By Fortune Editors
January 10, 2013

By Peter Hebert, contributor

The best investors (and gamblers) focus on good process as much or more than on good outcome. You can have a great process and a great outcome and it gets called deserved success. Or you can have a great process with terrible outcome and we call that bad luck.

Some might say: “Who cares? What matters is not how, but whether you win, and how much!” But that is dangerous thinking. If you’ve ever sat at a blackjack table and slapped your forehead because a clueless friend hits on 18 and wins—mistaking his winnings for skill—you know why.

“Successful” investors and entrepreneurs get anointed winners and are copied—while the “losers” get mocked as if they should have known better all along. The truth is this: Not enough attention is paid to the path they took, the decisions they made, the sectors selected, the market environment at the time and whether their process is a recipe for repeatable success—or a complete fluke.

Copycatting success is why there are so many me-too competitors in so many fields, and also why it’s so dangerous if you’re an entrepreneur running a business (or an investor in one) without a sustainable competitive edge. But are the investors or entrepreneurs the public deems winners the ones that ought to be followed? Or might we take away the wrong lessons from the halos we mount on the currently rich and renowned?

It’s a hot and timely topic in my own investor circles, and not without controversy. A group of us in Palo Alto recently hosted a private gathering for friend and author Michael Mauboussin, long-time chief investment strategist at Legg Mason (LM), most famously affiliated with Bill Miller. His new book seeks to untangle luck and skill in business, sports and investing. The discussion and debate that ensued was lively.

As Mauboussin pointed out, one of the best ways to tell whether an endeavor — whether playing blackjack, investing in the stock market or becoming an entrepreneur — is dominated more by luck or skill is to answer the simple question: Can you fail on purpose?

Mauboussin’s analysis identifies certain competitions where the most highly-skilled participant (think Usain Bolt in a neighborhood footrace or Magnus Carlsen playing chess in Washington Square Park) will win every contest. In contrast, investment (public equities, in particular) outcomes are influenced to a much larger degree by luck—in which an identical process could yield an entirely different outcome.

Consider Miller himself, long the subject of whether his 15-year streak of besting the S&P was skill, luck or a mere calendar coincidence. The same holds for some venture capitalists with “winning streaks.” Unlike the “hot-hand” in basketball, there’s better evidence of path dependence where hot deals (and a strong reputation) can lead to even more hot deals.

The truth is the venture business is hits-driven, where it’s undeniable that how much you make when you’re right (minus how much you lose when you’re wrong) matters far more than how often you’re right or wrong. But it’s also as, if not more, important to focus on a process that leads to replicable success.

Peter Hebert is managing partner of Lux Capital.


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