[The Weekend Bulletin] #158: Capacity to Suffer, Looking Crazy to Being Crazy, Diversification vs Di-worse-ification,...

...Valuing Banks, Incentives, 30 Inspiring Passages, and more.

A digest of some interesting reading material from around the world-wide-web. Your weekly dose of multi-disciplinary reading.

Investing Wisdom

• This old article resurfaced on the back of a recent discussion. In it, the author explains the idea of 'capacity to suffer', a concept popularised by famed investor Thomas Russo. This is an important characteristic that both, the investor and the investee, need to demonstrate for long term success. The author also provides a few ways in which companies demonstrate this capacity to suffer.

• Traditional finance theory, supported by empirical evidence, has us believe that reasonable diversification can be achieved with a 20-stock portfolio. While this is true in one sense, it isn't in another. A 20-stock portfolio does indeed reduce a majority of the volatility of the portfolio compared to a single stock portfolio, although it does not provide a complete diversification like a broad index when looked through the lens of a few other measures. This write-up explains.

• Saumil Zaveri's (DMZ Partners) letters have always made for an interesting read. We've look at a few in the past. The current one, 15th in the series, and unfortunately the last public one, makes for an equally interesting read. The following are some of the topic covered in this letter:

  • Spectrum of Looking Crazy to Being Crazy

  • Similarity between banking and investing

  • DMZ’s philosophy

  • Being patient vs being wrong

  • Being early vs being wrong

  • Valuation vs business risk

  • 'Monitoring the situation closely'

• In the wake of the recent troubles at some of the banks in the US, Prof. Aswath Damodaran writes a primer on valuing banks, covering topics like why FCFE is not the right metric to look at banks, how he was wrong to advocate the dividend discount models for banks post 2008, what he currently thinks is the right framework to value banks, and why valuations of banks, in general, have come off (and rightly so).

Mental Models & Behavioral Biases

• This article looks at Incentives from the perspective of the different types of tasks we undertakes, and argues that some incentives may do more harm than good.

Personal Development

• This is a neat collection of 30 passages from various books and articles that will -among many other things - inspire you to lead a well-rounded life, face adversity, channel emotions, and look within.

Blast From The Past

Revisiting articles from a past issue for the benefits of refreshing memory and spaced repetition, as well as for a fresh perspective. Below are articles from #83:

• Of all the decisions an investor makes, the one that requires the most courage is an implicit decision - to do nothing. The benefits of holding on to a good business are widely known, however, very little is spoken about the conviction to remain invested. This dated article provides some fodder.

  

• In case you are wondering why holding requires the most courage, this thread by Prof. Bakshi has the answers (summarised in the pic below):

  

  Source

• Drawing analogy from the behaviour of animals, this mental model provides an interesting framework to analyse people, especially leaders, and decision making. Called the 'Hedgehog and Fox', this model provides us with the two extremes of a scale along which we most leaders lie. The fox here is a metaphor for someone who has many strategies (multi-faceted), while the hedgehog represents someone who holds a single world-view (focused). Take a pause here, and think about the leader of a business that you want to invest in - would you prefer that he is a fox or a hedgehog? Think why you make a choice over the other. Now read the following three articles to find the answer:

  • Evaluating business leaders (alternate link)

  • Evaluating business leaders and for personal reflection

  • Better decision making

Readworthy Passage

Let's read together a random, but read-worthy, passage from a randomly picked book.

In the 1970s, the philosophers Samuel Gorovitz and Alasdair MacIntyre published a short essay on the nature of human fallibility that I read during my surgical training and haven’t stopped pondering since. The question they sought to answer was why we fail at what we set out to do in the world. One reason, they observed, is “necessary fallibility”—some things we want to do are simply beyond our capacity. We are not omniscient or all-powerful. Even enhanced by technology, our physical and mental powers are limited. Much of the world and universe is—and will remain—outside our understanding and control.

There are substantial realms, however, in which control is within our reach. We can build skyscrapers, predict snowstorms, save people from heart attacks and stab wounds. In such realms, Gorovitz and MacIntyre point out, we have just two reasons that we may nonetheless fail.

The first is ignorance—we may err because science has given us only a partial understanding of the world and how it works. There are skyscrapers we do not yet know how to build, snowstorms we cannot predict, heart attacks we still haven’t learned how to stop. The second type of failure the philosophers call ineptitude—because in these instances the knowledge exists, yet we fail to apply it correctly. This is the skyscraper that is built wrong and collapses, the snowstorm whose signs the meteorologist just plain missed, the stab wound from a weapon the doctors forgot to ask about.

...

Here, then, is our situation at the start of the twenty-first century: We have accumulated stupendous know-how. We have put it in the hands of some of the most highly trained, highly skilled, and hardworking people in our society. And, with it, they have indeed accomplished extraordinary things. Nonetheless, that know-how is often unmanageable. Avoidable failures are common and persistent, not to mention demoralizing and frustrating, across many fields—from medicine to finance, business to government. And the reason is increasingly evident: the volume and complexity of what we know has exceeded our individual ability to deliver its benefits correctly, safely, or reliably. Knowledge has both saved us and burdened us.

That means we need a different strategy for overcoming failure, one that builds on experience and takes advantage of the knowledge people have but somehow also makes up for our inevitable human inadequacies. And there is such a strategy—though it will seem almost ridiculous in its simplicity, maybe even crazy to those of us who have spent years carefully developing ever more advanced skills and technologies.

It is a checklist.

- From The Checklist Manifesto by Atul Gawande.

Quotable Quotes

"Courage is knowing it might hurt, and doing it anyway.

Stupidity is the same.

And that's why life is hard."

- Jeremy Goldberg

"Competition can be an effective motivator, but don't let it choose the problem for you. Don't let yourself get drawn into chasing something merely because there's a lot of competition for it."

- Paul Graham

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That's it for this weekend folks.

Have a wonderful week ahead!!

- Tejas Gutka

[May 13, 2023]