Mosaic Theory
Mosaic theory is an analytical method used in securities analysis.
It involves the assimilation of different types of information – public, non-public, and non-material – to create a detailed and wide view of a company’s value or trade/investment potential.
The concept is based on the idea of traders and analysts piecing together various bits of data, much like a mosaic, to form a holistic understanding of the company’s situation that goes beyond what’s immediately apparent from standard financial reports.
This is opposed to the approach of focusing heavily on one type of analysis – e.g., technical analysis, quantitative analysis.
Key Takeaways – Mosaic Theory
- Uncover What’s Not Know or Obvious
- What’s known is already in the price.
- Mosaic theory is the idea that you can reveal undervalued opportunities by integrating diverse information sources, which can provide a competitive edge.
- Demands Expertise and Resources
- Effective use requires significant time, analytical skills, and access to varied data.
- Navigate Legal Risks Carefully
- Differentiate between non-material and material non-public information (MNPI) to avoid legal pitfalls.
Importance of Mosaic Theory
Mosaic theory is the idea that traders and analysts can make well-informed choices by looking beyond conventional financial documents.
By and large, if something’s in the price it’s already known.
Everybody combs over all the public stuff.
Accordingly, traders need to find things that are unknown – e.g., better information, better analysis, a unique angle – to add value in excess of simply indexing to a representative benchmark.
Fundamentally market success for traders boils down to having an edge on information or analysis.
A thorough analysis that accounts for various information types is important for maintaining this competitive edge.
Components of Mosaic Theory
Let’s look at the basic categories/types of information:
Public Information
Company filings
Important documents like 10-K and 10-Q reports (in the US), and press releases provide a wealth of information about a company’s financial health and business strategy.
News articles and financial reports
Daily news and financial analyses help track a company’s activities and industry standing.
Industry analysis and research
Reports and forecasts from industry experts offer insights into market trends and sector challenges.
This can come from dedicated researchers, credit agencies, etc.
Alternative data providers are another example (e.g., satellite imagery of parking lots to estimate sales).
Non-Public Information
Expert networks and industry contacts
Conversations with industry insiders can provide clues that aren’t available to the general public.
Supplier and customer relationships
Insights from business partners can reveal much about a company’s operational strengths and weaknesses.
Site visits and observations
First-hand observations of company operations can provide unique insights into their efficiency, culture, and future prospects.
Non-Material Information
General economic trends
Broad economic indicators can influence a company’s performance and are important in forecasting its future.
This can include the macroeconomy – often excluded in the analysis of individual securities – or on a sector basis (e.g., the general outlook for whatever it is that they sell).
Competitor activity
Understanding the actions of competitors can offer foresight into potential market shifts.
Subtle trends or changes
Identifying minor trends can sometimes predict future industry or economic shifts before they become obvious.
Overall
Mosaic theory integrates these diverse sources of information to provide a nuanced view of trading opportunities.
This helps analysts discern not only the current state of a business but also its potential future direction.
Applying Mosaic Theory in Practice
Example: Uncovering Hidden Value
Imagine a trader – let’s call him Alex – who is evaluating a technology company, TechABC.
Through standard financial statements, TechABC appears to be performing modestly with a stable revenue stream.
Nonetheless, Alex uses the concept of mosaic theory to look deeper in a holistic way:
Public Information
Alex reviews TechABC’s latest 10-K, noting significant investment in R&D.
A recent press release announces a patent for an innovative product.
Non-Public Information
Through conversations with an industry expert, Alex learns that TechABC is in the process of securing a strategic partnership with a leading tech giant, though this hasn’t been publicly announced yet.
Non-Material Information
Alex observes an increasing trend in consumer demand for products that TechABC specializes in, thanks to general market research data.
Combining these insights, Alex hypothesizes that TechABC is likely headed for significant growth once the partnership becomes public and the new product hits the market – that’s not currently discounted into the share price.
This analysis helps Alex uncover potential hidden value that wasn’t apparent from financial reports alone.
