Brilliant Stock Pickers: Scientists or Artists? 

One of the monsoon rituals that I really look forward to is my annual get together of school friends.

So, some 5-6 of us check into a nice, cozy resort and spend most of the time just lazing around and taking those nostalgic walks down memory lane.

Trust me, there aren't many better feelings than sitting in a room with your closest chums, sipping your favourite drink and watching monsoon clouds descend on the mountains outside.

Absolutely heavenly I should say.

Talking about heavens, I was surprised when a friend spoke about taking 'heavenly' help for investing in stocks.

He was referring to investing in stocks based on astrological predictions or 'Astro Stock' prediction as it is popularly known as.

He said that a few of his friends invest based on astro predictions and have made a good amount of money.

In fact, he wasn't averse to the idea of trying it out himself.

Well, I tried to make him understand that I belong to a different school of thought.

Anything that does not involve the concept of fundamental analysis and intrinsic value is not investing. It is speculation as per me.

And since astro prediction has nothing to do with the PE ratio or the return on equity or even intrinsic value or fair value, I am not sure about the long-term viability or money-making potential of 'Astro' prediction.

My friend did not agree, He replied that even fundamental analysis and intrinsic values are not 100% accurate and scientific.

So, they fall in the same league as astro prediction as per him.

Well, it was time for me to share my experience, I guess.

I thought hard and came up with an example.

If you give a math problem to a couple of students and ask them to come up with an answer the next day, both will come up with an exact same answer if they follow the rules.

There is almost no ambiguity in mathematics. Either you have the right answer or the wrong answer. It is as scientific as it can possibly be.

On the contrary, if you ask the same two students to draw a bus stop or a marketplace, there is a strong possibility that their versions of the same will be different from each other.

It is highly unlikely that they will come up with the exact same drawing and with the exact same color scheme.

Hence, drawing is not mathematical. It is not science and is rightly called as an art form.

On the one hand you have math, which is science and then you have drawing or painting, which is art.

There are many activities that lie on the science vs art or skill vs logic spectrum.

Where does investing lie? Is investing in stocks scientific like the math problem the students solved or is it an art like the drawings they drew?

Well, if you ask a science or a logic lover, someone like me for example, he will tell you that stock picking is more science than art.

After all, behind every stock there is a business and behind every business there is financial history, there are numbers and there is a P&L statement. And therefore, wherever there are numbers involved, there is logic and there is science.

However, if you ask someone like my school friend who's more into astro prediction and things like that, he will tell you that there is no one answer to where a company's stock price could be couple of years down the line.

Ten different analysts can come up with different estimates of where a company's future share price will be.

And hence, they will conclude that predicting a company's future and its stock price is more 'art' than 'science' as there is no one answer.

Hmmm....this is getting confusing, isn't it? Is stock picking an art or a science?

Well, in my view, it doesn't have to be an 'either-or' situation.

I don't think investing is either science or art. In fact, I believe that investing is both 'science' as well as 'art', with the relative percentages to be decided by the investor himself.

Allow me to explain this with an example.

What kind of an investor are you? Are you the kind of investor who likes to invest in a company that has an earnings power of Rs 100 per share based on its historical performance and has traded at a PE multiple of 15x but is now available at a PE multiple of 10x because of some near-term concerns?

This means that the stock has intrinsic value of Rs 1,500 but is trading in the stock market at Rs 1,000 per share, thus pointing to a 50% upside in 1-2 years if the earnings go back to Rs 100 per share.

Or are you the kind of investor where the current earnings power is Rs 100 but is expected to go up by 10x over the next 10 years?

However, the share price of this company is not Rs 1,000 but is currently trading at Rs 2,000 per share. But 10-years down the line, there is a chance that this stock can even trade at Rs 20,000 per share if earnings go up by 10x in 10 years.

Are you more attracted towards company A or company B?

If you are more attracted towards company A and if you prefer this style of investing, then you are more a quantitative investor or an investor who is more about science than art.

However, if you are more attracted towards company B, then you are more interested in the qualitative aspects of the company and you are more artistic than scientific.

A quant or a more scientific investor may earn lower returns than a qualitative investor but his returns are more assured than the qualitative investor. The qualitative investor can indeed earn big returns but it requires a strong understanding of the company's competitive advantage and the quality of its management. And this is more art than science.

Quantitative investing on the other hand is more science than art.

Warren Buffett and Charlie Munger can be called as more qualitative than quantitative whereas Ben Graham and Walter Schloss were more quantitative than qualitative.

Buffett and Munger are more about skill and art whereas Graham and Schloss are more about logic and numbers.

The value investing world is also divided into people who follow the Warren Buffett philosophy of having a larger 'art' component as compared to the Ben Graham philosophy of having a much lower 'art' component.

I am myself a proponent of the Ben Graham philosophy and try to reduce the 'art' part as much as possible in my analysis.

I am more about raw numbers and insisting on a huge 'margin of safety'.

Therefore, the choice of having how much percentage of 'science' and 'art' in your investing is entirely yours.

You must decide what you are comfortable with.

However, I won't recommend making investing 100% art based where you are paying no attention to the company's fundamentals and financial performance and are focused solely on the company's future and things like astrological prediction.

Making it 100% science is also not recommended. At least a some understanding of the company's fundamentals should be there.

I think it will be an interesting exercise to see where you lie on this spectrum. Do try it out.

Happy Investing.