The Self-Awareness Paradigm

“We know well that mistakes are more easily detected in the works of others than in one’s own. When you are painting you should take a flat mirror and often look at your work within it, and it will then be seen in reserve, and will appear to be by the hand of some other master, you will be better able to judge of its faults than in any other way” – Leonardo Da Vinci

It is important, in both investing and in life, to try to stand apart from yourself. Some call it “meta-cognition”, but most simply refer to it as “self-awareness”. It is the ability to think about your very thought process, and examine it as if from a third party’s perspective – unbiased. Stephen Covey points out that this ability explains why man has dominion over all things in the world, and why he can make significant advances from generation to generation: “This is why we can evaluate and learn from others’ experiences as well as our own. This is also why we can make and break our habits”. Making good habits, and breaking bad ones, is essential to long term success; in my view, the process starts with the awareness of common biases. The ability to act without bias is one of the hardest parts of investing – as they often lead to misjudgments and errors, of which we only become aware in hindsight (if at all).

For this reason, it is best to be pro-active and not reactive. This is to say that people often view evidence as supporting their beliefs, instead of examining all of the facts objectively, and actively. I would recommend approaching every idea tentatively, and always looking for disconfirming evidence. When examining a company for investment purposes, Warren Buffet recommends avoiding the market price, initially. Instead, one should examine the facts without any preconceptions, and come to a rational conclusion about the value of the business. Once you’ve put a price on the whole business, using the annual report, then compare it to the market price. By using this method, you will not begin your research with any pre-conceived notions, and you will certainly not be subconsciously “confirming” a thesis. Remember that human beings are best at interpreting all new information so that their prior conclusions remain intact.

“If a man will begin with certainties, he shall end in doubts; but if he will be content to begin with doubts, he shall end in certainties.” ~ Francis Bacon

Note: How am I to find an interesting company without screening for low prices? You can start by using screens such as Joel Greenblatt’s, or simply examining 13-Fs. Just make sure to begin with doubts.

~ by eboro on June 2, 2010.

2 Responses to “The Self-Awareness Paradigm”

  1. Definitely a useful sets of quotes and ideas here. It reminds me too of the Mungerism to ‘always invert’. Use the facts to compose a conclusion, and then try to work backwards and deduce what would have to be the case in order for the conclusion to be true. Or, to say it differently, the facts lead me to value a business at X; what would have to be true for the market to value the business at today’s price Y?

    One of the reasons I like blogging and talking about my holdings is that it is a tactic that encourages this self-awareness or meta-cognition. Sometimes I craft a defense, and then I read it later and see weaknesses that I previously had not. Or, a kind reader and conversant highlights the weaknesses for me.

  2. That’s exactly how I think about it: what would have to be true for the markets to value the business at the current price. It’s similar to what Mauboussin and Rapaport call “Expectations Investing”. I’ll write a post on expectations investing soon, possibly outlining the model I had described to you earlier.


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: