Why the investing process is more important than the outcome

In The Little Book of Behavioural Investing, James Montier highlights many behavioural traits that make a successful investor.

He highlighted a matrix that was written about in Winning Decisions, a book written by Russo and Shoemaker. The matrix can be seen below:

Good outcomeBad outcome
Good processDeserved successBad break
Bad processDumb luckPoetic justice

A good process in investing is essentially the value investing approach. If an investor understands the business thoroughly, has evaluated the management team and competitive advantages and purchases the business with a huge margin of safety in price, a good process has been followed.

The ideal place to sit in this matrix is the upper left, “deserved success” box. Below, I will highlight some examples of these four combinations and discuss why it is important in investing.

A bad process and a bad bad outcome

These examples are quite obvious. Any investment that was actually speculation, hoping the stock price would jump up and instead seeing it crashing down falls into this category.

An example of this was buying Pets.com stock in 2000. This business did not have a viable business model at the time and was unprofitable. Many investors who purchased this stock likely didn’t study the fundamentals of the business and ended up losing their capital when the company filed for bankruptcy.

Pets.com stock price. Source: Bloomberg

A bad process and a good outcome

This is where an investment is made, a mistake occurred, but the outcome ends up being favourable. A good example of this could be buying Google stock at its initial public offering, without knowing anything about the business or the management team. This investment would’ve resulted in a 20+% annual rate of return. However, investing without understanding the business is not following a good process.

Source: Google

A good process and a bad outcome

This is where an investor covered all bases, understood a business thoroughly and invested with a margin of safety, but still suffered a poor result.

An example of this is Warren Buffett’s investment in World Book. World Book was an encyclopedia company that generated strong and consistent cash flows year over year. Warren Buffett acquired the company in 1986, but as you could imagine, the product became obsolete with the inventions of the internet and personal computers. One could argue his process was incomplete, however, I would argue that this is just a bad outcome that would’ve been nearly impossible to avoid. Predicting such a huge shift in the world would’ve been extremely unlikely. As John Templeton says:

Over my 45 years of investing, about one third of my investments have not worked out

Even the very best investors have a relatively high error rate.

There is always a chance that something comes out of left field and creates a “bad break”.

A good process and a good outcome

Now, this is where an investment is made within one’s circle of competence and with a margin of safety, where the assumptions made played out resulting in a great investment. Examples of these include the following case studies I have written up in the past:


Being rational in investing is very difficult. The best investors in the world focus on having the right process, and trust that over time, their outcomes will average out and be “good”. However, this is easier said than done. If one bought Amazon or Google at their IPO without doing any research, it would be very challenging to admit that this was just “dumb luck”. On the flip side, being rational when an investment turns out poorly and determining whether it was due to a process mistake or just a “bad break” is equally as challenging. If it was a process issue, one needs to learn from the mistake and improve for the future. But sometimes, a poor outcome could just be a “bad break”.

I think François Rochon has a fantastic principle on this with his fund, Giverny Capital. He calls it “The Rule of Three”:

One year out of three, the market will go down (by more than 10%). One stock out of three that we will buy will be somewhat disappointing. And one year out of three, we will under perform the indexes.

He simply focuses on the process, ensuring he buys great businesses at fair prices and accepts that sometimes, bad outcomes will occur.

Rochon also has a post-mortem section of his annual reports, where he analyses mistakes he has made in the past. He often mentions mistakes that actually lead to a profit, which fall into the “bad process, good outcome” category. This is what makes him, and many other investment greats, so successful.

To conclude, here are two quotes, one from James Montier and one from Ben Graham:

It’s incredibly difficult to look in the mirror after a victory, any victory, and admit that you were lucky. If you fail to make that admission, however, the bad process will continue and the good outcome that occurred once will elude you in the future.

I recall to those of you who are bridge players the emphasis that bridge experts place on playing the right hand right rather than on playing it successfully. Because, as you know, if you play it right you are going to make money and if you play it wrong you lose money—in the long run. There is a beautiful little story about the man who was the weaker bridge player of the husband and wife team. It seems he bid a grand slam, and at the end he said very triumphantly to his wife “I saw you making faces at me all the time, but you notice I not only bid this grand slam but I made it. What can you say about that?” And his wife replied very dourly, “If you had played it right, you would have lost”.

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