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Latticework of Mental Models: Gresham’s Law

This article is the fifth of this weekly series called Latticework of Mental Models, which will be authored by my friend and partner in writing the Value Investing Almanack, Anshul Khare. Anshul will write on various mental models – big ideas from various disciplines – which can help you think more rationally while analyzing businesses and making your stock investment decisions.

Few weeks back, we discussed the mental model of Storytelling. I am going to use the same model to start this post. Let me start with a true story, and take you back to medieval India.

Between the years 1324 to 1351, Delhi was ruled by an emperor named Mohammad-bin-Tughluq from the Tughluq dynasty. He had a scholastic background and spoke multiple languages. In spite of good intentions, some of the policies that he enforced during his rule backfired which made him infamous as an eccentric ruler. One such failed idea was about an experiment that he did with the local currency.

Tughluq noticed that India had very few silver coins and a comparatively larger number of bronze and copper coins. He decided to promote bronze or copper coins by passing a royal order that bronze and copper coins are to be accorded the same value (i.e., same purchasing power) as silver coins. In other words, he wanted the markets to mentally consider bronze and copper as silver itself so that 1 gram coin of bronze can buy the same goods as 1 gram of silver. It looked like a neat idea however the emperor failed to consider the law of unintended consequences.

Corporate Governance: Charlie Munger on Governance

Charlie Munger is widely quoted in value investing community for his multidisciplinary ideas. However, he has some unconventional advice on the subject of corporate governance also which deserves a discussion. Let’s look at some of the insights from Munger on the issue of governance.

Munger believes more in the spirit of corporate governance rather than enforcement of compliance rules and regulations. If the intention is not right, people can always bend the rules and find workarounds for carrying out unethical practices without breaking the law. But when you know that the intentions are right then even an occasional instance of non-compliance doesn’t bother you because you trust the person and know that things will eventually get sorted out.

Munger is of the opinion that different companies have different cultures and you cannot come up with a one-size-fits-all solution in form generic compliance rules. An organization is made up of diverse set of people with different interests and values. Such collection of people behaves as a complex adaptive system. The moment complex rules are infused to command more control it invariably results in unintended consequence. So the solution is not to device more rules but to make the system simpler.

In the annual meeting for Wesco Financials in 2007, Munger pointed out –

A lot of people think if you just had more process and more compliance—checks and double checks and so forth—you could create a better result in the world. Well, Berkshire has had practically no process. We had hardly any internal auditing until they forced it on us. We just try to operate in a seamless web of deserved trust and be careful whom we trust.

This brings us to the Munger’s first idea for simplifying the corporate governance puzzle.

Seamless Web of Deserved Trust

A system in which the individuals making decisions do not bear the consequences of those decisions seems incompatible with a seamless web of deserved trust. Munger explains –

Good character is very efficient. If you can trust people, your system can be way simpler. There’s enormous efficiency in good character and dis-efficiency in bad character.

Moreover, unethical behavior is contagious. Gresham’s law says that bad values (or currency or people) drive out the good values from a system. If you find that it’s easy to cheat and steal in an organization, it’s just a matter of time before majority of the people in that system start exhibiting dishonest and unethical behaviour. Even if everybody was absolutely honest to begin with. Such is the human behaviour.
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When to Sell a Stock (E-Book & Checklist)

Most investing discussions revolve around when to buy a stock. “Which stock should I buy?” is the first question that comes to your mind when you think about investments. But equally important is the question – “When should I sell a stock?”

Now, there aren’t any “10 Immutable Laws of Selling.” In fact, the answer to this question is often as difficult and subjective as deciding when to buy a stock.

But, without doubt, a disciplined sell process injects a healthy dose of Darwinism – survival of the fittest – into the portfolio. This process weeds out the weakest stocks – the ones that have deteriorated / deteriorating fundamentals or diminished margins of safety – in favour of stronger ones.

In a special e-book, and through a diagrammatic checklist (see below), I try to answer some of the questions around when to sell a stock. Not every selling rule under the sun may be included herein, but I’m sure what you read and see below will still be of some help to you.

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Latticework of Mental Models: Mean Reversion

This article is the fourth of this new weekly series called Latticework of Mental Models, which will be authored by my friend and partner in writing the Value Investing Almanack, Anshul Khare. Anshul will write on various mental models – big ideas from various disciplines – which can help you think more rationally while analyzing businesses and making your stock investment decisions.

There are certain days in everybody’s life which in spite of being ordinary remain etched in the memory for a long time. It was 15th of December. I distinctly remember it because I bought my car that day.

The ownership of new car brought with it an excitement to take care of it which included an urge to diligently track the car mileage. You know, boys with toys. At an average of 13 km/litre it was a satisfactory performance. However, after few weeks I started noticing that the mileage numbers would go down occasionally and then come back again to the normal.

There wasn’t any change in my driving style or driving routes. Except the source of fuel there was no other variable that could cause the variation in performance. So my hypothesis was that the quality of fuel was affecting my vehicle’s performance. To empirically validate my theory I decided to keep track of different fuel stations where I got the petrol from.

How to Find Great Businesses, the Peter Lynch Way

One of the first books I ask new investors to read is Peter Lynch’s One Up on Wall Street.

The easy-going and simplistic stock-picking style discussed in this book brought Lynch great success in his profession as a fund manager at the US mutual fund company, Fidelity, where he generated an average annual return of 29% during 1977 to 1990.

Lynch wasn’t just a great investor, he had a wonderful way of getting across the secrets of his success in everyday language, exemplified by this warning of the perils of putting money into businesses that you don’t understand.

