Book Reviews: Darwin meets the stock market in 'Latticework'
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Money manager Robert Hagstrom says investors should lift their eyes from the financial pages now and then, and pick up something like Charles Darwin's "Origin of Species."
That is what the best investment minds do, including Charles Munger, Warren Buffett's right-hand man, and Bill Miller, Hagstrom's colleague at the Baltimore investment firm Legg Mason. Miller's Legg Mason Value Trust fund has beaten the Standard & Poor's 500 index in each of the last 10 years.
Hagstrom, who wrote "The Warren Buffett Way," decided to look deeper into the way that investors such as Munger and Miller think.
The conclusion, laid out in his latest book, "Latticework: The New Investing," will make liberal-arts majors everywhere happy - or at least confident that they can manage their investments.
The world's great investors pore over balance sheets and income statements for hours, but they are also students of the liberal arts.
"Munger talks about worldly wisdom," Hagstrom said. "A subdivision of that would be improving your stock-picking skills." But delving into worldly wisdom by studying biology, psychology, math and physics often yields more useful knowledge than homing in on, say, how to read a balance sheet, he said.
His belief is something of a paraphrase of the old proverb about teaching a man to fish so he can feed himself for life. Studying narrow subjects gives people specific skills; studying broadly teaches them how to think.
Connecting Darwin to dividends may sound like some pretentiously academic approach to investing, but Hagstrom, 44, is no ivory-tower intellectual. From his book-filled Wayne, Pa., office, he manages Legg Mason's Focus Trust mutual fund.
"Latticework" is his fourth book.
His first book, "The Warren Buffett Way," sold 800,000 copies and spent 21 weeks on the New York Times best-seller list. He returned to much the same subject in his third book, "The Warren Buffett Portfolio."
But it is his second title that gives him his credentials as a person of diverse interests. In "The Nascar Way: The Business That Drives the Sport," he chronicles Nascar's transformation from small, daytime races for moonshine runners into a $2 billion business.
"Latticework" fleshes out his research on Buffett, who is considered one of the world's greatest investors. Buffett has consistently beaten the market while running Berkshire Hathaway, a quasi-mutual fund that invests in many different businesses, from the Buffalo News to Geico, the insurance company.
A latticework, of course, is a structure of crossed strips or bars. For Hagstrom, it symbolizes how various fields overlap and how studying one often offers insight into another.
"This is not a how-to book on investing," Hagstrom says in the preface. The book is a bit of a mishmash, with summaries of experiments in psychology, explanations of how ant colonies operate, advice on how to read analytically and a suggested reading list of about 100 books.
Hagstrom acknowledges that "Latticework" is not light fare. But he thinks the book will give investors better mental models to use in picking stocks.
Too many investors, pros and amateurs alike, still rely on physics when they think about the markets, Hagstrom said. In Newtonian physics, systems operate in equilibrium. They don't change unless there is an action, and that action is answered by an equal and opposite reaction. This world is static and predictable.
The physics model gave rise to theories that financial markets are efficient, that they do not change much, and that, therefore, individual investors cannot beat the market by capitalizing on inefficiencies.
But Hagstrom argues that markets are dynamic, much like biological systems. They evolve - just as plants and animals do, according to Darwin's theory. Different species of investors rise and rule the markets for a while, only to fall out of favor along with their stock-picking styles.
Looking at the markets this way, Hagstrom argues that value investors, for example, who focus on buying stocks with low price-to-book or low price-to-earnings ratios, are dinosaurs. Their models are old and have not made investors much money in the last decade.
Hagstrom is not singling out value investors for extinction. Anyone with an unyielding world view is at risk. Investors will fare better if they view Corporate America as a Darwinian battleground where only the strong survive.
"You always want to circle around those companies that have become the fittest, and therefore you don't get hung up on the idea that the companies that you invested in 10 or 15 years ago are going to be the best performing today," he said. "You don't want to get caught up in a static view, which is that things don't change."