Actively avoiding losers
Most portfolio managers attempt to outperform a benchmark by picking winners. To
do this they make educated guesses about the future fortunes’ of companies and we
all know that by definition the future is completely unknowable. Paradoxically,
the more they attempt to pick winners by trying to predict the unknowable future,
the more they increase the likelihood of being wrong and investing in losers. At
Transparent Value, we believe this introduces human behavioral biases that make
such predictions very unreliable.
Our methodology, called the Required Business Performance®
Methodology seeks to identify situations in which behavioral biases have pushed
the stock price beyond management’s ability to deliver. It also insulates us from
behavioral biases when we make stock selections. We calculate the Required Business
Performance® of each stock, then
objectively calculate the probability that this performance will be delivered.
Can management deliver the Required Business Performance®
to support the stock price?
Traditionally investors approach an investment decision from an “is it worth it”
perspective”. We instead ask “What is the business performance required to support
the stock at its current price” and “Can management deliver the Required Business
Performance to support the stock price?”
We believe this tells us the likelihood behavioral
biases have impacted the stock price. We believe that if, based on our analysis,
management is likely to deliver; the stock is a worthy investment because its behavioral
risk profile is attractive.