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Stock Analysis and the Illusion of Control

“The greatest obstacle to discovery is not ignorance – it is the illusion of knowledge.” ~ Daniel Boorstin

The Art of Thinking Clearly is a nice book from Rolf Dobelli. In one chapter, Dobelli shares a couple of instances…

Every day, shortly before nine o’clock, a man with a red hat stands in a square and begins to wave his cap around wildly. After five minutes he disappears. One day, a policeman comes up to him and asks: ‘What are you doing?’ ‘I’m keeping the giraffes away.’ ‘But there aren’t any giraffes here.’ ‘Well, I must be doing a good job, then.’

A friend with a broken leg was stuck in bed and asked me to pick up a lottery ticket for him. I went to the store, checked a few boxes, wrote his name on it and paid. As I handed him the copy of the ticket, he balked. ‘Why did you fill it out? I wanted to do that. I’m never going to win anything with your numbers!’ ‘Do you really think it affects the draw if you pick the numbers?’ I inquired. He looked at me blankly.

Consider my own example. I was once a die-hard cricket fan…or let me say I was a fan of only watching India win (and hated it when they lost).

So, during crunch matches, I used to change my seating places in front of the TV frequently to hit upon one from when India started doing well.

I got up from that place, and the Indians either lost a wicket or dropped a catch, so I stuck to that place throughout the crunch situation.

I thought my seating place controlled the fate of the Indian team, which was such a stupid thought.

I suffered from what is known as an “illusion of control”, which is basically the tendency to believe that we can influence something over which we have absolutely no sway.

Illusion of Control in Investing
Illusion of control is also seen in stock investing, when investors who do a lot of hard work before picking up stocks believe that their hard analysis and knowledge gives them control over the future of stocks they own.

On the other hand, there are many who do not start investing at all – or outsource the task to a broker or ‘trusted’ friend – because they see stock analysis as an enormous task.

“So many stocks and so less time to deeply understand businesses!” is a common refrain from people who avoid doing any independent analysis on stocks and invest or speculate largely based on tips they receive from others.

The mere thought of analyzing companies seems paralyzing, and thus people either defer their investment decision-making for years, or simply give up on doing it themselves.

Now the moot question here is…

How Much Analysis is Enough?
I have received a lot of emails over the past two years from readers asking a few of such questions –

  • How much business understanding is enough before making an investment decision?”
  • Can I invest in a stock without a perfect understanding of its business?

This is something even I wondered during the initial part of my investing career – “Do I need to have a perfect understanding of a business before considering buying its stock?”

Based on my experience and that of other successful investors around me who have bought stocks with “perfect” knowledge and also with “imperfect” knowledge, the answer is – No!

The reality is that, no matter how hard we try to analyze the intricacies of a business, we may not be as important to the results as we’d like to think we are.

Several investors (me included) spend too much time exposing themselves to all the informational noise that is distributed over the Internet in the hope of boosting confidence enough to be comfortable with our investment decisions.

But it’s important to understand, as a wise man said, that over the long-run you will probably do better building a portfolio of companies that make you uncomfortable (those you’ve bought with imperfect knowledge) than building a portfolio of companies that make you comfortable (those you’ve bought with perfect knowledge).

Your investment process should be focused simply on understanding and valuing businesses, and being better at it than other investors.

Trying to increase your confidence by gathering information that is supposedly unknown to most others really only makes you more comfortable with your investment decisions, not better at them, and is generally an unproductive use of your limited time.

Here is something Seth Klarman wrote in Margin of Safety

Some investors insist on trying to obtain perfect knowledge about their impending investments, researching companies until they think they know everything there is to know about them.

They study the industry and the competition, contact former employees, industry consultants, and analysts, and become personally acquainted with top management. They analyze financial statements for the past decade and stock price trends for even longer.

This diligence is admirable, but it has two shortcomings.

First, no matter how much research is performed, some information always remains elusive; investors have to learn to live with less than complete information.

Second, even if an investor could know all the facts about an investment, he or she would not necessarily profit. This is not to say that fundamental analysis is not useful. It certainly is. But information generally follows the well-known 80/20 rule: the first 80 percent of the available information is gathered in the first 20 percent of the time spent.

Moreover, business information is highly perishable. Economic conditions change, industries are transformed, and business results are volatile. The effort to acquire current, let alone complete information is never-ending. Meanwhile, other market participants are also gathering and updating information, thereby diminishing any investor’s informational advantage.

…Investors frequently benefit from making investment decisions with less than perfect knowledge and are well rewarded for bearing the risk of uncertainty.

The time other investors spend delving into the last unanswered detail may cost them the chance to buy in at prices so low that they offer a margin of safety despite the incomplete information.

In short, even as the experts are busy focusing on such areas as “forensic” accounting, “channel checking,” public policy analysis, “lie detection” on conference calls, data mining and networking, you may do better by starting with imperfect knowledge, and cut out on the signal-to-noise ratio that has degraded substantially over the years.

