…is almost always more profitable than investing when everything seems certain.
Investors, like most people going about their daily lives, don’t like doubts and uncertainties. So, they pay money and give up opportunities to avoid it.
Of course, it’s a good idea to avoid entirely what you can’t totally get your mind around, successful investing is largely about living through the uncertainties.
If you need reassurance, you’re giving up quite a bit to get it. Like high fees to experts who would predict the future (which you falsely believe as reassurance, which it isn’t), or expensive prices for stocks (because everyone knows their future is clear, which often isn’t).
On the other hand, if you can get in the habit of seeking out uncertainty, you’ll have developed a great instinct. Plus, in the long term, it’s highly profitable.
Mohnish Pabrai wrote in his brilliant book The Dhandho Investor –
Wall Street sometimes gets confused between risk and uncertainty, and you can profit handsomely from that confusion. The Street just hates uncertainty, and it demonstrates that hate by collapsing the quoted stock price of the underlying business. Here are a few scenarios that are likely to lead to a depressed stock price:
High risk, low uncertainty
High risk, high uncertainty
Low risk, high uncertainty
The fourth logical combination, low risk and low uncertainty, is loved by Wall Street, and stock prices of these securities sport some of the highest trading multiples. Avoid investing in these businesses. Of the three, the only one of interest to us connoisseurs of the fine art of Dhandho is the low-risk, high-uncertainty combination, which gives us our most sought after coin-toss odds. Heads, I win; tails, I don’t lose much!
While value investors are typically averse to taking high risks, that’s more a reflection of the price they’re willing to pay for any given investment than the types of situations they most often pursue, which are often fraught with uncertainty.
As businesses constantly evolve and change in response to challenges and opportunities, the lack of clarity around those changes. And the risks inherent in the potential outcomes can cause share prices to diverge widely from underlying business values.
The ability to recognize and capitalize upon that dynamic, and understand whether it’s temporary or permanent, is a key element of what sets the best investors apart.