Michael J. Mauboussin: An interview by Bob Morris, Part 1

Posted on: December 7th, 2012 by bobmorris

Michael J. Mauboussin is Chief LMCM in 2004, Michael was Chief U.S. Investment Strategist at Credit Suisse. Michael joined CS in 1992 as a packaged food industry analyst, and was repeatedly named to Institutional Investor‘s All-America Research Team and The Wall Street Journal All-Star survey. He is the author of The Success Equation: Untangling Skill and Luck in Business, Sports, and Investing (Harvard Business Review Press, 2012), Think Twice: Harnessing the Power of Counterintuition (Harvard Business Press, 2009) and More Than You Know: Finding Financial Wisdom in Unconventional Places, Updated and Expanded Edition (Columbia Business School Publishing, 2008). More Than You Know was named one of “The 100 Best Business Books of All Time” by 800-CEO-READ. He is also co-author, with Alfred Rappaport, of Expectations Investing: Reading Stock Prices for Better Returns (Harvard Business School Press, 2001).

Michael has been an adjunct professor of finance at Columbia Business School since 1993 and is on the faculty of the Heilbrunn Center for Graham and Dodd Investing. In 2009, Michael received the Dean’s Award for Teaching Excellence. He earned an A.B. from Georgetown University. He is also chairman of the board of trustees of the Santa Fe Institute, a leading center for multi-disciplinary research in complex systems theory.

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Morris: Before discussing Think Twice and The Success Equation (Part 2), a few general questions. First, who has had the greatest influence on your personal growth? How so

Mauboussin: Well, I’d answer as I’d guess most people do by citing my parents. But perhaps their influence was not in a traditional fashion. My parents taught me many important lessons about working hard, being honest, and doing things right. They also placed great emphasis on education. But my personality is very different than theirs was, and my interests rarely intersected with theirs. For example, growing up I was very into athletics, which was something that mystified them somewhat.

But here is the key: they always supported me. As I like to say, they were always behind me but never too close. So they afforded me freedom that was vital to my development and allowed me to grow in the way that I did.

Morris: The greatest impact on your professional development? How so?

Mauboussin: I’d have to mention two people, Al Rappaport and Bill Miller. Reading Al’s work early in my career provided an intellectual foundation upon which pretty much everything else was built. Bill Miller showed me the virtues of learning across disciplines and making connections. He was the one who introduced me to the Santa Fe Institute, a place that has deeply influenced my thinking.

Morris: Years ago, was there a turning point (if not an epiphany) that set you on the career course you continue to follow? Please explain.

Mauboussin: Absolutely, and I would call it an epiphany. I studied political science in college and had virtually no business schooling before starting on Wall Street. And the fact is much of what I heard and saw my first year or so didn’t make sense because I didn’t have a robust framework for thinking about the stock market and corporate performance.

A colleague in my training program handed me a copy of Al Rappaport’s book, Creating Shareholder Value, in 1987 and it was the first thing that made sense from the first to the last page

There’s a lot of rich content in that book, but I’ll mention three lessons that I took to heart. First, the value of a business is based on the present value of future cash flows, and earnings are an unreliable indicator of value. Second, competitive strategy analysis and valuation are joined at the hip—you can’t do thoughtful valuation without understanding the competitive landscape, and the litmus test of a good strategy is that it creates value. Finally, stock prices reflect information about the expectations for future financial performance. Managers and investors can understand those expectations and use them to inform their decisions.

Of course, I was blessed to be able to collaborate with Al on Expectations Investing, which showed how investors could make use of this framework.

Morris: To what extent has your formal education been invaluable to what you have accomplished in life thus far?

Mauboussin: I think my formal education played a relatively small role in my accomplishments. I had some great teachers and peers in college, for example, but I haven’t applied much of what I actually studied.

As I think about it, I think intellectual pursuits filled the gap vacated by my athletic activities after college. So I didn’t really get intellectually engaged until I was in my early to mid 20s.

Morris: What do you know now about business world that you wish you knew when you went to work full-time for the first time? Why?

Mauboussin: I’m not sure I know much now! But I would say the thing that’s become clear to me over the years is the importance of psychology and social psychology in understanding decision making. In economics, for instance, you’re taught that people are basically rational. But you don’t have to be in the real world long to see that’s not true.

