The most lucrative investments are often those that are left out by the public and dismissed as too risky. The best value investors are characterised by the fact that they find and invest in companies that have unjustly fallen out of favour and are therefore available at a ridiculous price. But how do these investors manage to make themselves independent of public opinion and trust solely in their own opinion? In this context, Warren Buffett speaks of his inner scorecard.
In this article, I would like to briefly present what is behind the concept of the inner scorecard and how we can use this concept to be more successful as private investors.
What you will learn in this article
- Why we need to think independently as value investors
- How Warren Buffett defines his inner scorecard
- Why in reality we often pursue goals outside our inner scorecard
- How we can learn to be independent
Independent thinking is essential for successful investing
"It is impossible to produce superior performance unless you do something different."
Sir John Templeton
There are many other quotes that could be used here, because everyone from Andre Kostolany to Benjamin Graham has spoken about the importance of independent thinking for success on the stock market.
Guy Spier, successful investor and author of The Education of a Value Investor, for example, says in an interview at Manual of Ideas: "We have to learn to decide within ourselves whether our actions and decisions make sense and not think about whether it makes sense to the public."
There is indeed the market efficiency hypothesis, which says that stock markets are efficient, i.e. that all available information concerning the future is already correctly reflected in stock prices. In reality, however, there are indeed extended phases in which share prices deviate more or less strongly from their "true" or intrinsic value.
This can be the case, for example, when the market as a whole is dragged down by an economic crisis. In 2008, it was not only the prices of bank shares that fell sharply due to the subprime crisis, but also actually the prices of all listed companies.
Or there are company-specific events that have an excessively negative impact on the share price. Such events in the recent past include, for example, the VW diesel scandal at VW or Carl Icahn's exit from Apple. In such cases, many investors do not sell because they have analysed the impact of the event on future earnings and have concluded that the shares are actually worth less. Rather, they sell because everyone else is also selling and they do not want to be the fools who end up with the presumably worthless shares in their portfolio. In such a case, many investors act irrationally.
Accordingly, there are many situations on the markets in which it can be worthwhile to form one's own independent opinion and then, if necessary, to take a position contrary to the market.
However, this is more difficult than we think. When we, like Warren Buffett, are in the public eye and each of our investments is not only commented on at length and scrutinised by the press. Even if we, as private investors, were to talk about our latest VW investment among our acquaintances, for example, we would hear the current (negative) opinion from the press from the majority of people.
The concept of the inner scorecard
"If the world could not see your results, would you rather be thought of as the world's greatest investor but in reality have the world's worst record? Or be thought of as the world's worst investor when you were actually the best?"
So which would you rather be? Would you rather the public thought you were the best investor in the world when in reality you had the worst track record? On the other hand, would you prefer it the other way around: everyone thinks you are a really bad investor, but in reality you have beaten every index over the years?
Variation (as far as I know, this quote also comes from Warren Buffett himself):
"Would you rather be considered the best lover in the world but in fact are not or would you rather be the best lover to your spouse but the public thinks you are bad?"
So would you rather everyone thought you were the best lover in the world (or the best lover)? Or would you rather actually be?
Those of us who would choose the second option in each case have an inner scorecard.
So what does that mean exactly? From my personal perspective, it means that we define for ourselves what principles we want to live and act by. For example, what does success mean to us? What is a fulfilled family life for us? What are our ethical principles (keyword value system)? And so on.
I think intuitively most of us would choose the second option. Everyone, including myself, likes to think of themselves as independent thinkers. Nevertheless, the "opinion of others" (to put it in layman's terms) is often more important to us than we think. And this refers both to what others think about us and to how we form our opinions.
In reality we are often anything but independent
Much of what we do happens subconsciously. Our brain is polarised in such a way that we, for example, give too much weight to the opinions of well-known institutions and authorities or stick to our opinion once it has been formed, even if there is already other information to the contrary.
And the opinion of the public, or perhaps only of individuals, is certainly important to us. Why, for example, do the managers of large funds often have the same stocks in their portfolios? Or why are analysts' recommendations so similar in many cases? Perhaps I will answer this with a counter-question:
Which would you prefer?
