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1/ Investors tend to think of investing as a formula (like physics) because its simpler to visualise: Good mgmt+good biz+industry tailwinds = good investment outcome. But business is like biology. There is evolution, mutation, reaction, reflexivity, etc which cannot be modeled
2/ Evolution & mutation like aspects bring in uncertainty and hence probability. Not just at the biz level but also at the investor level since investing strategies operate in a context. They lose their edge if widely followed
3/ Eg. If everyone followed what is written about Buffett then certain types of stocks would get priced out and the incremental new investor wouldn’t make return / make very low return.
4/ Having said this there are some basic fundamental rules just like rules that govern cell division. Most fundamental of them being that value is created when return on capital exceeds cost of capital. Cyclical, buy and hold strategies use this same rule but apply it differently
5/ There is no way one can predict the future course of business because of this biology like nature. Yet getting to “value” a biz through a DCF requires one to have projections of future cash flow. Over 12y as a professional investor I have never once seen projections being met
6/ Plus with our behavioural biases never once have I seen anybody (or myself for that matter) project negative cash flows or downward trending sales or reducing margins in a for a DCF or any projection exercise for that matter
7/ Which means that determining return through projections is inefficient. How then does one allocate capital? Unfortunately the little work on this topic goes back to math (hence formula) and in my opinion some of it can only come through skill derived post vast experience
8/ One of the ways I have found useful is the troika of disaggregation, triangulation and inversion. You can’t make much use of these tools though unless you read widely and know operating numbers and data points.
9/ And even after doing that you will be left with incomplete information. There is a natural discomfort of the human mind to deal with it. Which is where experience and learning can possibly help. Even then you can possibly go wrong
10/ If there are any additional tips that practitioners have on how to deal better with uncertainty and make decisions I would love to hear them /Fin
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