target="_blank" rel="nofollow" href="#ued256ab4-a765-5b66-9065-1eadc74c539a">Chapter 8 of Graham’s book talks about not letting the mood swings of Mr. Market coax us into speculating, selling in panic, or trying to time the market.
Chapter 20 explains that, after careful analysis of a company’s ongoing business and its prospects for future earnings, we should consider buying only if its current price implies a large margin of safety.
In chapter 12 of The General Theory of Employment, Interest, and Money (“The State of Long-Term Expectation”), Keynes remarks that most professional investors and speculators were “largely concerned, not with making superior long-term forecasts of the probable yield of an investment over its whole life, but with foreseeing changes in the conventional basis of valuation a short time ahead of the general public.”3
Buffett took the simple but fundamental truths of investing from these three chapters quite seriously and applied them throughout his life, with a high degree of intensity, and it has made him one of the wealthiest individuals in the world.
Take a simple idea and take it seriously.
—Charlie Munger
The simple ideas with intensity of pursuit is what gets you to the promised land.
—Mohnish Pabrai
Buffett’s key takeaway from The Intelligent Investor was this: If you eliminate the downside, then all that remains is the upside. After that, the key is to keep emotions in check and be patient. It really is that simple.
It’s simple but not easy.
In the world of securities, courage becomes the supreme virtue after adequate knowledge and a tested judgment are at hand.
—Benjamin Graham
Many newcomers in the investing field consider The Intelligent Investor to be too dry and not “exciting” enough. It does not reveal any secrets to finding the next big multi-bagger, and it does not offer any shortcuts for making money quickly. But, as I have realized through my multiple readings of this book, it does build the character and steely resolve required to become a good investor. And character building, as compared with wealth building, is a much more difficult subject to read about and practice. (For the former, refer to Rudyard Kipling’s poem “If” in appendix B.)
Mohnish Pabrai’s book The Dhandho Investor is one of the more accessible books written on value investing. Just like Buffett, Pabrai has a gift for simplifying complex sounding ideas. In his book, he writes:
Every business has an intrinsic value, and it is determined by the same simple formula. John Burr Williams was the first to define it in his The Theory of Investment Value published in 1938. Per Williams, the intrinsic value of any business is determined by the cash inflows and outflows—discounted at an appropriate interest rate—that can be expected to occur during the remaining life of the business. The definition is painfully simple….
Simplicity is a very powerful construct. Henry Thoreau recognized this when he said, “Our life is frittered away by detail…simplify, simplify.” Einstein also recognized the power of simplicity, and it was the key to his breakthroughs in physics. He noted that the five ascending levels of intellect were, “Smart, Intelligent, Brilliant, Genius, Simple.” For Einstein, simplicity was simply the highest level of intellect. Everything about Warren Buffett’s investment style is simple. It is the thinkers like Einstein and Buffett, who fixate on simplicity, who triumph. The genius behind E = mc2 is its simplicity and elegance.4
The Simplest Solution Often Tends to Be the Best
The grand aim of all science is to cover the greatest number of empirical facts by logical deduction from the smallest number of hypotheses or axioms.
—Albert Einstein
Occam’s razor, named after fourteenth-century English logician William of Ockham, is a principle of parsimony, economy, or succinctness used in logic and problem solving. It states that among competing hypotheses, the hypothesis with the fewest assumptions should be selected. Other, more complicated solutions ultimately may prove to provide better predictions, but in the absence of differences in predictive ability, the fewer assumptions that are made, the better.
Investors should remember that their scorecard is not computed using Olympic-diving methods: Degree-of-difficulty doesn’t count [emphasis added]. If you are right about a business whose value is largely dependent on a single key factor that is both easy to understand and enduring, the payoff is the same as if you had correctly analyzed an investment alternative characterized by many constantly shifting and complex variables.
—Warren Buffett
The way Buffett deals with difficult problems is to avoid them altogether. Unlike the figure skaters at the Olympics, we don’t get extra points for higher degrees of difficulty in investing. Originality and complexity are not necessary or sufficient conditions for generating superior long-term returns. As investors, our job is simply to compound capital over time at the highest possible rate with the minimum amount of risk. We achieve this objective by seeking out undervalued stocks of companies within our circle of competence. Be completely indifferent to whether the market cap is large or small or to whether the company is relatively unknown or widely followed.
Investing is not about being original or creative; it is about looking for the greatest amount of value (for the price paid) with the least amount of risk. Putting in more time and effort does not guarantee better results in investing. Rather, it is more beneficial to do less and make fewer but better choices.
The more decisions you make, the less willpower you have. It’s called decision fatigue. Focus on making fewer and better decisions. This allows you sufficient time to think about each decision deeply and reduces the chances of making a mistake. We should restrict ourselves only to those cases in which the investment decision looks like a no-brainer. As Charlie Munger says, “The goal of investment is to find situations where it is safe not to diversify.”5
Look for simple businesses that require fewer assumptions and fewer hypothetical scenarios to work out and that do not require discounting cash flows from way out into the future to justify the investment. As Thomas Carlyle aptly put it, “Our main business is not to see what lies dimly at a distance, but to do what lies clearly at hand.” In his 2004 letter, Buffett highlighted the importance of sticking to simple propositions:
If only one variable is key to a decision, and the variable has a 90 percent chance of going your way, the chance for a successful outcome is obviously 90 percent. But if ten independent variables need to break favorably for a successful result, and each has a 90 percent probability of success, the likelihood of having a winner is only 35 percent…. Since a chain is no stronger than its weakest link, it makes sense to look for—if you’ll excuse an oxymoron—mono-linked chains.6
It is important to identify and focus on the few key variables that really matter to an investment decision. This vastly simplifies the process and improves the probability of a successful outcome. The Occam’s razor mental model is useful because it enables us to separate the long-term signal from the short-term noise and to calmly think through any investing decision. Yes, reading the annual reports, filings, press releases, and footnotes to the accounts is important, and occasionally, we will be able to dig out some extra detail that might give us an analytical advantage, but, in my view, understanding the big picture (the two
