An excerpt from the Boyles Q1 letter to investors...
Confirmation and Disconfirmation
“The exceptions to any rule are most
interesting in themselves, for they show us that the old rule is wrong. And it
is most exciting, then, to find out what the right rule, if any, is. The exception is studied, along with other
conditions that produce similar effects. The scientist tries to find more exceptions
and to determine the characteristics of the exceptions, a process that is
continually exciting as it develops. He
does not try to avoid showing that the rules are wrong; there is progress and
excitement in the exact opposite. He
tries to prove himself wrong as quickly as possible.” -Richard Feynman (The
Meaning of It All)
There
is a powerful force in human psychology known as confirmation bias. This drives people to look for evidence that
confirms what one already believes—or wants to believe—and to ignore, or
rationalize, evidence that contradicts those beliefs. It is an especially prevalent cause of
investment error. As investors, we want
to find great ideas. We want to find
great management teams. And we want to
uncover a story that we think the market has gotten wrong, so that we may
profit.
And to
do this, we spend a lot of time learning. To some extent, our job as fundamental value
investors is part language learning, and part investigative journalism. The language learning occurs as we look at unfamiliar
businesses or industries. Unless it is a
company in the exact same line of business as one we’ve already studied, there are
likely to be a few new terms and products to learn about. Sometimes the amount of language learning is
extremely small, and sometimes it is large, but it is usually fairly
straightforward, and less prone to error.
The
larger part of the research process is that akin to investigative journalism. It is the deep dive into the business, its
people, and the competitive landscape. It
is large not just because it requires a lot of effort, but because it also
requires interpretation. The more
subjective the interpretation, the greater the chance for error; and there are
few, if any, greater causes of investment error than human psychology.
Because
investors want to invest, a positive story forms in their minds as they think
about and research potential investments. Almost any piece of data that can be viewed in
a positive light is so viewed, and that which can’t is normally explained away,
often by assuming that the negatives are far outweighed by the positives. Historical achievements are seen as
inevitability, or as managerial brilliance destined to continue. But the narrative of history isn’t always what
it seems. As Yuval Noah Harari writes in
his book Sapiens: A Brief History of
Humankind:
“...the better you know a particular
historical period, the harder it becomes to explain why things happened one way
and not another…It is an iron rule of history that what looks inevitable in
hindsight was far from obvious at the time.”
This
holds true with business history just as it does with human history. The more you learn about the biographies of
certain businesses, such as Wal-Mart or Google, the more you begin to realize
that not only were outsiders incapable of knowing what would happen, but those
directly involved in the businesses were just about as incapable as everyone
else. More pressure from larger competitors
or a potential acquirer willing to pay just a little more would probably have
had major impacts on the outcomes of those businesses, as well as many others.
How do
we use this knowledge to help us invest?
How do we try to prevent our minds from using information from the past
and present to cloud our picture of the future?
We attempt to give special attention to evidence that disconfirms our
current viewpoint. There is a natural
tendency to close one’s mind to such evidence and dismiss it as incorrect or
unimportant. But learning to welcome and
actively search for disconfirming evidence, as well as actively questioning the
implications if such evidence is true can give one a big advantage in investing
and in life. It can greatly improve
one’s mental processing over time, as it did for Charles Darwin, as described
by Charlie Munger in Poor Charlie’s
Almanack:
“He trained himself, early, to
intensively consider any evidence tending to disconfirm any hypothesis of his,
more so if he thought his hypothesis was a particularly good one.…Darwin’s
practice came from his acute recognition of man’s natural cognitive faults.…He
provides a great example of psychological insight correctly used to advance
some of the finest mental work ever done.”
