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Investor Beware

August 20th

Rationality frequently wilts when the institutional imperative comes into play. For example: (1) As if governed by Newton’s First Law of Motion, an institution will resist any change in its current direction; (2) Just as work expands to fill available time, corporate projects or acquisitions will materialize to soak up available funds; (3) Any business craving of the leader, however foolish, will be quickly supported by detailed rate-of-return and strategic studies prepared by his troops; and (4) The behavior of peer companies, whether they are expanding, acquiring, setting executive compensation or whatever, will be mindlessly imitated.

Warren Buffett

Institutional behavior often falls prey to irrational tendencies. A common aspect of large corporations is resistance to change, which, though akin to Newton’s First Law of Motion, can be detrimental to growth and progress. As investors, acknowledging this inertia and its potential impact on returns is crucial.

Corporations also have a tendency to compulsively spend available funds on projects or acquisitions, even when not justified. This could lead to resource wastage and sub-optimal returns to shareholders. Understanding a company's spending habits offers valuable insight into its future prospects.

Blind obedience to leadership is another concerning trait. Leaders may make unsound decisions, yet these are often backed by strategic studies prepared by eager-to-please subordinates. Distinguishing wise leadership from mere showmanship is an essential skill for an investor.

Finally, the trend of mindlessly imitating peer companies suggests a lack of individual critical thinking. This herd mentality in decision-making rarely benefits in the long run. Investors must value companies demonstrating independent, innovative thinking.

These institutional tendencies underline the importance of rationality in investment decisions. Being aware of these behaviors can guide you towards better, more informed investing.

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