Another of his catchphrases was to “invest in what you know” and he believed everyone could use this advice to spot successful companies.

In fact, he got many of his best ideas at home or when wandering around shopping malls, rather than by poring over company accounts.

Latticework of Mental Models: Storytelling

This article is the third of this new weekly series called Latticework of Mental Models, which will be authored by my friend and partner in writing the Value Investing Almanack, Anshul Khare. Anshul will write on various mental models – big ideas from various disciplines – which can help you think more rationally while analyzing businesses and making your stock investment decisions.

What if I told you that the DCF (discounted cash flow) analysis and the principle of time value of money was first discovered in 600 B.C.? And the person who discovered it was neither an economist nor a mathematician. He was a storyteller called Aesop.

“You must be kidding,” you might say. Well, let’s find out.

In my personal experience, one of the most effective ways to make a conversation (written or verbal) interesting is to tell a story capturing your idea. In fact, I can safely claim that whenever I hear or read something that starts with “let me tell you a story,” it gets me hooked for at least few minutes. I am sure your experience won’t differ too much from mine.

Even most of the holy texts in different religions contain lot of stories. Questions is, why is it so?

A Guide to Reading for Investors (Plus, What Prof. Sanjay Bakshi Reads)

Note: This article formed part of the April 2015 Special Report that I recently sent to subscribers of my premium newsletter Value Investing Almanack. If you wish to read similar premium posts in the future, I invite you subscribe to the Almanack. Click here to subscribe.

“I do not take a single newspaper, nor read one a month, and I feel myself infinitely happier for it. The man who reads nothing at all is better informed than the man who reads nothing but newspapers.” ~ Thomas Jefferson

Long time readers of Safal Niveshak blog and attendees to my investing workshops know my dislike for reading newspapers. The dislike is so deep that I’ve not had a newspaper subscription at my home for the past six years now, and neither do I consume news via electronic media. This also holds true of business television which I watch very occasionally and only when I want to get a hearty laugh and there’s nothing else that’s as funny on television at that time.

Now, one big reason I do not read newspapers is because I have a big problem with the fact that they decide for us what we should pay attention to and what we should ignore. It isn’t just the text of a news story that can mislead us; it’s also the choice of which stories get covered at all, and where they’re placed in the paper.

Life 2.0: Staying Active

I acknowledge how clichéd the title sounds. I mean who doesn’t know that being active is a good thing? But when I heard the following five words, it got my attention immediately – “Sitting is the new smoking.”

Whosoever came up with this line, understood the power of inversion.

In last seven years, I have tried four different gyms, two swimming pool memberships and started preparing for numerous marathons. Every time the initial motivation lasted only for few weeks and then life (career, family, friends, IPL) got in the way.

I am sure many of you have had the same experience. You make a plan and commit yourself to it but soon life’s randomness and uncertainties throw you off. The randomness of life, its uncertainties – I call it “the chaos monkey”.

The gym operators understand this and you would be surprised to know that they plan their capacity taking this into account. So if the gym can accommodate 50 people at a time, they would actually sign up 100 people because they know that 50% of them will just give up after some time.

I soon realized that the solution wasn’t to reduce or control the randomness of life but to come up with a system which works in spite of the uncertainty of our environment and to certain extent thrives on that uncertainty – a true anti-fragile approach. If you aren’t familiar with the concept of anti-fragility, I would strongly recommend Nassim Taleb’s book Antifragile.
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Latticework of Mental Models: Occam’s Razor

This article is the second of this new weekly series called Latticework of Mental Models, which will be authored by my friend and partner in writing the Value Investing Almanack, Anshul Khare. Anshul will write on various mental models – big ideas from various disciplines – which can help you think more rationally while analyzing businesses and making your stock investment decisions.

Have you ever wondered why Mark Zuckerberg (founder of Facebook) always wears the same grey t-shirt? Do you remember Steve Jobs’ black turtleneck that he wore for all his stage appearances?

These billionaires could afford anything in the world. Then what’s going on here? I’ll give you a moment to think about it and come back to it later in this post.

Last week, we delved into the characteristics of complex systems and discussed few ideas to protect ourselves from unintended consequences produced by complex adaptive systems.

However, just because we have discovered a tool to address a problem doesn’t mean that we should go on using it for every problem. Charlie Munger nailed it when he said –

To a man with hammer everything looks like a nail.

We don’t want to be that ‘man with hammer’. So what am I suggesting here?

Perhaps you have heard it numerous times before but let me just make you read it once more – “An ounce of prevention is better than a pound of cure.”

How about dealing with a situation just by avoiding it?

Dear Jealousy

Dear Jealousy,

I ask for an apology in advance because you may not like what you will read in this letter below.

You see, we have lived together in peace for years now. But, off late, I have started feeling dizzy having you on my side. Please don’t feel bad because I will soon explain my reasons for what I’m feeling now with respect to our relationship.

I remember you as early as the age of five, when you clouded my mind as soon as I saw my richer cousins with remote-controlled cars, nicer clothes, and bigger houses.

You stayed with me even as I was passing through high school. Those years, you made me jealous of my friends who scored higher marks then me and thus got a greater appreciation from the girls in the class. Then, when I was in college, you held my hand tight as I saw other classmates who arrived in their own cars while I took rickety buses. When I saw them also having cell phones, I felt your hug even tighter.

There were also times I found myself jealous of people who had no conscience and were famous for that. You made me think that I should become just like them. Thank God I didn’t!

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