Building Mosaics
How the research process is akin to sizing and grouping tiles to create a picture of a company
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Building Mosaics
In my introduction to corporate finance classes, we recently completed our chapter on financial ratios. One of the analogies I used in class is that each ratio - current ratio, asset turnover, profit margin, etc. - is like a tile in a mosaic. The value of any tile is based on its usefulness in understanding the full picture.
In my third decade of researching companies, I’ve found this to be a useful framework.
Here are some additional angles to the mosaic analogy to consider as you evaluate your own research process:
Missing pieces
When researching a company, there's a temptation to delay action until the mosaic is complete. However, the quest for the last few tiles can lead to analysis paralysis, causing you fail to take an appropriate action despite having sufficient information to make a decision.
I’ve found it’s impossible to build a full mosaic of a company quickly. Instead, the last few tiles only emerge with time, as we discussed in “Look at Your Fish":
What I’ve learned is that the longer I’ve followed a company, the more nuances and angles I learn and appreciate. The most valuable insights didn’t come on day one or even month one of following a company. They more often come in year one or year three.
In investing, we wrestle with making decisions in the face of uncertainty. Our sensitivity to this uncertainty, and thus our desire for perfect information before making a decision, depends on our personality, experience, and behavioral biases.
One way to manage uncertainty is through position sizing in your portfolio. Newer companies, for example, can get a smaller weight. Over time, as the remaining tiles fall into place and you get more comfortable with the company, the weight can increase.
Various sizes
Each hand-cut tile in a mosaic is different, but the size of each tile impacts the finished product. Similarly, knowing the appropriate size for each bit of learned information influences your perception of the company.
For me, I tend to make tiles related to moat and management larger than tiles related to the balance sheet or growth. For you, it might be the opposite. Others might make ESG risks or innovation bigger.
Indeed, most company debates are between investors who’ve looked at the same information, but used different tiles and created different mosaics.
Ultimately, the winning mosaic is the one that most closely matches reality.
Changing tiles
It’s a mistake to assume that a mosaic - even one that proved accurate at a point in time - will remain the same forever. Companies are not static assets and therefore the mosaics change with time.
Sometimes the tiles break - a good CEO retires, a new product fails, the company makes a bad acquisition. Other times, the tiles no longer fit their purpose - a company’s moat could be getting wider or management has improved its capital allocation process.
Once we’ve built a mosaic, it can be challenging to make changes. We have a picture in our mind of how it “should look” and we can be slow or reluctant to break it down and rebuild it.
Sometimes, an overhaul is necessary. If you think this applies to your company, don’t re-read reports you’ve written or rankings you might have given the company.
Instead, start with a fresh piece of paper. You may find that with a beginner’s mind, some of your tiles no longer fit and need to be adjusted.
Final thoughts
Building company mosaics through deep and persistent research is one of my favorite parts of the job. With experience, I’ve found that beautiful patterns can emerge and it’s fun to see them come together during the research process.
Stay patient, stay focused.
Todd
Todd Wenning is the founder of KNA Capital Management, LLC, an Ohio-registered investment advisor that manages a concentrated equity strategy and provides other investment-related services.
At the time of publication, Todd, his immediate family, and/or KNA Capital Management, LLC or its clients do not own shares of any company mentioned
Please see important disclaimers.
It does seem so much of the work is, "I think this, but I don't know it, let's see."