Follow the Greats; Think for Yourself

In the comments section of a previous post, I wrote the following:

[A]nother problem for the investor that dispenses with thinking--on the premise that "if it's good enough for investor x, it's good enough for me"--is that he never actually develops as an investor.

So, not only is he paralyzed in the face of new data, or extremely unsure and "trigger-happy", but his mind is stultified in a sort of permanent state of dependence on what others think.

The above is exactly the type of mentality that is usually punished severely (at least over the long-term)--again, both in life as in investing. It is no coincidence that every great investor routinely speaks negatively about group-think...

As a scribbler on everything from paper and the margins of my books to restaurant napkins and my hand, I have to consolidate my notes every once in a while to keep my notes clean and organized.

Last night, when doing so, I found this passage from John Galt's speech in Atlas Shrugged written down:

An error made on your own is safer than ten truths accepted on faith, because the first leaves you the means to correct it, but the second destroys your capacity to distinguish truth from error.

Think about that sentence for a minute. Do you agree? Imagine if a government agency (like, I don't know, the SEC) forced some of the truly great investors to divulge their investment positions quarterly, would you be a better investor after following their picks blindly for ten years or after thinking for yourself just one?

Buffett (Not) Related to Recent Fraud

Though not before significant (and possibly total) losses to some investors. the SEC just reported that it caught a fraud early--something its workers should take great pride in.

The story, in short, is that a supposed international real estate firm claimed Buffett as an honorary chairman and Credit Suisse as a significant investor. These two names were enough for many people to invest substantial amounts of money with the company.

As one of the victims stated, "My analysis was that if IRH was good enough for an investment and endorsement by Warren Buffet[t] it was good enough for me."

The one hundred grand that this guy invested, along with hundreds of thousands of dollars of other victims, was wired to the Philippines--and the US government is hoping to get it back. The full story, including a statement by Buffett about his non-relation to the firm, is here.

Why mention it at The Guru Five? While wrong, I found the thinking behind the victim very interesting, because what he stated is remarkably similar to the process of many investors in choosing stocks owned by Berkshire or other investors.

You may have heard something like this before: "If Burlington Northern is good enough of an investment for Warren Buffett, it is good enough for me."

Now, investors can know with a great deal more certainty whether Buffett is actually invested in BNI, or Heebner in Morgan Stanley, and so on, but there are still serious problems with this type of reasoning.

The biggest problem results from the fact that the above investor "drops the context"--meaning he ignores the reality that the ongoing cash flow stream, other portfolio companies (which may or may not serve as hedges that offset a weakness in the business), and knowledge are going to be different in each case.

What is proper for one investor to hold, may not always be proper for another to hold.

Perhaps there are safer investments, with more upside, for the investor managing a smaller sum of money. Perhaps the super-investor is hedged via instruments or positions that aren't required to be reported. And perhaps the investment that another great investor picked isn't as safe for a person who knows nothing about it (and will act vastly different in light of new data, usually with horrible results).

In life, as in investing, thinking independently is a good thing. And, as the returns of some of the investors profiled here show, it is a virtue that (over the long term) is usually rewarded handsomely.

NYT: Einhorn's Book Required Reading

A recent two-page article in the New York Times says that "Fooling Some of the People" should be "required reading for Mary L. Shapiro, the new chairwoman of the S.E.C." We fully agree. Here is the introduction:

TWO events occurred last week that seem unrelated. But, as often occurs in our interwoven world, connecting the dots is revealing.

First was Linda Chatman Thomsen’s testimony last Tuesday before the Senate Banking Committee. Ms. Thomsen, the director of enforcement at the Securities and Exchange Commission, offered her take on how the nation’s top securities cop missed the Ponzi scheme Bernard Madoff is said to have run for decades, noting how aassiduously the S.E.C. chases tips it receives.

“Without fear or favor,” she said.

The next day, shares in Allied Capital, a business development company that invests in small to midsize concerns, plummeted almost 50 percent. Allied, whose stock was favored by small investors for its rich dividend, said it was trying to renegotiate its own loans amid the credit crisis. Dividend in danger, Allied’s stock closed at $1.56 on Friday; last September, the shares touched $16.

The two events are linked by this: Just as the S.E.C. failed Mr. Madoff’s investors as tipsters told the agency he might be up to no good, it also seems to have let down Allied’s shareholders by ignoring analyses of aggressive accounting at the company.

The article goes on to re-cap the book's theme and its main points. If you find the rest interesting, buy the book. It's good.