10 Characteristics of Great Investors

Source: Qilehui

Although investment decisions rarely involve complex calculations, successful investors have a "feel" for numbers and probabilities.

At the same time, financial statements can help understand the connection between company strategy and value creation, comparing how different companies in the same industry allocate resources to assess their competitive advantages and strategic positions. Companies with higher profit margins and lower capital turnover adopt differentiation strategies, while companies with lower profit margins and higher capital turnover adopt pricing strategies.

Therefore, evaluating a company's profitability essentially involves assessing how long it can maintain its current competitive advantage.

For most listed companies, the investable period is not very long, roughly around ten years, with many unknown factors such as technological changes, shifts in consumer preferences, and competitive environments. What remains constant is that the present value of future free cash flows determines the value of financial assets.

At the micro level, great investors have a clear understanding of how a company makes money and are well aware of changes in profit drivers.

At the macro level, great investors can understand the unique position of the companies they invest in within the industry and whether their competitive advantages are sustainable. Strategy and valuation interact and influence each other.

What sets apart ordinary investors from great investors is their ability to compare fundamentals and expectations, or in other words, their ability to identify "errors" in market expectations.

Take horse racing as an example. The bets placed on a horse reflect its odds, which can be seen as expectations, while the fundamentals are how fast the horse can run. As Charlie Munger said, "We want to find a horse with a 1/2 chance of winning and odds of 3 to 1."

Excellent investors understand what might have happened after comparing expectations with fundamentals. Taking bird flight as an example, having wings and feathers and being able to fly are surface-level connections, but the flapping of wings generating lift through aerodynamics is the intrinsic connection that allows both birds and airplanes to fly in the sky.

Similarly, when great investors compare the present with the past, they seek to understand the intrinsic driving factors behind that history, rather than just comparing prices or other surface-level aspects, in order to avoid falling into cognitive traps.

Excellent investors constantly seek their own advantages while focusing more on the process rather than the outcome. Because of the existence of probabilities, good decisions sometimes lead to bad results, and bad decisions can sometimes lead to good results.

In the long run, with the right decision-making process, even if there are occasional bad results, the overall performance of investments will be satisfactory. It takes a sufficient amount of time and a number of investment decisions for probabilities to take effect.

Opinions are hypotheses that need to be verified, not unchanging principles. Many people tend to hold on to consistent views, and we hope that others will also remain consistent. This desire for "consistency" becomes stronger as we grow older.

Research has shown that people who actively seek out arguments opposing their own views perform better in predictions. This active effort to go against human nature helps counteract the "bias" of protecting one's own views. The best investors understand that the world around them is constantly changing, and their views should reflect that fluidity. If IQ represents cognitive ability and RQ (Rationality Quotient) represents decision-making ability, the overlap between the two is actually lower than most people imagine. What's important is that we should focus on cultivating our RQ.

Warren Buffett has made a very insightful analogy, "I have always believed that IQ and talent represent the horsepower of an engine, while RQ represents the output power. Many people start out with an engine that has 400 horsepower but actually only delivers 100 horsepower of actual output, which is far less than the full output of 200 horsepower."

Take price as an example. Price is very useful information in the financial market, but because investment activities have a social attribute, price will transform from a simple source of information into a source of influence.

Take the dot-com bubble as an example. As stock prices rise, investors' book wealth increases, which has an impact on those who do not hold stocks. Many people eventually start buying, which further inflates the bubble. Negative feedback gives way to positive feedback (buying when prices rise and selling when prices fall), and positive feedback causes the system to deviate from its original direction.

The wisdom of the crowd is often right, but once there is an error, you need strong contrarian thinking. The reason why it is easier said than done is because it often means putting your career at stake.

Almost all investment institutions focus on developing their strengths, but they often neglect the importance of position allocation.

The establishment of a general investment portfolio goes through the following process:

Only by fully answering the above three questions can positions be effectively allocated. The most common methods are mean-variance (maximizing returns based on a given risk) and the Kelly criterion (maximizing the average return of the portfolio).

Charlie Munger said his favorite quote from Einstein is: "Success comes from curiosity, focus, perseverance, and self-criticism, where self-criticism refers to the ability to change one's own ingrained ideas, even those most cherished."

Reading is an important way to cultivate the above-mentioned qualities. Munger also said, "Among the smart people I know, none of them are not avid readers."

Great investors have three reading habits:

Buffett said he spends 80% of his working time reading every day.

Don't limit yourself to business and finance, let your curiosity determine what you read. Because ideas or information from other fields can sometimes turn into excellent investment references unintentionally.

Don't only seek out like-minded opinions. Through reading, carefully understand the viewpoints of those who hold different but equally thoughtful opinions, so as to maintain an open mindset. Reading is particularly important for investors because investment requires synthesizing diverse information and ideas to continuously find profitable opportunities.