I recently finished David Deutsch’s The Beginning of Infinity: Explanations that Transform the World (2011), which I thought was an excellent book. It’s not about finance or investing – Deutsch is a physicist – but I kept finding interesting parallels here and there.
For example, Deutsch writes about how we make progress in our knowledge of how the world works. He describes it as a quest for better explanations. For example, our knowledge of our solar system has improved from Ptolemy to Kepler to Newton. We have better explanations now.
But what makes that process of creating better explanations go? At the heart of it, Deutsch says, is a culture of criticism. We make bold conjectures about how things work and then they are subject to testing and criticism.
Why is that important? Because it allows us to remove bad explanations – basically to correct errors as we go along. If this sounds a bit like Karl Popper, it’s because Popper had a definite influence on Deutsch. He quotes Popper several times. And he includes Popper’s Conjectures and Refutations and The Open Society and Its Enemies in a short list of books “everybody should read.”
As a result of this constant revision, we should be humble about how we think about ideas. And we need to evaluate them in a way that takes into account this process of revision. Here is a passage from Deutsch’s book that I particularly liked:
“So there is no resource management strategy that prevents disasters, just as there is no political system that provides only good leaders and good policies, nor a scientific method that provides only true theories. But there are ideas that reliably cause disasters... The only rational policy, in all three cases, is to judge institutions, plans and ways of life according to how good they are at correcting mistakes: removing bad policies and leaders, superseding bad explanations, and recovering from disasters.”
Maybe we add that this is a rational way to judge investment philosophies? Basically, ask the question, how good is an investment philosophy at removing mistakes and recovering from disasters?
What makes this tough to apply to investing is that it’s not obvious, sometimes, if you’ve made a mistake – even after the position is long closed out. Just because you lost money on an investment doesn’t mean it was a mistake. Sometimes a pair of aces gets beat by an unlikely hand. It happens. But it doesn’t mean you shouldn’t have played your aces. And then there are mistakes of omission. These would be things you didn’t do. Maybe you spent a lot of time looking at Visa in 2010 and passed. Those mistakes never tally up in your track record, but could well be the most consequential mistakes.
For the sake of this discussion, let’s call a mistake anything that led to a realized loss. If so, how might we judge an investment philosophy in a Deutschian way?
Some things to think about: How big were the mistakes? Were they closed out quickly or did they linger for years? How did the investor come to recognize the mistake? How does the investor recognize mistakes generally?
This could also apply to companies. How good are they at fixing mistakes? How well is a company positioned to recover from mistakes? I wrote about Howard Hughes recently, which I think is a good example of fixing a mistake as they aim to cut G&A and sell assets. (Of course, one could also argue it took them too long to do so).
These ideas need to be fleshed out more, but I think it's an interesting angle to pursue.
*** Europium Crisis
Deutsch makes a similar point about people's ability to solve problems…
He tells a great story about europium. In the 1970s, this element was critical in making color television sets. Europium is one of the rarest elements on Earth. The known reserves could only support a few million more television sets… and then we’d all be watching black and white. Only the elites would have color. So the story went.
But that didn’t happen… why not?
Because, color screens today are made up of liquid crystals, consisting of very common elements. They do not require a cathode-ray tube, like old television sets. In short, they don’t need europium. And even if they did, it wouldn’t matter. As Deutsch writes, “now enough europium has been mined to supply every human being on earth with a dozen europium-type screens, and the known reserves of the element comprise several times that amount.”
This is why I can never get excited about a resource depletion story. I don’t care if it’s oil, uranium, rare earths, or whatever… It’s always the same story – and there are many, many such stories in financial history. As Deutsch says, such debates really come down to a “contrast between two different conceptions of what people are.” In the pessimistic one, people are merely consumers, blindly eating away at limited resources. In the optimistic one, they are problem-solvers… who can create alternatives and new supply.
As Deutsch writes “by casting problems in terms of resource depletion and ignoring the human level of explanations” we miss all the important determinants of what we’re trying to predict, namely: “[Do] the relevant people and institutions have what it takes to solve problems?”
Anyway, I really enjoyed Deutsch’s book, which ranges over many topics and has far greater depth than I can show here. It makes you think. And I like the underlying humility in the approach he advocates for – one built on continued testing and revision of ideas.
Lastly, a great quote from Karl Popper in Deutsch’s book: “I believe that it would be worth trying to learn something about the world even if in trying to do so we should merely learn that we do not know much… It might well be for all of us to remember that, while differing widely in various little bits we know, in our infinite ignorance we are all equal.”
*** Owner-operators are Problem Solvers
I think this is one reason I like investing with owner-operators. They are problem solvers… with a great incentive to solve problems. They have skin in the game. Whether it’s Vincent Bolloré at Vivendi or Charlie Ergen at EchoStar or Prem Watsa at Fairfax Financial or John Elkann at Exor… they are all talented people who have shown an ability to solve problems. (Note Woodlock House owns the shares of all these companies mentioned).
As a passive, outside minority investor, I can’t be there everyday watching the store. I have to trust the management team to do that. This reminds me of one of my now favorite Warren Buffett quips, which he gave only recently:
Andy Serwer: Let’s talk a little bit about Apple. You have a $45 billion dollar stake, more or less. How closely do you follow the company?
Warren Buffett: Well if you have to closely follow a company you shouldn’t own it!
That’s funny… and wise. Investing demands patience. And the ability to net a big multi-bagger probably hinges on your ability to hold on to a stock for many years. That is hard, but it’s harder if you are watching the company too closely.
My friend Ian Cassel put it poetically when he wrote about the dangers of thinking about your positions too much. He advised: “Give them some room to breathe. Some room to disappoint you but still hold on. Some room to exceed your expectations but not sell."
Thank you for reading. I had thought I might post some thoughts on earnings on a few of my holdings, but I feel like I don’t have anything interesting to say – maybe because nothing really interesting happened. Which is fine by me. Onward and – hopefully – upward!
***
Published November 20, 2019
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