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Fact, fiction and other thoughts

Lesson from science for any businessperson, investor, or human being: if you want to learn something about the fields you are involved in, ask questions that will allow you to know when it breaks.

Let’s do something different. The mind enjoys the challenge and resulting cognitive pleasure of finishing things. For example, we enjoy recognizing “faces” in the clouds, or patterns in the night sky. These aren’t really there of course, but our brains are exceptionally good at effortlessly creating them. Most people know some of the names for the regular patterns that generations of humans have identified at night. The “big dipper”, the “southern cross”, and the “crab” are but a few examples of many. Instead of carefully crafting one or two ideas fully, I want to present a few quarter and half ideas. And full questions. Essentially my first idea is to leave it up to the reader, and the magnificent power of his or her brain, to do the rest. Enjoy.

Which share was the best performing in the US during the last 30 years? It’s a little known specialty chemicals company (!) called Belchem. Shares in Belchem provided a total return to those lucky enough to hold them for the last thirty years of 101 000%! In other words, investors made about $1010 for every $1 invested in this company 30 years ago. It’s a wonderful thought, 1000 times your money. I could retire on half that.

After fantasising about the money that I could have made from an investment in Belchem, I found myself vexed by a question that I didn’t like my own answer to. Would I have stayed invested in Belchem for 30 years? Replace Belchem by Remgro, PSG, Bidvest or any other stellar performer. The answer is probably (approaching 100%) NO. To stay invested in a Belchem, or any other business for decades, invariably (?) requires MOST professional investors to act irrationally at some point. When one makes an investment decision, or any other decision for that matter, the future is not known. All we know is the past (dimly at that), and the present, from which we have to plan and act as the veil of the future continually unfolds before us.

Professional investors have models that are essentially attempts to summarise the relevant past in order to rationally engage with present decisions. If I knew in 1985 that Belchem would give me 1000 odd times my money, I would have mortgaged my nappies, my mom, and deferred breast feeding for a month to buy shares in the company! But I didn’t, and I couldn’t have known. You have to make decisions based on what you presently know. And what you know is invariably based on what has and is happening with conceptual room and the appropriate weight for future possibilities built in.

I have not tested this but here’s a thought. Every one of these companies, the 100 baggers, or 1000 baggers, would have been rejected based on SOME essential filter in most if not all models during some point in their rise to return greatness. For example, maybe at some point their P/E’s were too high for the value guys, or at another point they did not have clear and sustainable growth prospects for the growth guys, or any combination of factors that would have led somebody (with a model) to sell them based on THAT model. And if they did not sell at that time, they would have acted irrationally according to their view of the world.

Bottom line. Which model of rationally making investment decisions in the present, without knowing future outcomes, would NOT have sold a Belchem at some point during the last 30 years? I don’t know. Perhaps there is some model, such as “buy everything on the market”, or “buy everything with reasonable solvency and liquidity”, that would have included Belchem for thirty years. But then surely THAT model would have owned Belchem in such tiny amounts that even a 101 000% return would not have moved the needle in the ways we like to fantasize about. The uncomfortable thought I end up with is that a professional investor will never hold onto a Belchem for decades, and if he or she does, that decision was based on hope and luck, two things professionals claim they don’t rely on.

Facts and fictions

The human mind does not take easy to thinking probabilistically. If I ever got the chance to design a school curriculum, kids would learn to program, they would learn to ask why at least 5 times a day, and they would learn to think in terms of probabilities. Oh, I almost forgot, I would also try to show kids that it’s a very worthwhile practice to feel with people but to disagree (intellectually) with them often.

Most people do not know that science specialises not in showing something to be true, whatever that exactly means, but in trying to determine when something is NOT. For example, and sorry to burst your astrological bubble, astrology is not true because some people happen to meet the love of your life in the month of their “star sign”, but it is proven false because many people do not meet their soul mate when it was predicted of them. It is not how many confirming instances astrology has notched up, but how many times it has been dead wrong.

The lesson from science for any businessperson, investor, or human being (these three categories are not mutually exclusive for the most part) is that if you want to learn something about the fields you are involved in, ask questions that will allow you to know when it breaks. If you know when it doesn’t work, then you know the limits of its functionality, if you only know its functionality, you will eventually be unpleasantly surprised by its limits. Well-known business books almost always claim to show you how to be excellent at business or to explain why a particular business is great. They mostly do neither, although they often do tell stories of significant motivational value.

Consider that most books telling the story of great businesses, and claiming to show the factors leading to their success, do so after the fact of their greatness. It is quite easy to look retrospectively at Apple and find a whole host of factors of why it is now great. After his success, Steve Jobs was touted a genius, but before his success he was once fired. Books like Good to Great by Jim Collins are great, but not in the way you would think. They are great as stories, but terrible as explanations of business greatness.

The explanations in Good to Great are terrible, as explanations of business greatness, because Mr. Collins only considered confirming instances of his theory and the factors he outlines. In other words, his book is the equivalent of business astrology, as he never tells us about the hundreds of firms that didn’t make it when applying his few “rules” for making a business great. Anybody can draw a near perfect bull’s-eye around an arrow that has already been shot. The Holy Grail in business is to find the recipe, if any, of hitting the bull’s-eye of business greatness when it is drawn before the arrow is shot. If I follow Mr. Collin’s principles to the T, will I achieve business greatness? I won’t bet on it.

Other thoughts 

I have assumed throughout that all of us are on the same page as far as saying what “rationality” is. Truthfully, I’m in a few minds about the concept. The only element I am rationally confident applies to rationality tout court is logical coherence. In other words, you will everywhere and at anytime be irrational if you do not accept as true the conclusions of a deductive argument from true premises. For example, if the first premise truthfully (?) claims that all men are mortal and the second that Socrates is a man, then it must follow that Socrates is mortal. Claiming otherwise in this argument is irrational.

But, consider my argument regarding Belchem. Would it always be irrational to have held Belchem for 30 years? Hardly. All I would need to justify a form of rationality concerning Belchem is to include the appropriate premise(s) as a point of departure. For example, if I am convinced that history is a poor guide to the future, that speciality chemicals is an essential and ubiquitous element in economic growth, that small companies have the ability to grow by many orders of magnitude before saturating their economic ecosystem, then I possibly have the makings of a rational basis for including a Belchem in my portfolio for decades. I may be wrong on any number of those premises, but I wouldn’t be irrational.

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