100 Ways to Beat the Market #11: Filtering Investment Ideas

Editor's Note: Greg Speicher (@greg_speicher) is a guest blogger at Vuru and is a value investor focused on beating the market. Follow Greg's blog at gregspeicher.com and have a read of his ebook: 10 Ways to Improve Your Investment Process.

When Bill Ackman was recently interviewed on Bloomberg Television, he was asked if he was interested in Hewlett Packard given its recent large sell-off.  Ackman commented, “One of the things I learned a lot earlier in my career is to do a calculation which I call return on invested brain damage, which is before I make an investment which requires brain damage, or a lot of work and energy, I figure out how much money I can make.  The higher the brain damage, the higher the profit has to be to justify it.”

Ackman does not want to spend time on an idea if the payoff isn't large, particularly if it is a complex idea requiring extensive analysis. Ackman also said, “I have the fairly quaint notion that the value of anything is the present value of the cash you can take out of the business over its life.” So, if a business is not predictable, he will take a pass and look for something that is.

Buffett has similar filters before he will get interested in an idea.

First, he's looking for “seven footers”. Making an analogy to putting together a basketball team, Buffett wants ideas with obvious big upside potential. Only after finding a seven footer would he invest the time to check his skills, character, grades, etc. He also wants ideas where, if he could, he would put his entire net worth in the idea. He is not interested in taking a flyer on something.

The lesson here is obvious. Time is short. Don't squander it on ideas that don't offer large asymmetrical payoffs, especially if its something you could literally spend a year on and end up with a lot of superficial knowledge but no real insights into its future prospects.