1. Be numerate (and understand accounting). To be a successful investor, you have to be comfortable with numbers.There are rarely complicated calculations but a feel for figures, percentages, and probabilities is essential.
  2. Understand value (the present value of free cash flow). The present value of future free cash flow determines the value of a financial asset. This is true for stocks, bonds, and real estate. Valuation is challenging for equity investors because each driver of value – cash flows, timing, and risk – are based on expectations whereas two of the three drivers are contractual for bond investors.
  3. Properly assess strategy (or how a business makes money). This attribute has two dimensions. The first is a fundamental understanding of how a company makes money. The second dimension is gaining a grasp of a company’s sustainable competitive advantage. A company has a competitive advantage when it earns a return on investment above the opportunity cost of capital and earns a higher return than its competitors.
  4. Compare effectively (expectations versus fundamentals). Perhaps the most important comparison an investor must make, and one that distinguishes average from great investors, is between fundamentals and expectations. Fundamentals capture a sense of a company’s future financial performance. Value drivers including sales growth, operating profit margins, investment needs, and return on investment shape fundamentals. Expectations reflect the financial performance implied by the stock price.
  5. Think probabilistically (there are few sure things). Investing is an activity where you must constantly consider the probabilities of various outcomes. This requires a certain mindset. To begin, you must constantly seek an edge, where the price for an asset misrepresents either the probabilities or the outcomes.
  6. Update your views effectively (beliefs are hypotheses to be tested, not treasures to be protected). Most people prefer to maintain consistent beliefs over time, even when the facts reveal their beliefs to be wrong. Great investors do two things that most of us do not. They seek information or views that are different than their own and they update their beliefs when the evidence suggests they should. Neither task is easy.
  7. Beware of behavioral biases (minimizing constraints to good thinking). The heuristics and biases literature notes that we tend to operate with rules of thumb (heuristics), which are generally correct and save us lots of time. But these heuristics have associated biases that can lead to departures from logic or probability. Examples of heuristics include availability (rely on information that is available rather than relevant), representativeness (placing people or objects in categories that are inaccurate), and anchoring (placing too much weight on an anchor figure). There is now a long list of heuristics and biases, and great investors are those who not only understand these concepts but take steps to manage or mitigate behavioral biases in their investment process.
  8. Know the difference between information and influence. In classic markets for goods or services, prices are a highly informative mechanism. Prices also provide useful information in capital markets. The main value is as an indication about expectations for future financial performance. (This is less true for derivatives, which may be efficiently priced even if the asset from which its price is derived is inefficiently priced.) As we saw in a prior point, great investors are adept at translating between expectations and fundamentals, and keep them separate in decision making. Great investors don’t get sucked into the vortex of influence. This requires the trait of not caring what others think of you, which is not natural for humans. Success entails considering various points of view but ultimately shaping a thesis that is thoughtful and away from the consensus. The crowd is often right, but when it is wrong you need the psychological fortitude to go against the grain.
  9. Position sizing (maximizing the payoff from edge). Success in investing has two parts: finding edge and fully taking advantage of it through proper position sizing. Almost all investment firms focus on edge, while position sizing generally gets much less attention. Proper portfolio construction requires specifying a goal (maximize sum for one period or parlayed bets), identifying an opportunity set (lots of small edge or lumpy but large edge), and considering constraints (liquidity, drawdowns, leverage). Answers to these questions suggest an appropriate policy regarding position sizing and portfolio construction.
  10. Read (and keep an open mind). Berkshire Hathaway’s Charlie Munger said that he really liked Albert Einstein’s point that “success comes from curiosity, concentration, perseverance and self – criticism. And by self-criticism, he meant the ability to change his mind so that he destroyed his own best – loved ideas.” Reading is an activity that tends to foster all of those qualities.

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