Our investment philosophy follows a fundamental belief — the stock market functions much like the classic jelly-bean-counting experiment. That might sound strange, but hear me out:
In The Wisdom of Crowds, James Surowiecki describes a jelly-bean-counting experiment done by Jack Treynor. In the experiment, Treynor asked a classroom of students to guess the number of jelly beans in a jar. While there was a wide dispersion of guesses, the average guess of the classroom was surprisingly accurate — closer than almost every individual student in the class.
The crowd was collectively so accurate because each guess contributed 1) information, and 2) error. Under the right conditions— which is a large, unbiased group — the random errors cancel each other out, leaving behind the collective information of the class.
In a second experiment, Treynor claimed the jar was plastic instead of glass, suggesting that it could hold more jelly beans. In doing this, Treynor introduced bias to the group — the errors were no longer random. The result? The class’s guess became less accurate.
In many ways, the stock market resembles this jelly bean experiment. Most of the time, the crowd is collectively smart and individual stocks are fairly valued. Our goal, then, is to find a few select opportunities in which our guess is more accurate than the class overall.
Because a large, unbiased group tends to make accurate guesses, we seek out cases where the “classroom” is small or biased – where investors have little information or a distorted view.
Investors collectively may have limited knowledge about unique business models or underfollowed stocks. Investor bias can appear in a good business within a bad industry or from extrapolating recent experiences.
For example, Amazon was a fast-growing, unprofitable business that eventually proved to be extremely valuable; this partly explains why other unprofitable businesses have seen high-multiple valuations in recent years.
All of these scenarios can create great investment opportunities.
That’s why our investing approach starts by casting a wide net, then narrowing it down to a few select stocks that meet our criteria. We believe the crowd usually gets it right; we want to maximize our exposure to the few cases where we think the crowd is off the mark.
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