Archives for May 2016

Latticework of Mental Models: Bayes Theorem

May 27, 2016 | 10 Comments

A statistics professor who travels a lot was concerned about the possibility of a bomb onboard his plane. He determined the probability of this and found it to be low but not low enough for him. So now he always travels with a bomb in his suitcase. He reasons that the probability of two bombs being onboard would be infinitesimal.

Do you think he has really reduced the risk?

Even those who aren’t well versed with the basic concepts of probability can say that the professor’s logic seems absurd.

Well, the bomb riddle is a famous joke among mathematicians. Nevertheless, it’s a thought provoking joke.

So to help you think about the riddle, let’s explore another related thought experiment.

A man wakes up in the middle of the night with a splitting headache. He remembers that there are few aspirin bottles in the bathroom. He dizzily stumbles into his bathroom to grab one of the four bottles in the dark and pops a pill from that bottle. An hour later, instead of getting relief from headache, he starts feeling a terrible nausea. Suddenly he realizes that only three of the four bottles in the bathroom contained aspirin and the fourth bottle contained poison.

8 Big Ideas from a Super Investor: Philip Fisher

May 23, 2016 | 8 Comments

Note: This article formed part of the April 2015 Special Report sent to subscribers of our premium newsletter Value Investing Almanack.

If you are a Warren Buffett fan, chances are slim that you haven’t heard of Philip Fisher. He belongs to the league of those very few super investors who have shaped Buffett’s investing style.

In his 2013 letter to investors, Buffett ranked Fisher’s book next to Ben Graham’s books –

…Phil Fisher put it wonderfully 54 years ago in Chapter 7 of his Common Stocks and Uncommon Profits, a book that ranks behind only The Intelligent Investor and the 1940 edition of Security Analysis in the all-time-best list for the serious investor.

Despite being considered as a super investor, Philip Fisher was little known to general public and rarely interviewed. He is widely respected and admired in the value investing circles all over the world. He is also known for his ‘scuttlebutt’ approach, which simply means seeking information from competitors, customers, and suppliers, all of whom have a vested interest in the company.

He wasn’t among those who made decisions just by reading annual reports. He believed in getting first hand information about the company from various sources.

Now, when it comes to following an advice, it’s more sensible to first take up the recommendation about “what NOT to do” instead of “what to do”. So, in the spirit of inversion, let me explore some of the don’ts in investing recommended by Fisher through his various interviews and writings.

Latticework of Mental Models: Winner’s Curse

May 20, 2016 | 6 Comments

Consider this thought experiment –

A friend of yours is the Chairman of the Acme Oil Company. He occasionally calls with a problem and asks your advice. This time the problem is about bidding in an auction. It seems another oil company has gone into bankruptcy and is forced to sell off some of the land it has acquired for future oil exploration. There is one plot Acme is interested. Until recently, it was expected that only three firms would bid for the plot, and Acme intended to bid $10 million. Now they have learned that seven more firms are bidding, bringing the total to ten. The question is, should Acme increase or decrease its bid? What advice would you give?

Do you advise bidding more or less?

If you’re like me and seeing this case study for the first time you’d probably go with a higher bid. After all, there are additional bidders, and if you don’t bid more you won’t get this land. Isn’t it?

Latticework of Mental Models: Pari-mutuel System

May 13, 2016 | 6 Comments

You don’t win by predicting the future; you win by getting the odds right. You can be right about the future and still not make any money. ~ Will Bonner

The way to win in stock market, according to Charlie Munger, is to work, work, work, work and hope to have a few insights.

Now, the question is – how many insights do you need in your investing lifetime?

Not many, as Munger says…

…you don’t need many in a lifetime. If you look at Berkshire Hathaway and all of its accumulated billions, the top ten insights account for most of it. And that’s with a very brilliant man—Warren’s a lot more able than I am and very disciplined—devoting his lifetime to it. I don’t mean to say that he’s only had ten insights. I’m just saying, that most of the money came from ten insights.

So you can get very remarkable investment results if you think more like a winning pari-mutuel player. Just think of it as a heavy odds against game full of craziness with an occasional mispriced something or other. And you’re probably not going to be smart enough to find thousands in a lifetime. And when you get a few, you really load up. It’s just that simple.

Munger uses horse racing’s Pari-mutuel betting system as one of his mental models to make sense of stock market investing. He is asking us to think like a Pari-mutuel player and look for the mispriced bets.

So what’s a Pari-mutuel system and how does one find a mispriced bet in such a system?

An Investor’s Best Friend

May 10, 2016 | 16 Comments

In one of his most dramatic investment outlooks yet, Bill Gross wrote in May 2015 about fears of his looming death –

Having turned the corner on my 70th year, like prize winning author Julian Barnes, I have a sense of an ending. Death frightens me and causes what Barnes calls great unrest, but for me it is not death but the dying that does so . . .

What I fear most is the dying . . . the suffering that . . .will accompany most of us along that downward sloping glide path filled with cancer, stroke, and associated surgeries which make life less bearable than it was a day, a month, a decade before.

He then went on to relate this to the coming death of the investment super-cycle the world over.