East Coast Asset Management's Q1 Letter

Found via Market Folly.

We believe there are two general kinds of mispricings - structural and psychological.

Structural mispricings exist when an event occurs that forces a large population of owners to sell without any change in the investment’s intrinsic value. Examples of structurally induced selling would include: when an investment is deselected from an index, when a company is spun off from a larger parent company, or perhaps when a company’s credit rating is reduced. These scenarios are just a few examples that produce a good flow of ideas into our workout category which we can then use to apply an appropriate lens.

Psychological mispricings are driven from collective investor psychology which induces broad selling or a lack of buying in an investment, asset class or group of securities. Psychological mispricings have produced some of our most compelling compounding opportunities. The study of how human beings perceive the world is a helpful tool to understand the psychological biases that produce mispricings.

More than half of our brain is used for processing sensory information with the majority of that processing being vision. Evolutionary psychologists have said that animals from fiddler crabs to humans use eyesight for collision avoidance, suggesting that vision is for directing action not providing knowledge. We want to focus and apply a lens in the direction where there is a gap between the directed action of the marketplace and that of knowledge (truth).

Two universal visual impairments are myopia and hyperopia. Individuals, who suffer from myopia, or myopes, have difficulty seeing distant objects; hyperopes have difficulty focusing on near objects. These impairments can be used to describe the optical challenges that affect investors.