by Robert Kantor

Investing only with the most experienced and successful individuals is the first rule of investing. To suggest that anyone can identify a person with the proper intuition and instinct to guide investment decisions may be frustrating to the average investor. To help understand the concept, let’s examine an interesting example of the degree of expertise and intuition one should look for in the people who run our investments.

Here is an example a friend of mine who ran the investment division of a large, privately held corporation. He knew of a professor at a top business school who had spent the previous eight years developing his techniques for flipping a coin and predicting the results of the toss. In fact, the professor predicted the outcome of his coin tosses 80 percent of the time. My friend indicated that his firm was looking to invest with such experts and would have backed the professor in the coin tossing business.

Phrased differently, after eight years of working on the highly-specialized field of coin tossing, this professor had developed expertise in how to toss the coin and the intuition to predict the results as he was tossing. If we had bet one dollar on the professor’s accuracy in each toss, we would have won, or earned, six dollars for every 10 tosses. We would have effectively taken a perceived risk of 50 percent and, through skill and intuition, reduced the risk to 20 percent. However, our returns would have been commensurate with the higher risk.

Using the same example, we can see how the skill level, without good business management, could lead to disaster. Suppose the professor was not only in charge of flipping the coin and predicting its outcome, but was also trying to manage the bets. Since he knew that he would be right on eight percent of his tosses, and he decided that on one toss to bet 10 dollars instead of one. His excuse is that he lost the last two bets and he is playing the odds. Of course, when he is wrong, and his entire stake has been lost, he will realize the folly of his decision.

A good business manager would have been able to exploit the professor’s talents without taking unnecessary risks. Thus, our recommendation that an investment involve both the experienced entrepreneur with successful intuition and instinct, and a competent business management team.

Just how does one identify the professor of this world?

1. Accept that some people will never develop imperative intuition regardless of the number of years they may engage in a given activity.
2. While there are a few exceptions, it is highly improbable that anyone in the business world will have developed sufficient intuition with less than five to seven years.
3. Ask the management group with whom you may invest if they have intuition that will guide them in their decisions, and ask for examples.

A previous project of rehabilitating a beautiful old hotel building into an office building in Oakland, Calif. serves as an example of how intuition played an integral part in smart investing. My then business partner and I had purchased the hotel for $3,000,000 and had plans to spend $7,000,000 on the renovation. The building would have been the nicest rehabilitated old class B building in town.

Market studies supported the renovation and the plan. However, my partner predicted the project would fail based on our knowledge of the area and our other activities with another beautiful old building nearby. He perceived a subtle swing in the Oakland market, away from well done rehabs and towards high quality class A offices. Several other very experienced developers were working on new buildings to meet this shift but we were ready to commence.

I reviewed Tom’s decision and carefully reanalyzed our position in the project. Most of the local real estate experts indicated that they didn’t believe the project would succeed. Tom had been working with marketing office space for over 10 years and had previously been more right than wrong. The change in direction meant redesigning the entire project, bulldozing out the entire insides of the building and replacing the core with a new class A building. The additional cost was $7,000,000 plus the additional financing, architectural and leasing costs. The building filled and is known as one of the nicest in Oakland.

Our intuition was not just to change the building’s physical appearance and improvements. Additionally, we knew that if we obtained a fine restaurant and other first-rate quality building services, we would distinguish the building sufficiently to entice the tenants. Our knowledge and experience fueled our intuition and success. Our team had the knowledge and experience to build the nicest class B building but had we done so we would have failed.

How can you be certain that the people in any particular field have the requisite experience and intuition? The answer is that you can’t but what you can do is to investigate these people as thoroughly as possible to determine whether it is probable that they do.

1. Interview all the major players in the deal. If it is a public company, try to speak with as many high-level executives as possible. Do not be intimidated by their relative positions. Investors are very important to these people and they will usually be cooperative. Of course, you should be polite and you should explain the nature of your inquiries.
2. Ask about the following:

• successes and failures in the past and what they learned from their failures
• most recent activities and the results
• substantial investment of their own in the investment you are contemplating
• plans and expectations for the investment.
• who you could contact regarding their prior performance (it is frequently a good idea to try to link to a series of calls by asking one person for another reference, which is both efficient and leads to the desired result).

Remember, the people on whom you are performing the due diligence are not on trial. Rather, you are working to determine whether they have the right experience and personal characteristics to warrant your investment.

Years ago, I decided to co-invest with a firm in the acquisition of a large residential apartment complex in an urban setting. In my interview with the firm’s two principals, I determined that they had been buying and managing urban apartment buildings in the immediate neighborhood for more than five years.

I reviewed the economic performance of each and determine that my new partners had been substantially more right than wrong in their prior activity. I also learned that one of the two had concentrated his attention on the day to day management of their properties well the other, with the business management background, had manage their acquisition and their corporate business.

I found that I could rely on their intuition when they declared that the building we would purchase was one of the best buys they had encountered.

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To learn more about the possibility of earning long-term, reliable cash flow with Headwater Capital, contact me at RAKantor@HeadwaterCapital.com or call 855-208-7551.