Blog on Value Investing | Safal Niveshak

Latticework Of Mental Models: Hyperbolic Discounting

Last year I decided to get a brand new laptop for myself. This got me started on the herculean task of selecting from thousands of choices available on numerous e-commerce websites.

After weeks of an excruciating process of comparing, shortlisting, and researching, I finally zeroed in on my final choice. Then started the wait for online discounts.

Very soon, the so-called online-sale-season arrived which offered a ‘whopping’ Rs. 100 discount on my selection. So much for the patience! But for a self-proclaimed prudent consumer, it still was a good deal.

What happened next is pretty much the story of every online shopper. Just when I was about to place the order, I saw the option of same-day delivery for an additional Rs 100. Guess what I did? Yours truly didn’t hesitate for a moment to take the offer.

Ironically, I waited for a week for a small discount but when the time came for buying I couldn’t wait another day and forked out extra money just to get my toy immediately. What happened to my admirable qualities of patience and prudence?

A little research on Google revealed that the introduction of get-it-now temptation in the deal caused me to behave irrationally. The symptom of this behavioural bias goes something like this.

When I have agreed to wait for six days, I don’t mind waiting for one more day. Well, if I can wait for six, goes the rationale, waiting for seven shouldn’t be a big deal!

But when I am told that I can get something today instead of tomorrow, my temptation refuses to wait for another day.

The 38th Lesson

On a warm Sunday morning in early-April this year, I got up with some pain in the little finger of my left hand. It was a small bump. It wasn’t there when I slept the previous night, so it seemed to have appeared out of nowhere.

“You may have hurt your finger while sleeping,” said my wife.

“But there’s no sign of a cut or bleeding!” I told her. “What could be this?”

“It happens sometimes,” she tried to soothe my nerves.

Anyways, a week passed, and then two, and that bump got slightly bigger. It was a bit painful earlier, then more, and then the pain gradually reduced. But the redness and the bump remained.

Over the next two months, I saw around five different doctors, and all asked me to wait and watch and do nothing. I thought none of these doctors knew anything about this bump because each one had named it differently. And that is when I did something I now realize was one of the biggest mistakes I’ve ever made in my life.

[Read more…] about The 38th Lesson

Short Investing Lesson from a Confused Donkey

I was listening to Tim Ferriss’s recent podcast where he interviewed Derek Sivers. In a response to the question “What advice you would give to your 20-year-old self?”, Sivers told the story of Buridan’s donkey.

It’s a tale about a donkey that’s standing exactly halfway between a bucket of water and a pile of hay. The donkey is confused for the poor animal can’t decide where to go first. He just keeps looking to the left to the hay and right to the water. Unable to come out of the deadlock, the donkey eventually falls over and dies from hunger and thirst.

It’s actually a thought experiment that illustrates a paradox in philosophy. The paradox is named after the 14th-century French philosopher Jean Buridan.

Are you wondering, what’s a philosophical angle about a donkey’s personal problem got to do with investing? Please bear with me for few more lines. I’ll come to it.

Let’s first understand how this paradox is connected to Siver’s advice for younger self.

Safal Niveshak Stream – December 3, 2016

Note to Readers: In Stream, we suggest worthwhile reading material on a variety of topics, not all of which are directly related to investing. Some of the articles require you to be paid subscriber of those sites. However, it is often possible to read such articles by going to Google News and searching for the article’s title.

Some nice stuff we are reading, watching, and observing at the start of this weekend…

Investing/Stock Market

(850 words / 3 minutes read) We are fortunate to be living in an era where we have all the teachings of wise investors available to us. As compared to 19th century, it has become much easier and cheaper for small investors to participate in the growth of businesses through stock market. Jason Zweig, in his recent article, reminds us some of the greatest words of investing wisdom that have been spoken in the past century. Zweig writes –

You don’t need to have known these people to be grateful for their wisdom. As the biologist Richard Dawkins pointed out in a lecture in 1996, many of us today know more about the world around us than Aristotle, the greatest mind of his age, did more than 2,300 years ago: “Science is cumulative, and we live later.

[Read more…] about Safal Niveshak Stream – December 3, 2016

Latticework of Mental Models: Illusion Of Control

Every day, shortly before nine o’clock in the morning, a man with a red hat stands at a busy traffic light and begins to wave his cap frantically. After five minutes he disappears.

One day, a policeman comes up to him and asks: “Sir! May I ask what you are doing?”

“I’m keeping the giraffes away,” replies the man.

The puzzled policeman looks around and tells him, “But there aren’t any giraffes here.”

“Well, I must be doing a good job, then.” says the man proudly.

You would conclude that the man with the red hat wasn’t in the pink of his mental health. However, is it just a case of misplaced understanding of causation vs correlation? Actually, there is more to it.

The man’s belief, that absence of evidence (giraffes) is a proof of his prowess in controlling giraffe traffic, is the result of a behavioural bias called Illusion of Control. It’s the tendency to believe that we can influence something over which we have absolutely no sway.

