Talk 2: A Lesson on Elementary, Worldly Wisdom as It Relates to Investment Management and Business

Given at USC Marshall School of Business

• facts are not enough, you need models which is the structure facts hang off.
• you need many models, otherwise you'll see everything through the narrow lense of a single pattern
• models are effective ways to understand aspects of complex systems
  • therefore models should come from a variety of disciplines, to capture more aspects of the whole interconnected complexity
• a minority of models will carry the majority of weight. 80/20 rule.

learn the fundamental ideas in each major discipline, always prefer the explanation that uses more fundamental ideas –> use the checklist style for these fundamental ideas

use a big bag of multidisciplinary tricks, mastered to fluency, applied to all complex problems in life

• This talk discusses models and their application in investing

• math

  • permutations
  • combinations
  • basic probability as discovered by Fermat/Pascal are highly applicable to the real world

• know the basics of accounting; know enough to understand it's limitations.

Double entry bookkeeping accounting is a fundamental and important invention: https://matheusportela.com/double-entry-bookkeeping-as-a-directed-graph

• Carl Braun's notion of the 5 W's – who, what, where, when and why, why, why

• Engineering models and hard science are the most reliable

  • quality control
  • breakpoint controls
  • backup system
  • critical mass

• bell curve from statistics

• cost benefit analysis

• biology and physiology models are the next most useful

• psychology models

  • the brain has shortcuts which can be manipulated, don't fall victim

    • Denial Tendency

• think of an economy as an ecosystem. Similar rules apply from nature to a competitive market economy

  • specialization, for example

advantages of scale

• surface area vs volume
• special access to expensive opportunities
• efficiencies with volumne
• social proof
• cascading one-winner take all industries
• chain store effect – advantage of scale with small units for experiment and local specialization

disadvantages of scale

• big, fat, dumb, unmotivated, corrupt beucrocracy

• Avoid natural antipathy towards information that runs counter to your current belief.

Learn to destroy your own favorite ideas/beliefs.

• copy what's working for others
• management matters - but, on balance, good business is safer to bet on than merely good management

why do some industries lose margin from fierce competition and others leave a margin for owners?

• brand identity
• competitive tendencies of the players
• airlines vs cereals example

• efficiency gains don't always benefit owners. Increase efficiency in a low margin business will still flow mostly to the end customer
• rapid tech development result in sometimes unpredictable competitive destruction
• stock market behaves like a pari-mutuel system at racetrack. Intelligent, intentional bets should out perform the average, plus the house take a %
• Bet big when a golden opportunity arrives; otherwise, don't. It's that simple
• Investment managers are in the business of selling their product to people; not primarily buying stock
• Ben Graham's Mr. Market concept

In the long run, it's hard for a stock to outperform the underlying business

• get in early
• find great businesses w/ great managers
• avoid taxes by buying and selling

• Ignore tax shelters

Buying great companies can get overdone at times. It always needs to be bought at a good price.

• "Fortunes Formula" by Will Poundstone

3 Rules for work

1. Never sell something you wouldn't buy
2. Never work for whom you don't respect and admire
3. Work only with people you enjoy