Investing Philosophy: Skill vs Luck

It can be difficult to distinguish between success and luck, especially in the world of investing.

Consider a coin flipping competition with one million participants. Each person guesses which side a coin will land on after flipping it multiple times. After each round, half of the competitors are eliminated and half move on. After 20 rounds, only 0.01% of the original participants remain – these are the "super flippers." They may feel proud of their success, but the inherent randomness of coin flipping suggests that luck played a significant role in their advancement.

In the cryptocurrency market, it is easy to mistake luck for skill. With millions of investors worldwide, it is possible for some to experience impressive returns due simply to chance. But what if there is more to the story? Is it possible that there is a common thread or strategy linking the most successful investors?

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To explore this question, let's consider a specific group of top investors: the 215 individuals who have achieved annual returns above 8% for a period of 20 years or more in the stock market. Interestingly, 9 of these highly successful investors all have a shared history. They were all born in the same town, attended the same school, and studied the same materials. Specifically, they learned the investing philosophy of Graham & Dodd (G&D).

One thing that sets G&D apart from many other investors and investing texts is its rejection of the "efficient-market hypothesis." This theory posits that all assets on the market are correctly priced, making it impossible to "beat the market." By rejecting this widely accepted idea, G&D encourages investors to determine the true value of an asset.

The key to the success of G&D students, and the difference between luck and skill, is their ability to identify the true value of an asset and to buy assets that are underpriced and sell assets that are overpriced. This is the foundation of our investing philosophy: finding and exploiting discrepancies between value and price.

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In our experience, these discrepancies often occur in assets with ambiguous returns or uncertain timeframes for realizing those returns. Leveraging our backgrounds in finance and statistics, we use probability theory and finance concepts that are frequently misunderstood to find an advantage. While we plan to delve deeper into these concepts in future writings and provide concrete examples of their successful application, the two concepts we rely on most are:

Expected value (e.g., if there is an asset with a 50% chance of paying you $100 tomorrow, how much would you pay for it?) and

Time value of money (e.g., would you rather have $100 today or $110 in one week?).

It is important to note that buying undervalued assets does not guarantee profits on every purchase. As with any type of investing, there are risks and macroeconomic factors beyond our control that can impact the market as a whole. However, by consistently identifying underpriced assets, we can increase our chances of success and outperform other investors.

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