Stop Trying Too Hard
James Montier of GMO writes…

The amount of information that assails us on a daily basis is truly staggering. Unfortunately, we tend to equate information with knowledge. Sadly the two are often very different beasts. We also tend to labour under the misapprehension that more information is the same as better information.

Experimental evidence suggests that often where information is concerned less is more!

In fact, numerous studies have shown that increasing information leads to increased overconfidence rather than increased accuracy.

And overconfidence, as you already know, is such a big killer of investment returns.

Use the “Less is More” Checklist
I believe rather than obsessing with the bewildering fusion of news and noise, you should concentrate on a few key elements in stock selection, i.e., what are the 5-10 most important things you should know about any business you are about to invest in?

Of course, if I knew the exact answer I would have retired long ago! 🙂

Even if I could know all the facts about an investment, I would not necessarily profit. This is not to say that fundamental analysis is not useful. It certainly is.

But information generally follows the well-known 80/20 rule: the first 80% of the available information is gathered in the first 20% of the time spent.

So if I were to list down eight questions that, I believe, would help me do an 80% analysis of a business, they would be…

  1. Is the business simple to understand and run? (Complex businesses often face complexities difficult for its managers to get over)
  2. Has the company grown its sales and EPS consistently over the past 5-10 years? (Consistency is more important than speed of growth)
  3. Will the company be around and profitably better in 10 years? (Suggests continuity in demand for the company’s products/services)
  4. How has the company performed on Buffett’s earnings retention test? (A new, but very important question to answer – added after reading Prof. Sanjay Bakshi’s recent post on Relaxo)
  5. Does the company have a sustainable competitive moat? (Pricing power, gross margins, lead over competitors, entry barriers for new players)
  6. How good is the management given the hand it has been dealt? (Capital allocation, return on equity, corporate governance, performance against competition)
  7. Does the company require consistent capex and working capital expenditure to grow its business? (Companies that have to spend continuously on such areas are like running on treadmills, which is not a good situation to have)
  8. Does the company generate more cash than it consumes? (Cash generators have a higher probability of surviving and prospering during bad economic situations)

Get Over Your Illusion of Control
I would leave you with this beautiful little video from the 2008 movie Kung Fu Panda, where the wise old tortoise Master Oogway explains the illusion of control to its disciple Shifu, who is charged with training the unlikely Po, a giant panda, to become the next great kung fu Dragon Warrior.

The master says – “My friend, the panda will never fulfill his destiny, nor you yours until you let go of the illusion of control.”

If you can’t watch the video above, watch here.

Also, if you understand Hindi, here is a video from the epic Mahabharata, where Lord Krishna tells Arjuna how he has the right to perform his actions, but is not entitled to the fruits of the actions…and thus he must not let the fruit be the purpose of his actions (getting over the illusion of control over the results).

If you can’t watch the video above, watch here.

How often in our lives do we try to force an apple or an orange out of something whose essence is a peach?

Master Oogway and Lord Krishna remind us that we cannot become so attached to an outcome that we imagine it in our minds.

In stock investing, often we focus so much on trying too hard that either we never start working on the process of picking up great businesses (seeing the enormity of the task), or we start believing that our immense hard work and knowledge gives us great control over the future of stocks we own.

The reality is that, no matter how hard we try to analyze the intricacies of a business, we may not be as important to the results as we’d like to think we are.

It’s thus important to remember what Klarman wrote…

Investors frequently benefit from making investment decisions with less than perfect knowledge and are well rewarded for bearing the risk of uncertainty.

The time other investors spend delving into the last unanswered detail may cost them the chance to buy in at prices so low that they offer a margin of safety despite the incomplete information.

Feel lighter? 🙂

Afterthought: Here’s something beautiful I found just a while back, which goes well with today’s thought of “less is more”, and giving up the illusion of control.

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About the Author

Vishal Khandelwal is the founder of Safal Niveshak. He works with small investors to help them become smart and independent in their stock market investing decisions. He is a SEBI registered Research Analyst. Connect with Vishal on Twitter.


  1. Manoj Dureja says:

    Thank you very much Vishal for this beautiful article. This certainly answered one of my critical questions on how much to research before making an investment decision.


  2. Reni George says:

    Dear Vishal

    Good Morning to you

    You are getting better day by day,might be the effects of good company…hahhaha Your this post and the previous one was marvelous and could be added to your best list.Hats off to you….

    As we said before in one of the post in the Google groups,the problem that we get a lot of pain in equity investing is that no sooner that we have selected the stock for investment,we set our eyes on the outcome……Actually we are less concerned about the process.

    We have all been guilty of all these,at some point of our investment cycle,but when we incline our investment more towards the process side and less towards the outcome,you would see that the results have been good and outstanding.

