Finding Good Opportunities

On the surface, science and investigative journalism appear to have nothing in common with investing since the two professions have nothing interesting to say about economics or a company’s business model. However, science and investigative journalism have a framework that helps in decision making which is very important in investing.

The scientific method is all about hypothesis testing. You start with a guess about how something works and then carry out experiments to prove your initial guess. More importantly, you try to disprove your initial guess. This second point is especially important in investing because if you find an investment you think is good, you will be biased to find evidence supporting your initial conclusion that the idea is indeed good. Searching for disconfirming evidence is a good way to overcome this bias.

Changing your mind based on new evidence is how to do good science. This is equally important in investing and a good framework for thinking about updating probabilities based on new evidence is explained by Bayes Theorem.

The main job of an investigative journalist is to carry out research, ask the right questions and follow the evidence wherever it may lead whilst being acutely aware of any prejudices that can influence the answers they find. For example, one needs to tread carefully when speaking with former employees of a company. If they were fired or left on bad terms, they could give biased opinions about the company’s product or management.

Investigative investing was popularised by Philip Fisher, Warren Buffett and Peter Lynch. They would talk to customers, employees and competitors about a company they were researching. One sure-fire way of understanding the competitive dynamics of any industry is to ask this question to the company’s management you are researching: “If you could press a button that would make one of your competitors disappear, who will you target?”. Ask this question to different managers at different companies and if you hear the same reply every time, you know who the main competitor is.

A combination of the scientific method and investigative journalism gives a good framework for making decisions and finding good investment ideas.

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