A Man’s Got To Know His Limitations

Lieutenant Briggs: You just killed three police officers, Harry. And the only reason why I’m not gonna kill you, is because I’m gonna prosecute you–with your own system. It’ll be my word against yours. Who’s gonna believe you? You’re a killer, Harry. A maniac.

[Briggs starts to drive away when the car blows up]

Harry Callahan: A man’s got to know his limitations.

That’s the end of the 1973 movie Magnum Force. Briggs, a vigilante cop, has an opportunity to shoot Harry Callahan dead. But Briggs is an egomaniac convinced of his own moral superiority. He opts for a clever revenge scheme instead. He flees in a car, which, unbeknowst to him, has a live bomb in the backseat.

A man’s got to know his limitations.

I was moved to reflect on this after a recent due diligence trip. In investing, outcomes are inherently uncertain. We never have perfect information when making investment decisions. We’re lucky to have “good” information in most cases. Even then, unexpected events have a nasty habit of blowing up our plans.

Investing is an exercise in probabilistic thinking. Outcomes do not necessarily reflect the quality of decisions (good investment decisions often result in bad outcomes and vice versa).

When investing, you’ve got to know your limitations.

If you’re a typical outside minority passive investor, you have minimal control over investment outcomes. Basically, the only variable you can control is your own behavior.

You need to be realistic about what you can and can’t know, and the kinds of things you should and shouldn’t expect to get right. The more you can expect to get a decision right, the more time you should spend on that area. Don’t waste time on things that aren’t knowable, or things subject to lots of random noise.

 

Things I Will Never Get Right

Forecasts for prices and other variables. (This would seem obvious but it never ceases to amaze me how much time and energy is wasted here)

Timing, in the sense of trying to buy the bottom tick or sell the top tick.

Macroeconomics.

Intrinsic value. (It’s not observable)

 

Things I Should Get Right More Than Half The Time

The general quality of a given management team.

The general quality of a given business.

Industry dynamics, competitive forces and secular trends.

The potential range of outcomes for a given investment.

 

Things I Should Get Right Most Of The Time

The handful of key variables that will make or break an investment.

How I’ll know if I’m wrong about any of the key variables that will make or break an investment.

Assessing the major “go-to-zero” risks: leverage, liquidity, concentration, technological obsolescence and fraud.

When to average down, when to hold and when to sell out of an investment, not based on price action but on the key drivers and risks.

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