Idea Generation and Investor Biases

Date Added: June 8, 2018 | Comments Off on Idea Generation and Investor Biases | Filed under: Blog

Good investment ideas can come from anywhere. They can come from your own experiences as a consumer or business person. They can come from reading both history and current events and they can come from simply observing the world around you. Often, they come from other people.

Aspiring investors are often advised to watch the actions of successful professional investors for ideas as to where they should invest. I don’t disagree with this advice.

However, I think it is also limiting.

The fact is that almost everyone you know will have an investable idea at some point in their life, some situation within their particular expertise that they identify as an opportunity. Your job is to know when that idea is within your own circle of competence and therefore whether it is an opportunity that you can understand with enough confidence to make a successful investment. I have personally been the recipient of great investment ideas from clients, from assistants, as well as from both retail and institutional investors.

The problem with a lot of investors and investment groups is that they are not open to the ideas of others often believing that ideas have to only come from their own work or some source that they view as “credible” because of that sources particular pedigree, their position in business, or most often their familiarity to the investor.

Let me give you a couple of examples of why this is a mistake.

There is an investment group that I respect and with whom I have become familiar. While not always agreeing with their investments, I appreciate their approach to investing, and their investment philosophies. From time to time I have made an investment recommendation to them. I don’t do this out of the kindness of my heart but in exchange for compensation in a consulting arrangement. They have not once yet accepted one of my suggestions despite the fact that to date everything that I have proposed to them has been quite successful. One of the suggestions which was made on two different occasions  were the distressed bonds of a particular company. Those bonds have now more than doubled in value and at the time of their recommendation had a current yield of approximately 17%. What’s more, this investment group had a former executive from the company that had issued the distressed bonds on contract. They should have had a great advantage in understanding this opportunity.

But………I wasn’t a known entity to this investment group’s bond team having only a dialogue with the CEO. I was an unknown, and therefore I believe, not taken seriously as a source of a very good idea, but rather as a source of competition. Furthermore, this investment group though they should have had a leg up in their understanding of the opportunity because of the presence of a former executive from the investment target on their team…………..didn’t. Why not? Because the guy was a disgruntled former employee having been passed over for the senior role and this clouded his vision on the matter of his former employer.

Result. Bond return in excess of 135%, but not for them. This is an example of how the rigid structure of institutions can get things very wrong.

But it isn’t just institutions.

Recently I had dinner with a former colleague. At one time I mentored this individual and I like to think I had some small part in his now having a successful investment practise. When we have dinner we generally pitch a few of our favourite ideas to one another. This time mine was a pharma company trading for only the cash they had on the balance sheet and cash expected in 2018 despite having an ongoing and incremental business. His was a public company real estate opportunity with yield. Since I am always looking for investments with yield for my Takota Income Value Strategy accounts, the next day, I spent some considerable time looking at the opportunity finally deciding that I wouldn’t pursue it because of general concerns about real estate. I happened to notice that my suggestion to him had appreciated about 17% between  our dinner and a few days later. I emailed him to ask if he had been able to take advantage of it – and found he hadn’t even looked at it. Big mistake.

To make matters even worse, I subsequently forwarded another idea to this same guy with a few brief notes. He dismissed the idea out of hand because he thought that one of the major shareholders hadn’t been recently successful in their equity investments. This opportunity was cheap, with good management, and with an attractive and potentially growing dividend yield. In my opinion another big mistake.

The lesson: Consider ideas from any sensible place if they are things which you feel that you can understand. Be curious, check them out. Do the work. You never know when or where you are going to find a great opportunity.


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