The 3 Types of Conviction In Investing and What They Mean
Conviction is a much discussed topic in the investment community. Everyone seems to be emphasising that you should have deep conviction before investing in a company. Let’s dive deeper to explore what I describe as the 3 levels of conviction.
Here’s a short story of Tom, Dick and Harry, with varying levels of conviction.
Earned Conviction
Tom studies companies in detail. He learns about companies through carrying out activities in his daily life. From daily necessities to discretionary items. Opportunities are all around us, we just must be more alert to identify them. The highest level of conviction- obtained from independent study and analysis of companies.
People in this category find an investment opportunity through their own research and digging. When they have conviction in a company, it is of the highest level.
Borrowed Conviction
Dick hears about a company through his friend over lunch. He knows that the company is expanding into the metaverse space. When he gets home, he conducts further research into the company and discovers that the metaverse could be a huge catalyst for the company. Even without accounting for potential earnings from this expansion, he estimates that the fair value of the company is about 20% lower than what it should be. The second level of conviction- obtained from listening to others but with own due diligence.
People in this category learn about an investment opportunity from others. Using this information, they will form their own opinion about the viability of this investment opportunity.
Blind Conviction
Harry hears about an investment opportunity from an online forum. He sees that the price of the stock has spiked 100% over the past month. People on the forum are hyping the stock up and he doesn’t want to miss out on further gains. So he decides to buy into it. Little did he know that as soon as he buys in, the stock plunges. Lowest level of conviction- obtained from hearsay without performing due diligence.
People in this category blindly follow Youtubers, Reddit forums like Wall Street Bets, family and friends without performing their own research. It almost always ends in tears, at least in financial terms.
Conclusion
Earned conviction does not come about easily. There is a certain skillset needed for it. People with a deep knowledge of a specific industry are likely to fall under this category. Borrowed conviction is good enough for most people, provided they perform adequate due diligence. The greatest investors get their best ideas from their community, and then perform their own research based on those ideas. Obviously, we would want to avoid blind conviction as much as possible.
Which do you think is ideal? And which category do you fall into?