The Wisdom of Independent Guessing
The best companies in terms of comparative return on invested capital (ROIC) are also the most highly valued, even though most investors have never even heard of return on invested capital. The market recognizes value, even though it couldn’t say why.
Every year, Michael Mauboussin hands his students a form and asks them to estimate IBM’s assets at the end of 1989 (not a number that you would expect even business students to know exactly). Every year, without fail, the mean of all the responses is within 5% of the actual number.
Every year, Mauboussin assembles a good-sized group of people (100-125 people) and gives them a ballot for the Oscars. On one side are the six most popular categories and on the other are six more estoeric categories. Each participant chips in a dollar and then guesses who will win the Oscar in each category. Without fail, the group’s mean response across the 12 categories does better than any single human.
Experiments like the ones that Mauboussin does work best when all the actors make their guesses independent of what everyone else is guessing. In other words, neither the IBM nor the Oscars experiments would work if people shouted out their answers one by one, because hearing the answers of others would shape the decisions of those that followed.
But in the stock market, of course, people are always shouting out their answers. As a result, the market is subject to manias and panics, which you might define as periods when investors are only worrying about how everyone else is answering the question, instead of what the right answer is.