Value Investing: When In Doubt ... Good

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Includes: DIA, IWM, QQQ, SPY
by: Open Square Capital

Summary

Value investing’s popularity means contrarian viewpoints can be scarce these days.

Be wary of certainty, investing is a probability based activity.

Doubt can be harnessed to allow you to question more deeply and analytically.

We blame Buffett. His folksy ways masquerading his savant-like genius. The ideas that he shares cuts through the noise and makes sense of the senseless and shines light on the murky. His comments are often so clear and so insightful that things really seem "simple". Take one part margin of safety, two parts competitive advantages and mix ... voila outsized market returns. His advocacy for value-investing and his description of how it's done is now so well known that investors today can state his rules verbatim.

Look at the various authors on the myriad of financial websites. Everyone is a self-described "value investor" and "contrarian", and yet everything seems to be a "buy" and contrarian opinions are the "sells". They have legions of followers who are also self-described "contrarians"? How is that possible? Yet, what's obvious from the message boards to the article feedbacks that advocate selling or shorting, divergent opinions are pests best squashed by specious arguments or personal attacks.

Keep in mind that if every investor is a contrarian value investor, then no one is. Keep in mind that value investing is difficult, and that what Buffett or Munger have said and done were said and done by two geniuses who's insights and wisdom have transcended the subjects of finance to become mainstream.

Court Differences of Opinion

Buying bargains and having a contrarian position by its very nature means that often there has to be uncertainty. Investing is a zero sum probability based game. For every winner there has to be a loser, so if everyone like-minded no one wins. This battle often comes down to who is more right? Being a value investor and contrarian means taking positions that the market has discarded and deemed unsalvageable. It means taking positions that even if there is a margin of safety, should feel at best a bit "uncertain" and at worst downright "uncomfortable."

Thinking that value investing is simply buying something cheap, or that being a contrarian means simply saying something snarky is dangerous. It can create intellectual laziness when everything calls for the exact opposite.

People tout margin of safety as one of their guiding principle, and that this margin is what counters the uncertainty. Yet, who or what's to say that you've calculated it correctly, or that there are no unanticipated factors you've never ... anticipated? Have you allowed or asked anyone to challenge it? Unfortunately, the safety often comes from groupthink and the comfort of the herd instead of a deeper analysis of the company and its competitive position/financial standing. What's the margin of safety you ask? "Well I saw Klarman or Combs take a position." It has to be and it must be better than that.

In order to have outsized returns you need differentiated viewpoints, and you need to be comfortable taking positions that are completely counter to current views. You also need to be comfortable challenging those views and accepting opinions that counter yours.

Doubt is the handmaiden for a contrarian. Your very first thought should often be "I'm not sure," followed quickly by "but I'll try and find out" because this is hard, and it's not supposed to be easy. This is why Munger focuses so much on mental models and psychological biases. The former helps you to think critically and analytically, and the latter keeps you honest with yourself. They're the foundations for thinking independently, and they form the bulwark for even attempting to be a successful value investor.

So the next time you think about buying something that seems cheap, make sure it doesn't feel "easy." Look around to see if anyone can convince you otherwise because doubt like fear can motivate and help you to save you from yourself.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.