This article was written by Nicholas Mitsakos : Chairman and CEO at Arcadia Capital Group.
“There is no one more despicable than one who knows he knows.” (Oliver Wendell Holmes)
Opinions about facts are not facts.
Look at the facts not the opinion about the facts. Anyone holding themselves out as an expert has, most likely, a very deep but narrow knowledge base that is rarely universally applicable. Fundamentally, listening to opinions rarely give useful insight. Often, it assumes looking backward but does not apply to the current situation.
An example is the Phillips Curve. A well-known economic concept that says as unemployment decreases inflation will increase. This is an opinion, not a fact. We must examine how any of the specific inputs are defined. For example, what is unemployment? How is this being calculated? This is meaningful because, while we may have a low unemployment number, it does not account for individuals who are no longer seeking work, although they can quite easily enter the workforce again. So, the “unemployment percentage” and many times be a meaningless statistic. The other component is inflation – what is causing inflation? We look at factors such as money supply and economic acceleration. What pressures exist for prices to rise? This calculation by Prof. Phillips was done in an era when we did not have global manufacturing that enabled flexibility and fundamental price control because of access to cost-effective manufacturing globally. Also, inflationary pressures have changed dramatically with an unprecedented role being played by the Federal Reserve. Central bankers did not have nearly influence or power, so the situation has changed. Look at the facts and not the assumed wisdom.
Global commerce, trade (and trade wars) tariffs, flexible manufacturing, and global markets, along with technological innovation and automation create significant pressures against inflation, regardless of employment levels. These are the set of facts to be considered, not an assumed economic model where few people understand the actual inputs from 50 years ago.
Another example looks at revenue projections based on historical business models. But what happens when those business models are changing? We discussed the example of the metamorphosis from Blockbuster to Netflix where a fundamental change in the business model made revenue projections from the historical model meaningless. Then, Netflix had to change their business model again to one of the original production and international expansion – once again obviating existing models for revenue.
Also, look at the assumptions behind Apple’s iPhone. “No one is going to wait in line for an iPhone 5 like they did for the first iPhone” a well-known investor once said. This assumed a static technological structure and ignored potential innovation, not only for the hardware but more importantly, software applications. The fundamental facts were that the business model was changing, and the iPhone became a device that received products and services personalized and specialized at an increasing rate. It became the ultimate distribution point for innovative products and services. Apple’s ability to innovate and enhance the desirability of each of those products and services further enhanced the desirability of each new iPhone model. On top of that, Apple’s fundamental business model is changing into a subscription service consumer can finance their more expensive and more feature-laden models. This is not unlike the automobile industry that introduced leasing as an option – a car lease is essentially a subscription model for an automobile. Apple is essentially offering a subscription model – a lease if you will – for its hardware products while building up its software services and other recurring revenue products. It is a completely different revenue model and the “investment expert” missed it completely. Once again, it is an opinion about a fact, and it is not a fact – regardless of the source. Facebook is confronting this same negative opinion onslaught. While the company has almost 3 billion users (about 40% of the world’s population) it is facing a publicity maelstrom over some of the postings and content. They received negative investment recommendations, and while the stock may not be a great buy, this negative publicity should not be the reason. Their user base is increasing, and the company is finding increasing ways to capture advertising revenue from its user base. The business model is showing effective revenue growth and profitability in all areas. In fact, is the set of facts to be focused on. Are these revenue sources sustainable, can they continue to increase, can they continue to increase their user base, what are the risks to each of these revenue sources? All of these are valid questions that are not being addressed or answered because the negative perspective about Facebook is simply summed up with controversy. But what has been the effect? There has been no effective negative impact, and, if anything, Facebook’s business has been improving while this may not be sustainable, an analysis should look at the reasons why it may not be sustainable. A talking head’s negative opinion is not one of those reasons.
Facts lead to knowledge leads to wisdom
Facts are what happened. Specific and verifiable. Knowledge is the appropriate combination of facts. Knowledge comes from understanding the facts that matter.
As we discussed above, understanding the key factors that cause inflation will address the issue of the Phillips Curve – not knowledge of the Phillips curve itself. Comprehending the combination of strategies that now comprise Apple’s sales strategy enables understanding its revenue model and potential prospects. Facebook’s profitability, or profit per user, or advertising rates, or other combinations are essential facts to combine to understand with a reasonable knowledge of its business and prospects.
Wisdom is the insight that leads to prediction. At its core, any investment strategy predicts the future. To predict the future effectively one needs the wisdom to grasp what will happen. Of course, this cannot be known, and there are many random events that can affect the future (see Anti-fragile and Fooled by Randomness by Naseem Taleb), and uncertainty should always be factored into any investment decisions or predictions. But an understanding of specific facts and combining those facts into knowledge enables a more effective investment strategy because it will be fueled by wisdom. It is that wisdom that gives one an understanding of what will happen with greater probability: the likelihood of inflation impacting the economy and financial markets, the trajectory for Apple’s revenue given their revised business model, the likelihood of Facebook’s sustained global revenue and user base growth.
Don’t make assumptions or accept assumed knowledge
The market represents assumed knowledge. The ability to outperform the market in many ways is the ability to move against the market. So, one is moving against assumed wisdom. This can be a lonely and anxious experience. It requires discipline and fortitude to go against the crowd. A successful investor goes against the crowd. Outperforming means being unique. Being unique, as much as anything does not come from thinking differently for the sake of being different. It comes from thinking differently because you have examined the facts and combined them into a set of knowledge that enables you the wisdom to predict.
Despite demanding work and insight, there will always be smart people to tell you are wrong. There are many examples of well-informed people dismissing innovative ideas superficially. The CEO of Verizon is quoted as saying “Apple will never make a phone.” He said this from his frame of reference, anachronistic, as to what it took to manufacture and deliver a phone successfully to the mobile phone market in the US as it was currently structured. But he failed to see the innovative tactics and first principles that Apple would apply in delivering their product. Assumed knowledge was his greatest enemy. It disadvantaged his firm, so Verizon was relegated to being a utility delivering Apple’s (and other smartphone makers) services. Continues to be a profitable business generating steady cash flow, it is not created the enormous equity value captured from the smartphone.
The assumed knowledge in the housing market was that home prices can never fall simultaneously in all major US markets. As the CEO of Citicorp famously said, “as long as the music is playing, we’re going to dance.” Obviously, we know the disastrous effect this assumption had. The assumed knowledge about the housing market permeated the industry and created risky investments and derivatives that were based on the false assumption of overvalued safety. The market did not understand the actual risk, except for a few lonely and unique individuals – who profited enormously from this erroneous thinking by the overall market.
Knowledgeable people will tell you to know when you see insight. They may be right, but more often, they are making assumptions based on assumed knowledge that is not applicable. The fortitude to understand facts and separate them from opinions, and to combine those facts into the useful knowledge that can lead to important decisions separates the successful investor.