What the Film ‘The Big Short’ Teaches Us about Value Investing

Spoiler Alert – Read this article after watching the movie.

It’s reasonable to wonder what a movie about the housing crisis and ensuing financial meltdown could teach regular people in the market about investing. But within The Big Short there are nuggets of wisdom that pertain to value investing. There’s also Margot Robbie in a bathtub, so something for everyone.

The movie is set in the 2000s and follows the events and characters involved in the housing market bubble (Spoiler Alert: that bubble burst). The characters were all prescient, and saw that the housing market was decidedly overvalued, and they realised that they stood to gain by shorting it. Most of the characters in the film, and their real life counterparts, profited immensely from those trades.

While the movie focuses on hedge fund managers, big time stock traders, and bond salesmen – not your typical lot to learn from for personal investing – there are truths in the movie that extend to all levels of value investors. If you’re in London, join us at London Value Investing Club where we as a group of value investor discuss various value investment opportunities.

The market doesn’t always make sense

“Markets can remain irrational for longer than you can remain solvent”

 – John Maynard Keynes

The quote from Keynes illustrates a truth from the movie, though it’s not directly evident without thinking about it a little. Part of the problem with following the type of people in the film is that they were all in situations where they had millions of dollars at their disposal. At a few points in the movie, characters were down nearly 40%, and considering whether or not to cut their positions. But they were all certain about the impending burst, so they held on for the massive pay day in the end. But what if the bubble took longer to burst? How long would they have held on, and what level of losses were they willing to tolerate?

If you’re investing for your own financial well being and don’t have millions of dollars in reserve, no matter how sure you are of a commodity gaining value, it may not do so within your time table.

The quote from Keynes illustrates this well. You may be entirely right about something, but the market won’t work on your watch. If you don’t give yourself enough time and leverage, it could be disastrous for you financially.

Do ground research away from your desk

One thing you will want to emulate from the characters in the movie is their commitment to research, regardless of their job.

To really get a sense of how disturbed the housing market was, several characters took a trip to suburban Florida to get a sense of what the situation looked like on the front lines.

Without getting into the specifics of the trip in the film (though we could talk about Steve Carrell giving financial advice to a pole-dancer all day), this is the kind of dedication to research that all investors should employ.

Obviously, every investment should come with careful consideration and research. But something that’s lost on a lot of modern investors is that this research can and should take place away from your desk. It may not necessitate a trip to Florida, but if you’re looking to invest in a new sector, go and talk to people who work in that field. There’s much to learn from this kind of research, and any bit of knowledge you can get will help you as an investor.

One advantage the modern investor does have is that now is the best time to do research from your desk. Taking a trip will always be a good idea, but once you have made your way out into the world, there are services, like CityFALCON, that let you follow information like never before.

Hold your position for as long as the fundamental story/hypothesis doesn’t change

While it’s important to know your limits, another lesson from the movie is to hold a position as long as the fundamental hypothesis does not change. Patience can be the most valuable resource for a value investor.

In the movie, almost everyone thought the characters were crazy for betting against the housing market. When they started to take losses, those naysayers took that as a sign that they were correct, and that these were a few outliers who were about to lose a lot of money.

But the main characters in the movie, and the real life people they’re based on, were right, and they held on even though they were taking losses. For value investors, this principle rings true in any circumstance. Remember why you invested in the first place, and if nothing has changed your original hypothesis, you should hang on until you have new information.

Few ‘experts’ actually know what’s going on in the market

In real life – and in the movie – many accomplished Wall street types spouted rhetoric around the stability of the housing market. These people were highly respected and earned massive pay cheques as market experts. Look how that turned out.

No matter how deeply respected, astute, or highly paid these ‘experts’ are, they might have no clue about what’s going on in the market. Even people who predicted the financial crash of 2008 have made huge errors since they made a killing in the crash.

It can be tempting to listen to a person who totally confirms your ideas, and just as tempting to dismiss someone who has opposing views. The market is complicated, capricious and uncontrollable. These factors make truly ‘knowing’ what’s happening at any given point a near impossibility, but after the fact it all looks so obvious. It’s important to keep this in mind when you’re doing any kind of investing; almost no one has any idea what’s really going on.