Study of psychology has also showed me that many situations are more nuanced than they appear. How people decide and interact are perpetually fascinating topics.

Morris:  From which non-business book have you learned the most valuable lessons about business? Please explain.

Mauboussin: The one comes to mind is Mitchell Waldrop’s book about the Santa Fe Institute called Complexity. This was my first introduction to the world of complex adaptive systems. And once you understand the basic ideas behind complex adaptive systems, your worldview changes radically.

You have a complex adaptive system when heterogeneous agents interact, from which a global system emerges. The agents also learn and change to reflect their environment, hence the term “adaptive.” Take an ant colony as an example. A colony is the result of the interaction of thousands of ants, and the colony has characteristics and properties itself similar to a species. But the key is that no ant has any clue what’s going on at the colony level—she’s operating with local information and local interaction. So, in complex adaptive systems the whole is greater than the sum of the parts and reductionism doesn’t work. In other words, you can’t understand the whole by adding up the parts.

Markets and businesses are complex adaptive systems. So that book gave me a new way of looking at these entities that was not only novel, but I think more accurate than the conventional wisdom.

Morris: Here are several of my favorite quotations to which I ask you to respond. First, from Lao-Tzu’s Tao Te Ching:

“Learn from the people
Plan with the people
Begin with what they have
Build on what they know
Of the best leaders
When the task is accomplished
The people will remark
We have done it ourselves.”

Mauboussin: To me that says that great leaders give their people the tools to succeed and empower them. There’s a great literature on what leads to intrinsic motivation, and I think every leader should know about it—a great source is Dan Pink’s book, Drive. The conditions for intrinsic motivation include autonomy, mastery, and a sense of purpose. These are fragile conditions but great leaders create an environment where they flourish, providing people with a sense of accomplishment.

Morris: Next, from Voltaire: “Cherish those who seek the truth but beware of those who find it.”

Mauboussin: Beautiful quotation. Learning is a perpetual process, and once you’ve “found” truth you stop learning. I’m reminded immediately of the splendid work of Phil Tetlock, a great psychologist. Tetlock did an extensive study of expert predictions in political, economic, and social realms. He found that their predictions were poor.

But he did see a difference in the ability to predict, based on thinking style. He distinguished between “hedgehogs,” people who know one big thing and fit everything into their worldview, and “foxes,” those who know a little about a lot but who don’t tend to be married to any specific point of view. Tetlock found that although hedgehogs get their 15 minutes of fame, foxes are consistently better predictors. Foxes seek the truth and hedgehogs have found the truth. I think Voltaire would like Tetlock’s work!

Morris: And then, from Oscar Wilde: “Be yourself. Everyone else is taken.”

Mauboussin: Yeah. We all come into this world with different endowments, personality, circumstances, and opportunities. The key is whatever you do, consider it in the context of who you are and what you are good at.

My mother once told me that one of my shortcomings was I was too lazy to work on improving my weaknesses. I’m sure that’s true. And certainly, most occupations require competence in various skills. But I think her comment was basically misplaced. The goal in life is to leverage your strengths. When you’re emulating others, it’s often hard to be yourself.

Morris: From Albert Einstein: “We cannot solve our problems with the same thinking we used when we created them.”

Mauboussin: Alan Kay from Xerox PARC used to say that “point of view is worth 80 IQ points.” In other words, new thinking about problems, done properly, makes you a lot smarter.

This is at the core of why I love the Santa Fe Institute so much. SFI was founded by eminent scientists who felt that academia operated in silos defined by discipline and that a lot of the interesting problems were at the intersections of those disciplines. So SFI’s mission is to take a trans-disciplinary approach to address problems. Sometimes people from other fields can provide a dash of insight that leads to a better way of thinking about a problem.

Morris: Finally, from Peter Drucker: “There is surely nothing quite so useless as doing with great efficiency what should not be done at all.”

Mauboussin: This reminds me of another Drucker point, which is that you should always ask the naïve question: if we weren’t doing this now, would we start today? The question forces you to constantly examine whether your activities make sense in the context of your competitive resources and the business landscape.

