The notion that more information is better prior to making an investment decision seems logical. However, information overload have adverse results on decision making ability. Psychological studies have cast doubt on the idea that more information is better.
The whole investment industry seems to be addicted to learning more and more about less and less, until we know absolutely everything about nothing. We tend to zoom in on the details and miss the big picture. Rather than stopping and considering what information we actually need before making a decision we tend look at all the data we can get our hands on and distract our minds with noise that does not improve the quality of our decision.
In an experiment administrated by a psychologist 10 bookmarkers were asked to make bets on race horses. They were shown 80 different variables of data from past performance of a race horse such as number of races won, performance in different condition, etc. Each bookmarker was then asked to rank the data variables by importance.
After completing this exercise the bookmarkers were then given data for the 45 past races and told to rank the top five horses in each races.
Each bookmarker received the past data variables in increments of 5, 10, 20, and 40 variables he had selected as most important. Thus the bookmarker predicted the race four times, once for each batch of information variables received. For each pick the bookmarkers were asked to give a degree of confidence ranking in their prediction.
Accuracy and confidence were closely related with five pieces of information on their first prediction. However, as more information came available two things happened. First, accuracy flat lined. The book markers were as accurate with five pieces of information as they were when they had 40 items of information. Secondly, the degree of confidence increased massively as more information became available. With 40 items of information the level of confidence more than doubled without any improvements in accuracy. So all this extra information wasnt making the bookmarkers more accurate but it was making them increasingly confident in their predictions.
In a similar study participants were asked to pick the best race car among 4 different cars. One of the cars was by far superior to the others. The participants were given a set of attributes about the car in increments of 4, 8, 12, 16 pieces of information. When only 4 pieces of information was available more than 60% of the participants were able to pick the best car. However, as more information became available the accuracy first flat lined and then actually decline while confidence kept increasing with more data. When faced with information overload of 16 pieces of information the participants accuracy dropped to a mere 20%.
We have a limited ability to process information and more information is not always necessary better. We are better off analyzing key data that that really matters rather than try to know absolutely everything about everything regarding an investment.
It is easy to get into a habit of looking through every single little detail but it is often more important to look at relevant data and ask the right questions about key characteristics. Warren Buffett is one of the great investors that do not let information noise pollute his mind. He does not try to forecast earnings for the next quarter by looking at 20 different moving variables. Buffett focus on the very basics and he says Our method is very simple. We just try to buy businesses with good-to-superb underlying economics run by honest and able people and buy them at sensible prices. That's all I'm trying to do."
There is not one right approach to investing nor are there a particular set of data that will always lead us to the right decision. It all varies depending on the investment approach. However, I found the following five attributes to be helpful in coming to a decision about a potential investment.
1 Is the company in a cyclical bull market?
2 Is the company stock overvalued or undervalued?
3 Is the companys fundamentals improving or deteriorating?
4 Does the company have sound management?
5 Does the company have sound financials with low debt and a respectable margin?