Marginal Utility of Information

Marginal Utility of Information

Informational Utility is the benefit an investor derives from uncovering information about a stock. This information largely comes from reading the annual report of a company. The information can be broken down in two ways, numerical (financial metrics) and narrative (the story of the stock).

Marginal utility is a lessening of the value of additional information. I would go further and suggest that too much information can be counter productive and actually harmful to your investment results, but it largely depends on your mindset and the way you approach a stock as an investment.

Peter Lynch once opined, “Never invest in any idea you can’t illustrate with a crayon.”, While Warren Buffet and Charley Munger have said that the riskiest thing you can do in the stock market is invest in something you don’t know a lot about. If you hold very few stocks in your portfolio (less than say eight) you might want to follow the Buffet/Munger model. If you hold more than say 10 stocks I would go with Peter Lynch’s advice.

I have about 17 stocks in my portfolio, over time I would like to reduce that number but my point is if you have a lot of stocks in your investment portfolio, you will probably suffer from the marginal utility of information and not be able to see the forest for the trees.

Bearing that in mind lets say you only want to focus in on the absolute essential investing information. Considering that mindset I propose the following parameters on how to approach the available information about a company’s stock. This approach will lend itself to investing in the mid to large cap area of the market.

Financial Metrics…
Revenue Growth…Free Cash Flow…Return on Invested Capital…Operating Margin.

The Story of the Stock…
Business Model…Industry Structure…Capital Allocation ability of Management.

I will expand on these pieces of information in future posts. Hey, maybe I should have written all this out with a crayon.