Wednesday, November 24, 2010

Getting the Odds in Your Favor

Michael Mauboussin from Legg Mason Capital has a bullish column this morning in the Financial Times on stocks.

Mauboussin makes three points why he thinks U.S. stocks could be poised for significant gains in the next few months (I have posted the link to the piece below). My favorite part of the article, though, is how he starts his column.

Investing money is sometimes compared to gambling, even though professional investors hate to be considered in the same boat as a Las Vegas card player. However, there have been numerous examples of very successful investors that have also been very good gamblers.

Bill Gross from Pimco, for example, put himself through college by playing blackjack, and is now head of one of the largest and most succesful money management firms in the world. Warren Buffett is an avid bridge player. And Ed Thorp - who wrote the book on blackjack card counting called Beat the Dealer - was also a very successful hedge fund manager.

So when I read these introductory paragraphs from Maubossin today I thought it was a pretty good way to think about investing:

Puggy Pearson, a colourful gambler who won the World Series of Poker in 1973 and dropped out of school before the age of 12, was once asked about the key to his success. “Ain’t only three things,” he crooned. “Knowin’ the 60-40 end of a proposition, money management, and knowin’ yourself.” With a flourish, he added, “Any donkey knows that.”

... Pearson’s point is that an investor should always seek to have an edge, where the expectations implied by the price fail to reflect the fundamental value. Betting on horses provides a simple but accurate metaphor, where the odds on the tote board encapsulate expectations and the likely performance of the horse captures fundamentals. You don’t make money knowing which horse will win or lose; you make money determining which horse has odds that are mispriced. / Markets / Insight - Flutter on equities could prove a winner

Put another way, success in money management can be boiled down to three factors: money management; emotional discipline; and looking for situations where the odds are in your favor.

Now to put these ideas to work!