The elements of investing

What are the basic fundamental building blocks of investing? What I would call the structure of investing. The steps are 1) information/search 2) analysis/investigation, 3) judgement 4) execution. This process describes individual investments but there is of course one additional part of the process….portfolio construction which concerns how to structure multiple investments.

In order to have sound investments you need each part of this process to be strong. I separated judgement and analysis. The reason I did this is that in my view there are many fantastic industry analysts that have poor judgement. They are good analysts, not good investors. They know every single element of an industry and develop full projections going out 10 years. They lack judgement because they fail to distinguish important trends and variables from unimportant ones. In other cases they can’t distinguish signal (knowable things) from noise (unknowable things). Or they understand all the above but bias their analysis because they think the market must know something they don’t or are afraid of short term performance issues.

Similarly information is not the same as analysis or judgement. A point made eloquently by Benjamin Graham:

Take as my example a fine company such as Avon Products. How can it make sense to say htat its price of $140 was “correct” in 1973 and that its price of $32 was also “correct” in 1974?…..the market may have had all the information it need about Avon; what it has lacked is the right kind of judgement in evaluating its knowledge

And finally all these things do not matter without proper execution. Warren Buffet has mastered all these elements but even for him execution has at times failed:

But the biggest mistake we make are mistakes of omission….the things I knew enough to do but I was sucking my thumb…I probably cost Berkshire at least 5 billion when Fannie Mae was having troubles…I did know enough to understand Fannie Mae and I blew it