The Best Long-term Performers in any Probabilistic field emphasize PROCESS over OUTCOME.

Process versus outcome

Probably the best discussion that I've seen about this issue comes from Michael Mauboussin's book More Than You Know. Tellingly, it's the very first chapter of the book, and it opens with this quote from Robert Rubin:

Individual decisions can be badly thought through, and yet be successful, or exceedingly well thought through, but be unsuccessful, because the recognized possibility of failure in fact occurs. But over time, more thoughtful decision-making will lead to better overall results, and more thoughtful decision-making can be encouraged by evaluating decisions on how well they were made rather than on outcome.

Mauboussin emphasizes the point, writing:

... investors often make the critical mistake of assuming that good outcomes are the result of a good process and that bad outcomes imply a bad process. In contrast, the best long-term performers in any probabilistic field -- such as investing, sports-team management, and parimutuel betting -- all emphasize process over outcome.

Winning the process game

Mauboussin very clearly lays out what the ideal goal of any investment process should be:

The goal of an investment process is unambiguous: to identify gaps between a company's stock price and its expected value. Expected value, in turn, is the weighted-average value for a distribution of possible outcomes. You calculate it by multiplying the payoff (i.e., stock price) for a given outcome by the probability that the outcome materializes.

What does this mean in practical terms? I often begin my investment research using a screen that identifies stocks with certain attributes. For our purposes here, let's say I'm looking for stocks that are currently out of favor with investors, so I set a screen looking for any stock that has declined by 20% or more over the past year and is currently trading at less than its tangible book value. Here are a few of the companies that pop up:

Company	Year-Over-Year Price Change	Price-to-Tangible Book Value
Banner Corp (Nasdaq: BANR)	(23.7%)	0.6
K-SEA Transportation Partners(NYSE: KSP)	(61.4%)	0.4
Oilsands Quest (NYSE: BQI)	(59.0%)	0.4
Hercules Offshore (Nasdaq:HERO)	(38.1%)	0.4
American National Insurance(Nasdaq: ANAT)	(26.5%)	0.6

Source: Capital IQ, a Standard & Poor's company.

To follow good process in evaluating these stocks, I'd first try to identify possible outcomes for them, and what those outcomes would mean for the stock price. 

1. Washington-state-based Banner, for instance, traded at more than twice its tangible book value prior to the financial crisis, so we could probably envision a case where shares recover to three or four times their current value. 
2. American National Insurance, meanwhile, has had cyclical valuation swings that have typically put its tangible book value multiple in a range of 0.5 to just above 1.0. In a scenario where toxic assets don't eat away at the balance sheet and investment returns start to increase, investors could see real upside here, too.
3. Of course, we also need to consider negative outcomes, as well. For example, investors would want to note that Oilsands Quest has never reported an annual profit. There may be a huge upside if the company finds a way to profitability, but its assets may not be worth all that much if it can only produce losses. 
4. Similarly, driller Hercules Offshore has been trying to find its footing again, but the need for a balance-sheet-strengthening capital raise may impact the value of currently outstanding shares.

Once you have a list of the potential outcomes for the stock in question, you can then weigh the potential for each of those outcomes to come to fruition, and end up with a good sense of whether the stock is a worthwhile investment.

http://www.fool.com/investing/general/2011/01/11/this-is-more-important-than-investment-profits.aspx

The Thought Process Is What Counts

The Thought Process Is What Counts

In value investing, it really is the thought that counts. The thought process is important. This is how you think about your investments and investment decisions. Analysis doesn't decide for you; it only serves to support the thinking behind the choices you make.

There are many analytical blocks and approaches to appraising company value and many ways to decide whether the price paid for that value is right. These are evident in the postings in this blog. However, it is repeatedly obvious that no single method works all the time, and if one did, everyone would make the same findings and buy the same companies and values would no longer be values. Every article, every book, every value investor has a unique application of the vlaue investing thought process.

The thought process is the intellectual process - the philosophy - that the value investor internalizes. The tools are there to help, and different tools will help more at different times. If you strive to understand the business value underlying the price before you buy, investing history will be on your side. As you get good at understanding value and price, your investment decisions and performance will only improve.

In the real, practical world of value investing, value comes in many forms. There is so much detail on any given company (much of which you can't know) that it often isn't realistic to become a walking encyclopedia on a company or its fundamentals. And formulas and ratios, although they work and can help, hardly can deliver absolute answers. Usually, taking a few shortcuts makes sense, reserving the deepest analysis to the most critical, difficult and largest investing decisions.

As a practical matter, the so-called Pareto principle, also called the 80-20 rule, applies to investing as it does in much of business: 80 percent of the picture comes from 20 percent of the questions you may ask or facts you may collect about a business. If you focus on most critical aspects of a given business, you'll get most of the picture, without digging up 100 percent of everything about it. If this weren't the case, you'd spend six months analyzing each investment.

You can't spend days on each company and you can't analyze all companies in the investing universe. A simplified, practical approach will help the new value investor get started, and will also help experienced value investors improve their game. You'll undoubtedly find yourself adding plays to your value investing playbook as you gain experience. And you'll also get better at finding that 20 percent that's really important.


Famed fund manager Peter Lynch, in his famous book, One Up on Wall Street, shared this wisdom: "Once you're able to tell the story of a stock to your family, your friends or the dog, and so that even a child could understand it, then you have a proper grasp of the situation."

Shopping for Value: A Practical Approach

Shopping for Value: A Practical Approach

"Value investing boils down to finding a good business, analyzing it to find the simple truths about it, and deciding whether the truths are on track and the price is right."

The thought process is what counts.

1. Recognizing value situations:

• Growth at a reasonable price (GARP)
• The fire sale
• The asset play
• Growth kickers
• Turning the ship around
• Cyclical plays

2. Making a value judgement in practice

3. It ain't over until it's over

• Keeping track
• Making the "sell decision"