Crossroads Capital – The Three Types of Mispricing

As Crossroads hits a decade of searching for value in public markets, we thought it worthwhile to continue the conversation we began last summer when we discussed our understanding of value (linked here). In brief, our view is that value is dynamic, perhaps better described as organic, and is continuously developing inside the evolving complex markets that remain our hunting ground. In that earlier note, we focused on the directional orientation of valuation. There is backward-looking valuation, driven by metrics and Fama-French categories that characterize the stereotypical “value” investor, and then there is forward-looking valuation, in which businesses are evaluated relative to their normalized earnings power a few years out. Typically the latter is where the real money is made, because the gap between what a business looks like today and what it will look like at a normalized run rate is precisely where the market’s pricing machinery breaks down.

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Also see: Hidden Value Stocks Q3 2025 Special Edition: Ryan O’Connor Of Crossroads Capital

On that note, we’ve often placed our positions into one of two categories: emerging compounders and special situations. But ultimately, value is found in market mispricings, not in the categorical groupings themselves. Recall that the goal of fundamental investing is to pay a price for a stake in a business that is less than its true value in the expectation that price and value will converge, earning an excess return as the gap closes. For that reason, understanding why mispricings emerge and when they can be taken advantage of is the foundation of our ongoing search for value.

There are three general types of mispricings, and in each one human psychology does most of the heavy lifting. Below, we look at each type in turn.

The Three Types of Mispricing

Duration Mispricing

The first type is what we’ll call duration mispricing. It’s created by the short-term incentive structures that govern institutional capital: Performance is measured in months, fees are paid against benchmarks reset annually, and careers are made and lost on the next print. The result is a profession whose participants cannot afford to be early even when they’re right. Blaise Pascal wrote in 1670 that “all of humanity’s problems stem from man’s inability to sit quietly in a room alone.” That line describes the modern institutional investor with uncomfortable precision: all portfolio managers’ miseries derive from their being unable to leave their best positions alone. The asset management profession is structurally designed to prevent exactly the behavior most likely to produce strong returns.

Warren Buffett described the flip side of Pascal’s idea at the 1998 Berkshire annual meeting: “We don’t get paid for activity, just for being right. As to how long we’ll wait, we’ll wait indefinitely.”

Clearly, Buffett had no problem sitting quietly and letting his investment theses play out. Indeed, Buffett noted in a 1999 BusinessWeek interview that investing success does not correlate with raw intelligence above a modest baseline; instead, it correlates to temperament, specifically the capacity to resist the urges that get other people into trouble.