Investor, Pay Attention

Note: This is an excerpt from the article Where Do Great (Investment) Ideas Come From, which I wrote for the May 2015 issue of our premium newsletter, Value Investing Almanack. To read the complete article and our vast archives spanning 4+ years, please click here to subscribe.

---

Consider that you are looking to buy a stock and the two that you come across on your screen are, say, Company A and Company B. Here are a few data points about the two companies, which are the only factors you would look at while making your decision. Look at them and think which one you would rather purchase –

Did you make a decision? Before you read on, jot down either Company A or Company B. Now I’m going to give you some more data points on these companies. No information has been changed, but some has been added.

Which stock would you rather purchase now? Again, write down your answer. I’m going to present the options a third time, again adding one new element.

Now, which of the two would you prefer?

Chances are, somewhere between the second and third lists of data, you switched your allegiance from Company B to Company A. And yet the two companies didn’t change in the least. All that did was the information that you were aware of.

This is known as omission neglect. When we fail to think about what we do not know, we underestimate the importance of missing information, and this leads us to form strong opinions even when the available evidence is weak. This can lead to bad decisions that we later regret.

For example, in the story The Adventure of Silver Blaze, Sherlock Holmes asked Inspector Gregory to consider a curious incident involving a dog. Gregory replied that nothing happened, and Holmes proclaimed, “That was the curious incident.” This clue enabled Holmes to deduce that the culprit must have been someone familiar to the victim’s dog. Most people would miss this important clue because most people, like Gregory, pay little attention to nonevents.

Now, some information is always available, but some is always silent – and it will remain silent unless we actively stir it up. In investing, such information that remains silent – or that you fail to notice – can be dangerous to your capital.

Consider my experience with the stock of Hotel Leela. I was in Bangalore sometime in early 2006 and visited Leela Palace to meet a friend who was attending a conference there. I was in awe of the property – it was grand, and amazingly beautiful.

On enquiring, I got to know that the hotel was one of the most expensive locations in India and was completely booked for the next few months.

The story was the same everywhere – most of Leela’s properties were booked for months, despite their premium pricing.

“What an amazing business!” I told myself. “Just imagine the kind of profits these guys must be making. I must have this stock in my portfolio!”

The next day, without enquiring more about Leela’s business and financial performance, I bought the stock, expecting it to be a story that was waiting to be unveiled. My premise was – Great hotel + Premium pricing + Overbooked = Great profits.

Well, it was indeed a story waiting to be unveiled…and for me! When I glanced through the company’s annual reports after buying its stock, I saw a business that was badly managed.

The debt/equity was rising, much more cash was burned than was generated, return ratios were average at best, and the profit growth had followed a highly inconsistent path. As I included more information on the company in my analysis, I started ruing my decision to buy the stock more.

Anyways, by the time I had realized and then accepted my mistake, the stock was already down around 45% from my purchase price. But I still sold it off. And thankfully so, as the company remains in doldrums and so does the stock.

Now, my idea is not to lead you to conclude that you need to gather a world of information on a business while doing its analysis (in fact, the first 20% information will tell you 80% about the business), but it’s important to pay attention and include the most important information while doing your analysis.

Don’t suffer from inattention blindness bias, as shown in this invisible gorilla experiment –

To pay attention means to pay attention to it all, to engage actively, to take everything around us, including those things that don’t appear when they rightly should. It means asking important questions (like some I listed earlier in this post) and making sure we get answers.

Even when you do this, you may not be able to emerge with the entire situation in hand, and you may end up making a choice that, upon further reflection, is not the right one after all. But it won’t be for the lack of trying.

One of the biggest lessons I learned while reading this wonderful book from Peter Bevelin, A Few Lessons from Sherlock Holmes, was that, while analyzing situations, it’s important to not jump to conclusions and instead try to collect facts as open-minded as possible.

As Mr. Bevelin quotes Sherlock Holmes…

No one can give rules for methods of thinking but it is possible to carry certain principles into operation. One is to strive to be delivered from hasty judgments.

“Men see a little, presume a good deal, and so jump to the conclusion.”

How common this is needs only a little study of our mental processes. In some this is a habit, in others a fault of education.

So the takeaway for you is to observe to the best of your abilities and never assume anything, including that absence is the same as nothing.

---

Note: This is an excerpt from the article Where Do Great (Investment) Ideas Come From, which I wrote for the May 2015 issue of our premium newsletter, Value Investing Almanack. To read the complete article and our vast archives spanning 4+ years, please click here to subscribe.