So where does this behavioural quirk come from? In millions of years of evolution, Mother Nature has hard-wired this cognitive bias in the human brain to increase the chances of survival in a hunter-gatherer environment. It’s nature’s way to deal with uncertainty.

Of Falling Stock Markets and Shutting Brains

In one of the old interviews of Mohnish Pabrai of Pabrai Funds, he described the root cause of a common, but difficult to overcome, inefficiency in share prices –

Our brains are in sync with the speed at which the market is moving and totally out of sync with the speed at which a business is moving. You have to learn to dramatically slow your brain, which is very hard for most people. The reality is that you should make decisions based on how the business is changing, and that’s a very slow process.

You wouldn’t know that businesses change slowly from the share price activity in the stock market. Such volatility, of course, can be a boon for the disciplined investor waiting for what Warren Buffett refers to as a “fat pitch.” Most maintain a watch-list of what they consider to be superior companies that they would be happy to buy, but only at the right price. But the problem for most of us lies in deciding what that right price is because most of us find it difficult to understand what that underlying value of the business is, to which we must relate the price. And thus, most of us would rather make our decisions just looking at stock prices – especially when they are moving fast, up or down – than underlying intrinsic values.

Book Review: Investing Between The Lines

Note: This book review was originally published in the May 2016 edition of our premium newsletter Value Investing Almanack. To know more and subscribe, please click here.

When an investor starts investigating a business, the first thing he wants to know is if the business is strong and profitable? And he can usually find the answer from the company’s annual report by reading the numbers like net earnings, debt, cash flow, profitability ratios etc.

The next question is, how accurate or authentic those numbers are? Of course, they are verified by auditors. But even Enron and Satyam numbers were also certified by auditors. And both of them ended up as biggest accounting scandals.

As an investor, how do you know that the management is telling you the truth? And how does an honest CEO communicate with the shareholders in a manner which establishes trust?

Laura Rittenhouse, in her book Investing Between The Lines, attempts to answer the above questions. She offers clues to separate the facts from the fluff in annual reports and quarterly earnings calls. Rittenhouse had raised a red flag on Enron, much before it collapsed, noticing a discrepancy between the net income cited in its CEO letter and its audited financial statement, among other things.

Safal Niveshak Stream – November 26, 2016

Some nice stuff we are reading, watching, and observing at the start of this weekend…

Investing/Stock Market

(3 minutes watch) Recently, government of India took a drastic step to invalidate the Rs. 1000 and Rs. 500 currency notes. We don’t have any opinion on how effective or ineffective this demonetization step would be in addressing the problem of black money and fake currency. However, it would be very interesting to see the unintended (positive and negative) consequences of this policy. One immediate effect was that people started hoarding Rs. 100 notes. Valid currency notes (1000s and 500s) suddenly turned into bad money and it drove out the good money (lower denomination notes i.e. 50s and 100s), perhaps temporarily, from the circulation. This is known as Gresham’s law. It is a monetary principle stating that “bad money drives out good.” Watch the latest episode of Latticework of Mental Models video series on Gresham’s Law.

Click Here if you can’t see the video above. [Read more…] about Safal Niveshak Stream – November 26, 2016

Latticework of Mental Models: Lucifer Effect

Let me ask you a disturbing question.

“Would you electrocute a stranger?”

Most of you would respond with an emphatic no. But perhaps you are underestimating yourself.

I am neither doubting your character nor your sense of morality but empirical evidence suggests that human beings underestimate their own vulnerabilities that can turn them into evil. To support my claim let me take you through a fascinating experiment.

In 1971, Philip Zimbardo, a young psychologist from Stanford University, wanted to study the psychology of imprisonment i.e., study the roles people play in prison situations. So he invited students to participate in an experiment and randomly assigned them the roles of ‘prisoners’ and ‘guards’. Tests showed that all students were normal people and physically and mentally healthy. A simulated prison environment was created to mimic real-life prison conditions, where they lived for several days. As part of the role playing the ‘guards’ behaved aggressively and ‘prisoners’ behaved helplessly. [Read more…] about Latticework of Mental Models: Lucifer Effect

Investing and the Art of Metaphorical Thinking

My momma always said, “Life is like a box of chocolates. You never know what you’re gonna get.” Mama always had a way of explaining things so I could understand them. ~ Forrest Gump

About a century ago, when the first automobile was introduced on the roads, most people referred to it as “horseless carriages”. Not only that, when the first set of cars came out, people called them “iron horses.”

Amusing, right? How limited people’s imagination was!

But today when the first lot of autonomous vehicles are getting ready for the roads, most people like to call them driverless cars. I am sure our future generation will be amused at our choice of words.

“Driverless? What driverless?” They would probably chuckle at the unimaginative terminology of their previous generation.

But that’s how a human mind works. The seeds of most revolutionary ideas are sown in those moments of unimaginative thoughts, like horseless carriages and driverless cars.

Driverless cars are as complicated and unbelievable to us as horseless carriages were to our great grandparents. And for a human mind, the best way to learn a complex idea is to find it living inside something else it already understands.