    Recently I selected two stocks,based on the basic checklist and oh that process,I bought it,where i have not went for the outcome result and the way the stocks have moved is more than satisfactory.
    When we are driving our car through the highway,we cannot calculate the outcome,which may be at a distance of 100 kms,we can just carry on the process of driving carefully and going at a steady and comfortable speed.Nor can we drive carefully by always looking at the rear view mirror (Judiciously going through the past results of ten years,fifteen years… )…It does not serve the purpose,Rear view mirror has to be used only intermittently.

    Even the best of the technologies have never been able to control the outcome….the earthquakes,the typhoons,the crisis in the equity markets.The problem is that after going through a hell lot of datas(additional useless noise).it just makes stock picking difficult,instead of making it easy.

    Anything that makes your process complicated,is useless at the first place itself.I do not keep any benchmarks for my returns,because that would force my add unnecessary data correlation into my investment process.I am more happy at a return which is a comfortable for me to get out of my equity investment.Anything above that would be a icing on the cake,but all that are unseen outcomes.

    so till the time,we treat our equity investments as a process of our investment and life cycle,we will be more than happy about that.

    Carry on Vishal,with such type of wonderful post.Feeling greatly obliged to be associated with you.

    Thanks and Regards
    Safe and Happy Investing

    Reni George

    • Indeed we as humans want instant gratification.
      Monitoring performance vs the process is the nemesis of many things like love, studying, bringing up children and what not.
      Letting nature take its course and providing timely inputs is something we should try to imbibe.

  3. An interesting blog post for value investors.

  4. Thank you for this post.
    I printed and will paste (right on the cover itself) of the ‘diary of the dumb investor’ these 8 points.
    BTW I finished reading ‘Think and grow rich’ and am speedily trying to finish ‘Predictably irrational’. Thank you for sending them to me, they are both wonderful books.

  5. Thanks for this beautiful article

  6. Akhilesh Pathak says:

    Dear Vishal,

    You are surely in the race of the best disciples of Ben Graham in 21st century !! Probably you would love to run this race ( safe to assume, considering your penchant for running and apathy for rat race) and so would all of us 🙂

    A relevant quote from Ben Graham’s behavioral teachers – “When a man is prey to his emotions, he is not his own master.”― Benedict de Spinoza

    Whether it is about diffidence( sometimes it pays to be timid and shy too..when everyone is so confident about Sensex at 25000 ) ,overconfidence or control..all should aid in our decision making process and should not become decision makers 🙂

    Great videos and ever amazing Gavin Aung Than made sure that learning is imbibed in the heart.

    I wanted something really badly and whole world conspired…All links are getting connected ( Started reading Zen habits, Awakin, Daily Goods and Zen Pencils around one year back and landed on Safalniveshak )

    May the force be with you !!

    With warm regards


  7. Vishal,
    I am a regular reader of your articles and kudos to the great work of yours. I sometimes wonder how you keep churning out so many articles and also make it so interesting.
    Thought I will add my 2 cents or paisa whatever it is on this topic.
    I always found ‘How has the company performed on Buffett’s earnings retention test?’ a debatable topic which contradicts other valuation principles.
    A value investor is one who is looking at the future and not the past (rear view mirror) and buying something below its intrinsic worth. However, past will show how the business could do in future. Please note that here the past we are looking only at the business and not how the market has valued. Given this understanding let us see the problems of this earning retention test.
    If you take Relaxo or Mayur or Ajanta Pharma or La Opala any other companies that had recent PE expansion, it will pass the test with flying colors. For every rupee held in book, the market price not just appreciated by 1 rupee but by many multiples. But does that say anything about future? Let us say that Mr. Market recently decided that he is willing to pay 4 times book for a company that was regularly going at 1.2 time book. It will pass this test, but at the same time exposes the investor to the risk of declining returns in the future. Reversion to the mean or base rate would take care of it. Yes, re-rating is sometimes permanent but can we bet on that against base rate? If we do that, it is speculation. Microsoft, Infosys and all those great companies would have passed this test in 2000 with flying colors but what was their return in the next 10?
    Conversely, this also could make a person reject a business that is going below book or very close to book recently due to any other reasons. Some of the examples include BHEL (now it got better but was trading close Rs.100 recently) and some banks. Recent example is MCX where the fear drove the price equivalent to book. They may fail the test but may give wonderful returns if you look the next 10 years.
    If you take Microsoft today and compare the move in book value in the last 10 years vs the market value increase percentage, it will fail the test. But does that mean Microsoft is a bad investment for the next 10 years. Common sense would say no.
    These are all different tools that provide us with different answers and we need to collate them to come to a reasonable conclusion.
    The question ‘How has the company performed on Buffett’s earnings retention test?’ has to be applied with caution. It has to be against the base rate or else one may risk investing in companies that had huge PE expansions and risk meager returns in the future.

  8. Anabil Dhar says:

    Someday i will learn to select companies, but i am growing into your fan Vishal Sir.


  1. […] appear when they rightly should. It means asking important questions (like some I listed earlier in this post) and making sure we get […]

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