The belief that human beings are fundamentally rational individuals is perhaps the most important foundational element of modern economics. While no economist would ever claim that all individuals are rational all the time, it has long been thought that rational
“The elementary part of psychology—the psychology of misjudgment, as I call it—is a terribly important thing to learn. There are about 20 little principles. And they interact, so it gets slightly complicated. But the guts of it is unbelievably important.”
Investors like to examine pricing anomalies, particularly related to commodities that could be viewed as substitutes but trade at radically different prices. One barrel of crude oil has approximately six times the energy content of one thousand cubic feet (mcf) of natural gas. One mcf of natural gas is approximately equivalent to one million BTUs (MBTU). Despite the energy equivalence, for a variety of reasons, the pricing relationship between oil and natural gas is almost never exactly six to one. Read this article for our analysis.
Much of what we do as investors involves studying businesses and critically evaluating the returns that are likely based on management’s competitive strategy. The elusive search for true “moats” is often frustrated by quick technological change which can make yesterday’s incumbent firm today’s dinosaur. Investors who pay a rich valuation for a business with a moat must be confident that the advantages leading to high returns today are not destroyed by new types of competition in the near term. Smart phones may soon threaten to drive retailers without a coherent competitive strategy to extinction.
We are pleased to publish a guest article by Meir Statman, the author of What Investors Really Want. Professor Statman is a pioneer in the field of behavioral finance and his book should be required reading for anyone involved in financial markets. Whether an investor is “seeking alpha” or satisfied with the low cost approach of index funds, investing without a keen appreciation for the behavioral pitfalls that impact nearly all of us can be a costly mistake.