MICHAEL MAUBOUSSIN: This is such a great question. And it’s such an important question, not just investing, but other facets of life. Whenever you see really, really good outcomes, you can almost always be assured that it combines skill and lots of good luck. Now, we know skill may stick around, but we also know that luck tends to be transitory. Right? Fortune smiles on you one day and frowns on you the next. And by the way, it works the other way. If you see really bad results, it’s often because skill is not there, but there’s often a lot of bad luck. And this sets up, as you pointed out, reversion to the mean.
So for example, really good results, skill and a lot of good luck, well, next time the luck may go away a little bit and you're going to see results a little bit closer to average. Really bad luck. The luck gets a little bit better. You can see results closer to average. So this is the idea of reversion to the mean, that over time, you will definitely see that pattern. So recognize that great outcomes, and by the way, this is true for corporations as well as investors, when the CEO’s face is splashed on the cover of every magazine, it’s typically he or she has enjoyed some good skill, but also lots of good luck, and the luck may often be transitory.
CONSUELO MACK: So what do I do with that information as an investor again? And I guess I could apply this, obviously, to stocks that I invest in, too. If a company has had a tremendous run of good performance, you know, consistently higher earnings, what do I do with that? I mean, how do I apply the outsider view to succeed?
MICHAEL MAUBOUSSIN: One of my favorite lines is from Seth Klarman, who is the founder and very successful investor at the Baupost Group.
CONSUELO MACK: Right, hedge fund.
MICHAEL MAUBOUSSIN: Hedge fund. And he says, “Value investing is at its core the marriage of a contrarian streak and a calculator.” And I love this. So the contrarian streak would say when everybody is bullish, maybe you want to be bearish. When everybody is bearish, you maybe want to be bullish. So it’s this idea of really going against the grain.
But it’s not complete, because often the crowd is right. Right? If the movie theatre is on fire, by all means, run out the door, right? Don't run in. So that’s where the calculator part comes in and says, if you see that everybody loves something or dislikes something, then apply the calculator. Figure out if there’s a price to value discrepancy. And if both of those things line up, it’s unloved and it’s really cheap, then you step in. Or if it’s loved and really expensive, then you shed the position. So it’s really the combination of both of those things that I think leads to great value investing. Very difficult to do emotionally, analytically. But I think that is the path to excess returns.
CONSUELO MACK: One Investment for a long term diversified portfolio that all of us should own some of in a long term portfolio. What would it be?
MICHAEL MAUBOUSSIN: Yeah. I would say today, the biggest, most attractive thing to me is the difference between the S&P 500 and say, the ten year treasury. So I don't know if I can do a long short, but just an S&P 500 index fund and against that, looking at again, a three to five year perspective versus the ten year. I think you’ll do much better. I think the equity risk premium is very attractive, and trying to capture that premium I think would be a great place for investors.
CONSUELO MACK: So we will leave it there. Financial thought leader, Michael Mauboussin, you’ve given us some really just terrific research and terrific ways to analyze this complex system that’s called the stock market. So thanks very much, Michael for being with us.
MICHAEL MAUBOUSSIN: Thank you, Consuelo. I appreciate it.
CONSUELO MACK: On that note, we will wrap up this edition of WealthTrack. I hope you can join us next week when I sit down with Great Investor Steven Romick, who has been in the top one percent of mutual fund managers for the past decade. He’ll tell us what contrarian value strategies he is following now in his five-star, FPA Crescent Fund.
Meanwhile, please go to our website, wealthtrack.com, to see this program again as a podcast or streaming video. And while you are there, check out WealthTrack Extra, where you can find complete, extended interviews with other recent Financial Thought Leaders and Great Investor guests. Thank you for taking the time to visit with us. Make the week ahead a profitable and a productive one.