Years ago, I met with the newly placed CEO of Campbell Soup, a company that was performing at a subpar level. He was examining every aspect of the business, and noticed a sizeable tomato soup promotion that took place every fall. Now, tomato soup is a very profitable business for Campbell Soup, and while the promotion led to nice volume gains, it wasn’t great for profitability. So the CEO asked why they were doing it. The executive in charge of the division replied, “I don’t know. We’ve always had a promotion in the fall.”

So the CEO dug deeper, and here’s what he discovered. About a century ago, Campbell produced all of its tomato soup shortly after the tomato crop was harvested in the summer. Because the company’s inventory of soup was to the rafters in its warehouse, it decided to run a promotion to sell some of it to the retailers at a discounted price.

Naturally, the company had long ago gone to year-round suppliers, eliminating the post harvest bulge. But the promotion continued as a vestige of the long-gone fall harvest. The point of the story seems to be the same as Drucker’s: Doing something well doesn’t make any sense if you shouldn’t be doing it at all. So you have to constantly ask the naïve question.

Morris: In Tom Davenport’s latest book, Judgment Calls, he and co-author Brooke Manville offer “an antidote for the Great Man theory of decision making and organizational performance”:  organizational judgment. That is, “the collective capacity to make good calls and wise moves when the need for them exceeds the scope of any single leader’s direct control.” What do you think?

Mauboussin: I’m in general agreement with this but I do think the answer is that it depends. There are some decisions that certain individuals may be well, or even uniquely, qualified to make. For example, if you have problems with your plumbing you’d want a qualified plumber, not a collective, addressing your issue.

That said, I think the spirit of this statement is correct. Two points come to mind. The first is that there was a paper written years ago by Kathy Eisenhardt and Don Sull called, “Strategy as Simple Rules.” Their basic argument is that in dynamic business environments, there are so many possibilities that trying to come up with a rule to deal with each is futile—or even counterproductive. So they argue that senior management should define a number of rules, say 5-10, that should guide employee behavior. Employees would then be free to make decisions as they see fit provided the rules were not violated. I think that makes a lot of sense and gets to Davenport and Manville’s point.

Second, we know that problems in realms that are complex are better solved by the wisdom of crowds than by a single expert. There is an enormous amount of information floating around in organizations and most of it doesn’t find its way to the top. So smart executives realize that tapping the collective wisdom of the organization can do a better job guiding decisions than some executive decree. The challenge, of course, is that one has to be careful and thoughtful in figuring out ways to tap the wisdom of crowds.

Morris: Here’s a brief excerpt from Paul Schoemaker’s latest book, Brilliant Mistakes: “The key question companies need to address is not ‘[begin italics] Should [end italics] we make mistakes?’ but rather ‘Which mistakes should we make in order to test our deeply held assumptions?'” Your response?

Mauboussin: This is at the core of the issue of finding causality. What cause what? We often have deeply held assumptions about what causes what, but rarely check our assumptions. So Schoemaker’s point is right on.

I think there’s been a strong movement in this direction, and it’s been substantially aided by technology. For example, retailers are now trying different ad campaigns on the Internet, and can effectively create control groups. In other words, some people see the ad and others of a similar demographic makeup don’t see it, and the retailer can measure the results.

There is a recent instance of Schoemaker’s point being proven out in political advertising. Politicians have historically spent lots of money on campaigns but didn’t really know what paid off. They had assumptions about what worked, but the assumptions were untested. So political scientists came along and ran experiments, showing for the first time what is effective and what is a waste of money. These trials lead to the good kind of mistakes that Schoemaker mentions—mistakes we can learn from.

Morris: The greatest leaders throughout history (with rare exception) were great storytellers. What do you make of that?

Mauboussin: This is a point that I emphasize both in Think Twice and The Success Equation. We love stories. They appeal to us, stick with us, and are easy to repeat. Our parents told us stories, and we tell them to our children, as has happened for countless generations before us.

Contrast that with statistical communication. Statistics don’t resonant with most people. If presented with a story or a statistic, people will default to the story a remarkable percentage of the time.

Great leaders, even those with malicious intent, understand this and exploit it.

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To read Part 2, please click here.

Michael cordially invites you to check out the resources at these websites:

His website

His Amazon page

His Columbia Business School faculty page

His Santa Fe Institute page

A “foolish interview” by The Motley Fool

YouTube program

You can also follow him at Twitter

 

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