Michael Mauboussin, a renowned investment strategist, author, and professor, is one of the clearest thinkers on the topics of decision-making, complex systems, and the intersection of luck and skill in markets and business. His work bridges the gap between academic theory and practical application, making him a vital resource for investors and leaders.

On Luck, Skill, and Process

  1. "The paradox of skill is that as skill improves, luck becomes more important." When everyone is highly skilled (like in professional sports or investing), the difference in outcomes is often determined by chance.
  2. "The message is to focus on process, not on outcome." A good process can lead to a bad outcome in the short term, and a bad process can lead to a good outcome. Over time, a good process will win.
  3. "The best long-term performers in any probabilistic field are those who focus on the process."
  4. "One of the best things you can do is to have an investment journal." This allows you to review your decisions and thinking at the time, helping you separate the quality of the decision from the outcome.
  5. "A key to long-term success is to place your bets in situations where skill is likely to be the determining factor." Understand the activity's position on the luck-skill continuum.
  6. "We should spend more time on activities with non-obvious, long-term benefits, and less time on those with obvious, short-term benefits." This applies to exercising, learning, and developing a good investment process.
  7. "Reversion to the mean is the most powerful law in finance." Extreme outcomes, both good and bad, tend to be followed by more average ones. Be wary of extrapolating streaks.
  8. "When you are in a field where luck plays a role, you should focus more on the process of your decisions and less on the short-term outcomes."
  9. "If you can't explain it to a smart 14-year-old, you probably don't understand it yourself." A test for clarity of thought.

On Decision-Making and Beating Bias

  1. "The four P's of decision making: probabilities, payoff, process, and psychology." A simple but powerful framework for making better choices.
  2. "The proper goal for an investor is to make good decisions. And the best way to do that is to have a good process."
  3. "To be a truly great investor, you have to be willing to be wrong." This means being open to changing your mind when the facts change.
  4. "We should always be asking, 'What is the outside view?'" Counteract the "inside view" (our own narrow perspective) by looking at the statistical base rates for similar situations.
  5. "Checklists are a very effective way to improve your decision-making." They help ensure you don't miss crucial steps, especially under pressure.
  6. "The number one rule of forecasting is to be specific." Vague forecasts ("the stock will go up") cannot be evaluated. Specific forecasts ("there is a 70% chance the stock will be above $50 in one year") force accountability.
  7. "Confirmation bias is the mother of all psychological biases." We naturally seek out information that confirms our existing beliefs and ignore contradictory evidence.
  8. "Create a decision-making journal to record not just what you decided, but why." This is critical for effective feedback and learning.
  9. "Seek out disconfirming evidence. Ask 'What would have to be true for me to be wrong?'"

On Markets, Value, and Expectations

  1. "The stock market is a complex adaptive system." It's composed of many interacting agents, making it inherently unpredictable and prone to emergent behaviors.
  2. "A stock price is a beautiful thing. It's a single number that reflects a torrent of information and expectations about the future."
  3. "Investing is the discipline of managing expectations." The current stock price reflects a set of expectations for the company's future performance. Your job is to find a gap between those expectations and reality.
  4. "The key question is not 'Is this a good company?' but 'Is it a good investment?' That requires understanding the expectations embedded in the price."
  5. "High-quality companies are often priced to reflect their quality. The real opportunity is in finding a delta between price and value."
  6. "Read the expectations, then develop your own view, and then see if there's a difference." This is the core of the "Expectations Investing" framework.
  7. "Competitive advantage is the cornerstone of value creation." A company that earns returns on capital above its cost of capital is creating value.
  8. "It's not what you buy, it's what you pay for it." A timeless investing principle.
  9. "The best analogy for the stock market is a pari-mutuel system, like betting on horses." You're not betting against the house; you're betting against other participants. To win, you need a variant perception.
  10. "A wide moat is what allows a company to sustain high returns on invested capital over time."

On Multidisciplinary Thinking and Mental Models

  1. "You have to have a latticework of mental models in your head." A famous concept borrowed from Charlie Munger, emphasizing the need to draw on insights from various disciplines.
  2. "The problem is that we're all specialists now. We have very deep knowledge in a narrow domain, but we don't have the breadth of knowledge to see the world as it is."
  3. "If you want to be a better investor, you have to be a lifelong learner."
  4. "Power laws are one of the most important concepts for an investor to understand." In many systems, a small number of events or participants account for a large percentage of the outcomes.
  5. "Understand the difference between linear and nonlinear systems." The world is often nonlinear, meaning cause and effect are not proportional.
  6. "Wisdom is the ability to apply the right mental model to the right situation."
  7. "Read more history. History doesn't repeat itself, but it rhymes." Understanding past patterns can provide valuable context.

On Sources of Edge and Information

  1. "There are four sources of edge in markets: analytical, informational, behavioral, and technical." The behavioral edge is often the most durable.
  2. "The single greatest error in investment management is the failure to distinguish between the fundamental and the psychological."
  3. "In investing, you're paid for being different and right. Being different and wrong is costly. Being the same as everyone else gives you benchmark returns."
  4. "The ability to suffer is a competitive advantage." Having a long time horizon and the emotional fortitude to withstand volatility allows you to exploit the short-term focus of others.
  5. "Information is only valuable if it is not already reflected in the price."
  6. "Look for situations where the 'time-horizon arbitrage' exists." Exploit the market's focus on the short term by focusing on long-term value creation.
  7. "The best investors are humble. They know they can be wrong."

On Analysis and Corporate Performance

  1. "Free cash flow is the ultimate source of value for a company."
  2. "Return on invested capital (ROIC) is the best single measure of a company's financial performance." It measures how effectively a company is investing its capital.
  3. "Growth without value creation is a common trap." A company can grow larger without becoming more valuable if the returns on its new investments are below the cost of capital.
  4. "Always invert. Instead of asking 'What will happen?' ask 'What is discounted?'" Focus on what the market is already pricing in.
  5. "The life cycle of a business is very important. Where a company is in its life cycle has a huge bearing on its valuation."
  6. "Intangible assets are becoming increasingly important for value creation." Financial statements often do a poor job of capturing the value of brands, patents, and culture.
  7. "Be very careful with peer group analysis. Companies that look like peers on the surface can have very different underlying economics."
  8. "The ability to walk away is a huge advantage. You don't have to swing at every pitch." Patience is a critical virtue in investing.

Sources and Further Reading:

  1. Book: The Success Equation: Untangling Skill and Luck in Business, Sports, and Investing
  2. Book: Think Twice: Harnessing the Power of Counterintuition
  3. Book: Expectations Investing: Reading Stock Prices for Better Returns (with Alfred Rappaport)
  4. Book: More Than You Know: Finding Financial Wisdom in Unconventional Places
  5. Interviews and Talks: Mauboussin has countless public talks and interviews. A great source is the "Value Investing with Legends" podcast, various CFA Institute talks, and interviews on "The Investor's Podcast Network."
  6. Research Papers: As Head of Consilient Research at Counterpoint Global, his papers are widely read. Many are available through Morgan Stanley's website, Columbia Business School's site, or the CFA Institute. A key paper is "Who Is on the Other Side?"