Fred Wilson has a post up this morning title Return and Ridicule which talks about the dangers of herd investing. Fred quotes Bill Gurley saying that ‘you can only make money by being right about something that most people think is wrong’ which I think is spot on. If lots of people share your idea about what is right then they will all want to invest, the valuation will rise and it will be much harder to make money. The same goes with starting companies – if lots of people have the same idea competition will be fierce and success will be harder to come by.
In a nutshell this is the case for contrarian investing, and it is a driving force in my investment decisions. I look for companies that can be the winners in new markets and investing in those companies before everyone else wants to usually means believing that their new market is emerging when other investors still aren’t sure. Our 2011 investment in Conversocial is a good example. As I blogged when we made the investment our thesis was that they would become the leader in social customer service, but at the time most people thought that social customer service would only be a subset of the established social media software market and there wasn’t space for a new entrant. In the two years since then founder Josh and the team have done a great job establishing social customer service as a category and it is now getting recognised by the major analyst groups, but we all had to endure a lot of doubters along the way.
The problem with contrarian investing and believing in things that most people think are wrong is that those people generally think you are stupid. Fred Wilson wrote:
I have found that return and ridicule are highly correlated over the years. We have made more money on things that were highly ridiculed than any other cohort. When I see people laughing at ideas and companies we have backed, I smile. It means we are going to make a lot of money on that investment.
I hear this, but it is only true if the belief you have that everyone else thinks is wrong is actually correct. As I’ve said, I think finding projects you believe in which others don’t is a great way to make money, but it is critical that you remain open to your investment thesis being wrong, or in need of tweaking. When people ridicule my investments I want to know why it is they don’t believe what I believe, and to make sure that they haven’t got a point. When they laugh I look forward to the day when they’re not laughing any more.