On Daruma’s Watch

monthly small-cap insights for investment professionals

February 2014
Volume 7, Issue 2


A recent visit to the Las Vegas blackjack tables, together with insights gained from the success of the British National Cycling team, provide inspiration for this month's focus on the investment-related benefits of small improvements compounded over time.

(To listen to this month's newsletter, click here.)

Mariko O. Gordon, CFA
Founder, CEO and CIO
Daruma Capital Management LLC

Blackjack, Cycling and the Power of the One Percent

Mixing work with family vacations can be tricky business, but the odds were with me this time. Needing to go to Las Vegas for the user conference of one of our companies (an event where customers learn about new products and industry trends), I decided to take a chance and drag my mother along.

Not because I needed chaperoning, mind you, but rather because her 85-year-old brother, Tingy (don't ask, I have no idea how he got that nickname), his wife Lil and a bunch of my cousins live there. So it seemed like a good opportunity to combine business and pleasure.

The arrival of my research colleagues Neal and Daniel meant it was time to switch into work mode, leaving mom to explore Las Vegas' other delights (like the mob museum) while we hit the conference.

At one point, my mom reminisced about watching craps games in her misspent youth, a revelation which gave me the bright idea of upping the ante further and drafting Daniel to be our casino tour guide and the evening's entertainment. This was his penance for opening his mouth and telling me he likes to play craps and blackjack. Besides, I was of no use - the only parts of a casino that really interest me are the financials and the spa, neither of which are suitable for spectating.

I bankrolled Daniel with a hundred big bucks and we bellied up to a blackjack table. To his credit, he wanted to quit while he was ahead, but we were having too much fun being voyeurs and made him stay long enough to lose. That part was predictable.

What was NOT expected, though, was how much the "blackjack ceremony" reminded my mother and me of a Japanese tea ceremony: slow, choreographed gestures made by both guests and host.

Every dealer we had made the same gestures in the same way, from the way they caressed the felt before dealing, to the way they used a card to scoop up the spent cards, to the way they snapped each card as they flipped it over. Even the reverence with which they removed a deck from its holder felt oddly familiar.

The same motions done in the same sequence at the same pace can put us humans in a trance. This, of course, is no accident. In a casino, every action has been carefully studied and chosen because it makes more money for the house. Not to mention that if a business is going to pick someone's pocket legally over time, it needs to ennoble the process with enough ceremony so as to make the victim feel honored to pay the price.

Make no mistake - nothing (except the obvious) is left to chance in a casino. No other industry better uses the scientific method to marry data with psychology in refining the art of separating people from their money.

All of which got me thinking: How can we, as investors, apply the same principles? Not the principles of separating people from their money ... rather, how careful study and deliberate choice can drive continuous, incremental improvements in our work.

It's a powerful idea - check out the recent success of the British National Cycling Team. Blogger James Clear describes how General Manager and Performance Director Dave Brailsford turned around the cycling team after taking it over in 2010. At that point, they had never won a Tour de France. To address this deficit, Brailsford led the team in pursuing what he calls the "aggregation of marginal gains."

Specifically, it meant working to improve, by a mere 1%, EVERY step in the process of running a world-class cycling team. This ranged from the obvious (tweaking bicycle designs and training regimens) to the obscure (washing hands properly to reduce illness; having each rider bring his own pillow for better road trip sleep). This attention to detail and the compounding effect of all these small tweaks led to the Brits winning the Tour de France a mere three years after Brailsford's arrival.

The benefits of small improvements compounded over time are many. Here are an obvious few:

It's easier to uncover small, 1% improvements. No big breakthrough or giant leap of imagination is needed, which means that everyone has a chance to contribute. There's no need for rocket scientists or massive budgets.

It's easier to make small changes stick. No explosive and fleeting superhuman effort is required to improve. Because it's not a flat out sprint that will exhaust itself, progress is sustainable and continuous, and the gains last longer.

It's less risky to improve bit by bit. Failures are kept small and happen less often, because the odds of nailing a small tweak are better than those of nailing a big, complicated one. What's not to like about having more times feeling like a champ and fewer times feeling like a loser?

It seems criminal, then, not to apply something as powerful as the "aggregation of marginal gains" to our line of work. Within the research process alone, for example, we can apply this by:
  • Reading a 10-K 1% better by always using a blackline version to monitor changes.
  • Getting 1% more out of management meetings by reviewing our questions prior to a meeting and making sure they'll address our concerns fully.
  • Improving our decision making 1% by getting enough sleep the night before.
  • Organizing our data 1% better by putting smarter tags on our notes to save us time on retrieval.
  • Making our models 1% better by adding more annotations.
The beauty of the "aggregation of marginal gains" is that every little bit helps, the list of possible tweaks is infinite, and it's easy to weave continuous improvement into a workflow when the "gain" is so easy to define, find and play with.

Surely the odds of compounding 1% improvements will result in success closer to that of the British National Cycling Team, rather than in losses similar to our blackjack adventure. In this case, the odds will favor us, unlike in a casino where, in the long run, the house always wins.

How to Deal Blackjack

As with many skills, when done well, dealing blackjack looks easy.

As this seven-minute, behind-the-scenes video reveals, however, it comes down to lots of technique and hours of practice.

Click here to watch - we'll see you in Vegas!

About Us

Founded in 1995, Daruma Capital Management invests in high-conviction portfolios of no more than 35 stocks.

Our annualized Small-Cap return net of fees is 13.6% vs. 9.1% for the Russell 2000 since inception (7/28/95 to 12/31/13).

Our annualized SMid-Cap performance net of fees is 12.9% vs. 16.3% for the Russell 2500 since inception (4/30/2010 to 12/31/13).

Please read the above performance in conjunction with our Small-Cap Equity and SMid-Cap Equity Composite Presentations. Past performance does not guarantee future results.

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