Mosaic Theory Explained with Insider Trading Example

I first encountered mosaic theory when studying for the CFA exams. It’s a useful technique for collecting information and making better investment decisions. Knowing the logic behind it can also help you stay clear of illegal insider trading.

What is Mosaic Theory?

Mosaic theory refers to the collection of public and non-public information on a company. The non-public information is also not material on its own. But when combined with the public information, analysts can draw conclusions. So similar to a mosaic, the information is pieced together to make a bigger picture.

Mosaic Theory Example

Let’s say you want to invest in a grocery store chain. So you start by researching the recent annual and quarterly filings. This gives you a good sense of the financial health of the business… but it’s not enough since you’re going to put down a big chunk of change. You want more confidence in your soon-to-be investment.

To take it one step further, you can visit the stores and ask questions. Let’s say there are 100 stores and you stop by 20 of them. That’s a good sample size. You then ask each manager how business is doing and if foot traffic is up in the stores. If you hear that business is good and traffic is up, that’s a good sign for investors.

The individual answers that you receive aren’t public or useful on their own. But when pieced together – along with other public info – you can get a better sense of how the business is doing. This is a prime example of mosaic theory at work. It’s a useful strategy but you also need to be cautious of what inside information you pick up…

How to Avoid Illegal Insider Trading

It’s vital to know the difference between non-material and material inside information. This distinction can help investors avoid big fines and stay out of jail. Insider trading is a serious issue.

Non-material information shouldn’t give you a leg up on other investors. It’s small tidbits of information that if other investors learned, shouldn’t impact the company valuation.

On the other hand, learning material non-public information is when you need to be cautious. For example, let’s say you’re playing tennis with the CFO of the grocery chain. During a volley, the CFO lets slip that a larger grocery chain has agreed to acquire the company. This information isn’t public yet and will definitely impact share price.

If you traded on that inside information, you’re breaking the law. So be cautious of the non-public info you pick up when using mosaic theory. It won’t work as an alibi to say you thought the information was already public or it wasn’t material. Not knowing the law is not a defense and we unfortunately live in a litigious society. So please always do your homework and seek out expert opinions.

Final Thoughts

Mosaic theory is great for analysts and hands-on investors. You can also apply this theory to other areas of your life. From many sources you can piece information together to make better decisions. And simply put… the more you know, the farther you’ll go.

Similar to compound interest, your knowledge compounds. Some of the world’s best minds have also learned there’s overlap with concepts in all professions. So whether you’re in finance or not, here are my CFA Level 3 Notes. You might make some unique connections to your line of work. And the behavioral finance notes are some of the most cross disciplinary.

Invest mindfully,

Brian Kehm

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