The Wisdom of Phil Fisher [and Howard Marks], Part III

After the concept of proper diversification, the next important piece of an investor's education is learning to think independently. Or as the reputable investor and philosopher Howard Marks might describe it -- using second-level thinking -- or interpreting facts differently.

Here's how Marks introduces the concept of second-level thinking:

Remember your goal in investing is not to earn average returns; you want to do better than average. Thus your thinking has to be better than that of others - both more powerful and at a higher level. Since others may be smart, well-informed and highly computerized, you must find an edge they don't have. You must think of something they haven't thought of, see things they miss, or bring an insight they don't possess. You have to react differently and behave differently. In short, being being right may be a necessary condition for investment success, but it won't be sufficient. You must be more right than others, which by definition means your thinking must be different...
For your performance to diverge from the norm, your expectations - and thus your portfolio - have to diverge from the norm, and you have to be more right than the consensus. Different and better: that's a pretty good description of second-level thinking.

Investors should theoretically have access to the same information. Where outperformance can be achieved is through the lens in which that information is interpreted.

For example, readers of my blog know that a favorite holding in my portfolio is RADCOM (NASDAQ: RDCM). It should be common knowledge that AT&T (NYSE: T) is RADCOM's main customer (accounting for about 2/3 of total sales in 2016), but the way in which these facts are interpreted are quite different by me and other investors.

Where other investors see the dangers of customer concentration to AT&T, I see 9 more potential Tier-1 customers for RADCOM's cloud-native VNF service assurance solution, MaveriQ.

How will investors view RADCOM if they are able to close a couple more notable deals early in 2017, perhaps Verizon (NYSE: VZ) and Vodafone (NYSE: VOD)? All of a sudden the narrative changes from a small microcap that has historically had trouble scaling and competing with incumbents in the past to a company that is disruptive, stealing market share and who enjoys a vast runway ahead of it in a winner-take-most scenario. My expectation is that new deals will have an impact on how investors begin to discount the future into RADCOM's stock price, namely that of a best-in-class asset.

Now, like in prior posts, I wanted to summarize some of Phil Fisher's best quotes and thoughts from Common Stocks and Uncommon Profits.

On not following the crowd; thinking independently

There are fads and styles in the stock market just as there are in women's clothes. These can, for as much as several years at a time, produce distortions in the relationship between existing prices to real values almost as great as those faced by the merchant who can hardly give away a rack full of the highest quality knee-length dresses in a year when fashion decrees that they be worn to the ankle.

These investment fads and misinterpretations of facts may run for several months of several years. In the long run, however, realities not only terminate them, but frequently, for a time, cause the affected stocks to go too far in the opposite direction. The ability to see through some majority opinions to find what the facts really are there is a trait that can bring rich rewards in the field of common stocks. It is not easy to develop, however, for the composite opinion of those with whom we associate is a powerful influence upon the minds of all of us. There is one factor which all of us can recognize, however, and which can help powerfully in not just following the crowd. This is the realization that the financial community is usually slow to recognize a fundamentally changed condition, unless a big name or a colorful single event is publicly associated with that change.

Recognizing such situations - prior to the price spurt that will inevitably accompany the financial community's correction of its appraisal - is one of the first and simplest ways in which the fledgling investor can practice thinking for himself rather than following the crowd.

Disclosure: I own RDCM shares.

Mike Arnold

full-time investor searching for talented operators, clean capital structures & scalable growth. no cigar butts or conventional wisdom. // hiker. hooper. writer

Portland, Oregon