- You are wrong with your assessment, but everyone else is just as wrong?
- Everyone else is right and you are unfortunately the only one who is wrong with your assessment?
It is emotionally very difficult for us to accept a situation in which we are the only ones who are wrong. Or we should better say: "could be wrong". For the mere possibility of such an outcome causing us to break out in a sweat. For this reason, in many cases we then sway to the opinion of the majority, be it with regard to share prices, economic issues or other developments. I bet we have all had these experiences.
A small note: This is also one of the reasons why we as private investors are able to achieve better results than professional managers. In many cases, managers of large funds simply have completely different incentives and also pursue different goals than just maximising fund returns.
Friedrich Nietzsche was already concerned with the independence of one's own opinion in the 19th century. The following quote has been handed down from him:
"The first opinion that occurs to us when we are suddenly asked about a matter is usually not our own, but only the customary one, appropriate to our caste, position, or parentage; our own opinions seldom swim near the surface."
Let's take, for example, the definition of success in connection with our Inner Scorecard. Regardless of how we define success for ourselves, we encounter many situations in the course of our lives in which we are confronted with external definitions of success.
Actually, this runs through our entire life: There are the tests and exams at school quite early on, and later the exams at university. Success here essentially means getting good grades. In the job, there are the end-of-year reviews in which we find out where our weaknesses lie (often from the company's point of view, of course). In this case, success means fixing these weaknesses and then getting a promotion at the next interview.
In very few cases does this coincide with our own definition of success. Nevertheless, over time we have learned to work extremely hard to meet these external criteria, which are outside our own scorecard. And in many cases, we have to or want to! After all, we want to get a good degree and get ahead in the job. Or do we simply not have an internal scorecard in this case?
How we learn to think independently
Understanding where we follow an externally defined scorecard
In order to understand the extent to which we are following our own inner scorecard and evaluating ourselves against that scorecard, we first need to raise our own awareness of the differences. We should be clear (or ideally write down) where we are externally assessed and to what extent this assessment is in line with our inner scorecard.
Essentially, we need to answer the following questions for ourselves:
- How and on the basis of which criteria do we evaluate ourselves?
- And how and on the basis of which criteria does our environment (e.g. our employer, our customers, other investors, the public, our partner, etc.) evaluate us?
- Where are there similarities and where are there differences?
Then we should ask ourselves how we feel when we do something that fits our own inner scorecard but deviates from external evaluation schemes. Perhaps a feeling of discomfort is one of the more innocuous descriptions. So do we really understand our motivation to do certain things well enough?
Ideally, we should work and function in an environment where
- either the external scorecard is congruent with our internal scorecard
- there is no external scorecard (which is very unlikely) or
- the external scorecard is so far away from us that we can easily distance ourselves from it.
Warren Buffett also operates in an environment where there is an external scorecard. For example, many journalists regularly write about him, evaluate his investments and comment on his decisions. However, Buffett is sufficiently far removed from these influences that they do not affect his independence. Buffett has managed to always do what he believed was right.
Align the investment process accordingly
In terms of investing, we can at least partially avoid external influences through a well-established and consistently followed investment process. I refer to the investment process here as the standard procedure in the run-up to an investment decision. In this process, we define how we proceed step by step to analyse an investment idea.
For example, in order not to be influenced too early by external influences and opinions about an investment, we can define in our investment process that we do not read analysts' opinions or forums such as Finbox, Yahoo Finance, SeekingAlpha etc. until we have formed our own opinion about the investment based on the hard data and facts.
This is not always easy either, because we are regularly exposed to an overflow of information and because we naturally also use such forums and portals to find investment ideas.
In order to achieve above-average success in the stock market, we must be able to think independently and, in some cases, make decisions contrary to public opinion.
Warren Buffett has called the ability to do this his inner scorecard.
However, it is not the case that it is enough to have this inner scorecard. Even if we have our own definition of success, for example, this does not mean that we align our actions with it. On the contrary, we often pursue goals defined by others, in many cases without even noticing it directly.
We must therefore regularly make ourselves aware of which of our goals actually lie within and which lie outside our scorecard and ideally define our investment process in such a way that we only read other opinions about an investment as late as possible.