and mathematical models. The formidable reams of comments. The polished PowerPoint presentations. The terabytes of information on Bloomberg and Reuters news services. The bacchanal dance to worship the god of information. It was all hot air. The financial crisis touched down and upended global markets, rendering the countless forecasts and comments worthless.
Forget trying to amass all the data. Do your best to get by with the bare facts. It will help you make better decisions. Superfluous knowledge is worthless, whether you know it or not. Daniel J. Boorstin put it right: ‘The greatest obstacle to discovery is not ignorance – it is the illusion of knowledge.’ And next time you are confronted by a rival, consider killing him – not with kindness but with reams of data and analysis.