Importance of Analysis
The idea behind mosaic theory isn’t just in collecting various data points but in the skillful interpretation and integration of these pieces to form a coherent thesis.
Traders analyze how these discrete bits of information interconnect and what they collectively reveal about the company’s future prospects.
Legality and the Mosaic Theory
“Material” vs. “Non-material” Information
- Material Information – Any information that could influence a trader’s decision to buy or sell securities if it were made public. Examples include non-public earnings reports, merger plans, or acquisition news.
- Non-Material Information – Information that, on its own, doesn’t likely materially influence a trading decision. This could include general industry trends or broader economic data. For example, monthly inflation data in the US will be influential at the macro level and influence individual securities via that effect, but won’t influence traders specific opinions of the security.
The distinction is important because trading on material non-public information can constitute insider trading, which is illegal under securities law.
Cases and Precedents
SEC vs. Cuban (2009) was a case where Mark Cuban was accused of insider trading based on confidential information about a stock offering.
The case highlighted the nuances of what constitutes insider trading and the importance of how information is used and understood in investment/trading decisions.
Cuban was eventually cleared of wrongdoing.
Guidance for Traders
For traders looking to apply mosaic theory effectively and legally:
Verify the Nature of Information
Always assess whether the information is material and public.
If in doubt, consider it material and non-public until verified otherwise.
Source Information Ethically
Be sure that all non-public information is obtained through ethical means and doesn’t breach any confidentiality agreements.
Document Analysis
Keep detailed records of how conclusions are reached.
This can be important if the legality of a trade is ever questioned.
Even individual traders have been questioned when their trades coincided with the release of material information that was previously non-public.
Documenting your trading decisions can also be good to help understand what your thought process was and use that as a record to improve it over time.
Insider Trading vs. Informed Trading
Insider trading involves buying or selling stocks based on material, non-public information, which is illegal and unethical.
In contrast, informed trading is based on extensive research and analysis of publicly available information. This aligns with legal and ethical standards.
Both practices use critical information to guide trading decisions, but insider trading breaches confidentiality and fairness in the financial markets.
Advantages of Mosaic Theory
Potential for Uncovering Hidden Value
Mosaic theory allows traders and analysts to integrate diverse information sources beyond what’s available in standard financial disclosures.
It’s all about doing whatever necessary to gain a competitive edge.
Provides a Broader, More Holistic Perspective on Investments
By considering a wide range of information, including non-material and non-public insights (where legally obtained), mosaic theory offers a more nuanced view of a company’s potential.
This holistic perspective can lead to more informed, and potentially more successful, trading decisions by capturing the broader financial, economic, social, and competitive context in which a company operates.
Limitations of Mosaic Theory
Time-Consuming and Resource-Intensive Process
The process of collecting, validating, and analyzing a vast array of information from multiple sources can be extremely time-consuming.
It’s certainly heavily in the purview of professional traders/investors and difficult for individuals without the background to go about it.
Additionally, the need for sophisticated data and analysis tools and access to expert networks can lead to significant resource expenditures.
In general, the trading and investment business has become more technologically- and people-intensive over time.
This makes it less accessible for some traders and smaller investment firms.
Requires Skill in Interpreting Disparate Information
Mosaic theory demands a high level of expertise in interpreting how separate pieces of information relate to each other.
Traders need to have the ability to discern patterns and derive meaningful insights from a sea of data.
This requires financial acumen and a deep understanding of the industry, market trends, economic indicators, etc.
How to Best Use Mosaic Theory
To use mosaic theory while reducing its limitations, traders and analysts can use several strategies:
Leverage Technology
Use data analytics tools to handle large datasets and identify patterns.
Better AI and machine learning tools are reducing time and resource constraints.
Professional Networking
A network of reliable, ethical sources including industry experts and analysts, to improve the quality and reliability of information.
Collaborative Analysis
Work within a team where diverse skills and abilities can complement each other.
This can enhance interpretative processes and reduce individual biases.