Follow the Data, Not the Drama

The stock market has been on a real roller coaster ride since the beginning of the year. After falling well into correction territory, it has bounced back recently. At one point, just as the Ukraine war was heating up, our portfolio was down 11%. As of the end of March, it was down less than 5%. 

Undoubtedly, investors, anxious over the events unfolding in Eastern Europe, bailed on the market to wait until things cleared up. If they missed the bounce in early March, they suffered permanent losses in their portfolios. Having ridden the roller coaster ride, our clients are sitting on very modest year-to-date losses of 5% (versus the so-called safe-haven bond market, which is down 7%).

The only reason investors sell is that they feel they can't stomach more losses. Yet, they wouldn't experience an actual loss if they didn't sell. It's a "loss aversion" thing. Investors feel much worse about losing money in a declining market than they feel great about making money in a rising market. They allow their feelings to dictate their decisions, which almost invariably leads to underperformance. 

Why Investing is Like Flying a Plane

I have found that investing is like flying a plane, which is a very unnatural, three-dimensional activity. That's because a pilot's sense of equilibrium (what they feel) is often not aligned with what is happening. Consider the difference between flying a plane under visual flight rules (sight with feelings as confirming evidence) and instrument flight rules (relying exclusively on data). The difference is dramatic. 

That was the difference for John F. Kennedy Jr. when he flew his plane into the ocean off Nantucket. He wasn't certified to fly instruments alone. He had to rely on his sight and feelings, which told him one thing when he couldn't see the horizon. As a result of his "special disorientation," he pitched the plane downward into the water, tragically killing himself, his wife, and sister-in-law. 

I had a similar experience during my flight training but was fortunately in a controlled situation at altitude with a flight instructor by my side. So, I have had the experience of having your feelings tell you one thing, and the data (i.e., instruments) tell you the opposite. It is undoubtedly challenging to decrease sensitivity to your feelings and follow the data, just like with investing. 

Determine Which Data to Follow

So that raises the question of what the correct data is to look at. Certainly not the news in all its forms—cable, social media, etc. That's like staring out the window in hopes of finding a horizon. The media only gets attention when it can provoke bad feelings of fear, dread, or hysteria, which never lead to rational decisions. 

One way to look at data is to place it in a group of concentric circles, with those circles closest to the middle carrying the most validity (and, therefore, decision-making weight). The data in the outer rings should be discarded or viewed with amusement. Which data belongs in which circle is debatable, depending perhaps on one's frame of reference and knowledge of which data is available. 

For me, as an investor, the data that sits in the innermost circle is a company's return on tangible equity (ROTE). In my professional opinion, it is the most valid and, therefore, most heavily weighted measurement of a company's business performance. ROTE is the profit generated on shareholders' capital, measuring how well a company's leadership manages its shareholders' money. It's a key indicator of management's efficiency in deploying shareholder capital to create long-term value. The ratio is calculated as follows:

Common Shareholder's Equity = Total Shareholder's Equity less preferred stock, goodwill, and intangible assets

The world could be on fire (more than it already is), but companies with a high ROTE (greater than 25%) are what Warren Buffett refers to as "magnificent" businesses—there's no reason to sell them. We use additional data, sitting in the adjoining circles, such as low debt, high-profit margins, and growing earnings, to reinforce the predictability of the innermost circle. 

With our eyes fixed on the critical data, we can ignore the drama going on in the world. It's crucial to have a component to your investment management process that keeps the bad news in perspective to replace the emotional buy and sell decisions that come with outside market noise. We want to make sure our investment decisions are based on the information we know, not what we think is going to happen. 

Follow the Data, Not the Drama

The stock market is known for its unpredictable swings, rising and falling in ways that can unsettle even experienced investors. One moment, prices are plummeting, causing panic, and the next, they are recovering unexpectedly. This kind of fluctuation is normal, yet many investors let their emotions dictate their actions, selling when the market dips out of fear of further losses. Unfortunately, this reaction often means missing out on the recovery that follows, leading to permanent financial setbacks. Those who stay the course, focusing on long-term trends rather than short-term turbulence, tend to fare much better in the end.

The reality is, selling is driven by fear - fear of losing more money. However, unless you actually sell, those losses remain on paper, not in your pocket. This fear-driven behavior is known as "loss aversion," a psychological tendency where losses feel much more painful than the joy of gains. When investors let emotions dictate their decisions, they often underperform in the long run.

Investing is Like Flying a Plane

Investing, in many ways, is like flying a plane. Flying is an unnatural experience, especially in three dimensions. A pilot’s instincts - what they feel - can often mislead them about what is actually happening. This is why pilots are trained to use instruments rather than rely on their senses, especially in low visibility conditions.

A tragic example of this was the fatal crash of John F. Kennedy Jr.'s plane. He was not certified to fly solely by instruments, so when he lost sight of the horizon, his instincts misled him, causing him to mistakenly steer the plane downward into the ocean.

During my flight training, I experienced a similar disorientation - but in a controlled environment with an instructor. I remember the unsettling feeling of my body telling me one thing while the instruments clearly indicated the opposite. It was a powerful lesson: trust the data, not the feeling. The same principle applies to investing. The market can be full of turbulence, and emotions will push investors to make rash decisions. But just like in flying, the key is to rely on the right instruments - the right data - rather than gut feelings.

Focus on the Right Data

The challenge, of course, is determining which data to follow. News sources - whether on TV, social media, or elsewhere - are designed to capture attention, often by amplifying fear and uncertainty. Relying on the media for investment decisions is like looking out the window of a plane in a storm, hoping to spot the horizon - it’s unreliable and disorienting.

Instead, think of financial data as a series of concentric circles. The most important, reliable data sits at the center, while the less relevant, more speculative information exists in the outer rings. The further from the center, the less influence it should have on your decisions.

For me, as an investor, the data that sits in the innermost circle is a company's return on tangible equity (ROTE). In my professional opinion, it is the most valid and, therefore, most heavily weighted measurement of a company's business performance. ROTE is the profit generated on shareholders' capital, measuring how well a company's leadership manages its shareholders' money. It's a key indicator of management's efficiency in deploying shareholder capital to create long-term value. The ratio is calculated as follows:

Common Shareholder's Equity = Total Shareholder's Equity less preferred stock, goodwill, and intangible assets

The world could be on fire (more than it already is), but companies with a high ROTE (greater than 25%) are what Warren Buffett refers to as "magnificent" businesses—there's no reason to sell them. We use additional data, sitting in the adjoining circles, such as low debt, high-profit margins, and growing earnings, to reinforce the predictability of the innermost circle. 

With our eyes fixed on the critical data, we can ignore the drama going on in the world. It's crucial to have a component to your investment management process that keeps the bad news in perspective to replace the emotional buy and sell decisions that come with outside market noise. We want to make sure our investment decisions are based on the information we know, not what we think is going to happen. 

Blocking Out the Noise

By focusing on these key data points, investors can tune out the daily drama that dominates financial news. The stock market will always experience ups and downs, and the world will always have crises that seem poised to shake the foundations of investing. However, making decisions based on fear and speculation leads to poor outcomes.

Successful investing isn’t about predicting the future - it’s about making informed choices based on reliable, measurable information. By keeping emotions in check and sticking to the data, investors can navigate market fluctuations with confidence and avoid the pitfalls of reactionary decision-making.

In the end, just like in flying, those who trust their instruments rather than their instincts will reach their destination safely.