Chris Umiastowski is the growth investor for Globe Investor's Strategy Lab. Follow his contributions here and view his model portfolio here.
In the late 1990s, prior to ever working as an investment professional, I fondly remember a summer vacation at a cottage where I lazily read the book Contrarian Investment Strategies: The Next Generation by David Dreman. What I remember most about the book is not the heavy emphasis on value investing strategies. It's how Mr. Dreman related the stock market to a casino where the odds are actually in your favour. Put a bunch of average people in a casino and the house is guaranteed to win every time. But put that same bunch of average people into long-term common stock portfolios, and they're very likely to make money over time. The stock market is almost like the healthy version of a casino, provided you take a long term view.
But when you buy stocks that many people think are insanely overvalued, as I often buy, it's possible to become addicted to your view that everyone else is wrong. This is, perhaps, much like becoming addicted to gambling in a casino. How do you avoid this emotional trap?
Growth investing, particularly the technology-focused investments I make, is usually about having an investment thesis where a disruptive company or industry ends up posting much better performance than most people expected. If the thesis turns out to be correct, then the investor is rewarded with incredible returns. But if the thesis is wrong, it can result in big losses.
To me, the way to succeed is to think like an unbiased scientist. The best scientists will come up with a thesis and then work hard to find data to disprove that thesis. If no data can be found, it helps improve the odds that the thesis is correct. But if the scientist takes a firm stand and is emotionally attached to the thesis, and unwilling to consider counter evidence, his analysis becomes worthless.
In the world of food and nutrition, several prominent doctors and scientists feel this way about the vilification of dietary cholesterol and saturated fat. Ancel Keys, the U.S. scientist who was primarily responsible for today's mainstream view that we should avoid saturated fat, is thought to have been blinded to any possible evidence against this thesis. This may have, unfortunately, slowed scientific progress for several decades.
Growth investors should constantly be on the hunt for data that invalidate their investment thesis. If I believe Apple is going to continue to experience solid growth and earn high gross margins, I need to look for evidence that their model is failing. Last week, the company announced a bunch of new products including the iPad Pro, Apple Pencil (stylus) and snap-on keyboard. Many industry pundits declared Apple's innovation era to be over because they were simply copying Microsoft. In my view, innovation results in sales growth and/or gross margin strength. It would be smart to watch for any signs of change on these metrics rather than get caught up in the opinion debate. Data trump opinions in science and investing.
Likewise, Facebook is often criticized because, apparently, the younger generation doesn't want to use the social network and something else is bound to come along to disrupt Facebook. The logic? Something always has come along. But I prefer to search for actual evidence that this negative outcome is happening. I'll continue to look at active user growth (both monthly average users and daily active users) as the primary metric. These numbers are publicly reported every quarter. And I'll search for signs that a competing social network is affecting Facebook. So far, nothing even seems to come close.
Finally, here's an example where I utterly failed: BlackBerry. When Apple released the iPhone it took about a year before it should have been crystal clear, through actual data and not pundit opinions, that BlackBerry was in real trouble. I knew Apple had disrupted the industry and I was smart enough to buy the stock. But I held onto my bullish view of BlackBerry. I felt the company had sufficient time to plug the holes in its product portfolio. In retrospect, I realize I did not actively seek out enough data to prove my own thesis wrong, which might have been quite easy if I were acting like an unbiased scientist. The result? Anyone who followed my advice lost money.
It's all well and good to feel comfortable with an investment. But if that comfort comes from closing your eyes, it's not helpful. The best way to feel comfortable is to play defence and actively seek out data that might destroy your thesis. If you find it, get out of the way so you don't get hurt.
Disclosure: The author owns shares of Apple and Facebook, both personally and in his model portfolio.