What is mosaic theory? It’s the collection of non-material, non-public information. You can then piece it together to make better financial decisions. But what does this mean? I first came across mosaic theory when studying for the CFA exams.
This is a useful concept for investing. It can help you avoid illegal insider trading. Although, it’s a broader term for law and intelligence collection.
A few years back in Washington D.C., I had dinner with a political legal analyst. I was surprised to see him light up when I mentioned mosaic theory. It’s not a common term for most people.
To learn this concept, let’s look at how it applies to investors. Let’s build up the definition, along with some examples…
What is Mosaic Theory?
Here’s one of my early YouTube videos that covers mosaic theory…
This short video can help reinforce this concept. And if you have any questions, feel free to leave a comment.
For mosaic theory, there are two keys to understanding the concept. You need to know the difference between public vs. non-public info, as well as material vs. non-material info…
Public vs. Non-Public Insider Info
Public info is available to anyone. This could include investor press releases, quarterly earnings reports and interviews shared online. If anyone can easily access the info, it’s public.
On the other hand, non-public info isn’t commonly available. For example, you might get non-public info through private conversations. This info might come from company employees, other stakeholders or politicians.
Mosaic Theory for Investors
Non-material info doesn’t have a noticeable impact on its own. For example, this is important for accounting. If you’re auditing a multi-billion dollar business, reviewing every thousand-dollar account doesn’t make sense. Relative to the size of the business, those accounts on their own are non-material.
On the other hand, changes with a $100 million account could be material. It might noticeably impact a business and investors. For more examples, material info could be a big legal settlement or a change in total sales projections.
Is Insider Trading Illegal?
It’s illegal to trade on material inside information. For example, imagine you’re playing tennis with a CEO…
The CEO runs a publicly traded company, and he lets slip that another business will acquire it at a premium. This isn’t yet public and it’s material info. If you traded based on this, you’d be breaking the law. Even if the merger doesn’t go through, it’d still be illegal to trade on.
On top of that, it can be illegal to indirectly benefit. For example, you can’t pass along the info to friends and family to trade on. You also shouldn’t benefit from other business relationships.
On the CFA exams, ethics can be one of the hardest sections. Unlike the example above, it’s not always clear cut. When it comes to some laws, there are many grey zones. If you’re studying for the CFA exams, you might find this article useful: Is the CFA Worth It?
Mosaic Theory Example
Mosaic theory is combining non-material, non-public information to make better investing decisions. Similar to a mosaic picture, you arrange small pieces of info to form a bigger picture. The non-material info alone isn’t useful for investing, but pieced together it can become material.
Mosaic theory can help you avoid illegal insider trading, and some investors might call it extreme due diligence. For example, let’s say you’ve been reading the SEC filings for a small grocery chain. You think its share price might be undervalued. But before investing, you make a trip to one of its stores…
You talk with employees about the business and hear that recent sales are way higher than expected. This would be non-public info and at one store, it’s non-material. However, if you visit enough stores and keep hearing the same thing, this info pieced together could become more useful…
You then decide to buy shares and see a bump when the next quarterly report beats estimates. This is just one example of how you can use mosaic theory to benefit as an investor. And it extends beyond the investing world…
Mosaic Theory Law and Intelligence
In the legal world, building a case can require collecting many pieces of info. Many facts on their own aren’t useful, but grouped together, you can build a more compelling case.
This applies to many areas and is useful with intelligence collection…
Here’s one of my favorite psychology books: Psychology of Intelligence Analysis – that’s a free digital copy from the CIA website.
What is mosaic theory? I hope you now have a better understanding. And if you have any questions about mosaic theory and investing, feel free to comment on my YouTube video. I’m also happy to answer any questions about passing the CFA exams.