Saturday Serendipity
Quote, Mental Model, Interesting find,
Hello,
Reading time: About 5 minutes
Quote
“Most people are not cut out for value investing, because human nature shrinks from pain.” —Jean-Marie Eveillard
Mental Model
Feedback loops
Feedback loops are basically the feedback you get in systems from the input you give. These feedbacks can be negative or positive. For instance take the example of you not sleeping early (don’t worry i do the same thing). Sleeping late causes you to wake up late or it reduces the amount of hours you sleep. This in turn reduces the amount of productivity you have, induces stress, gives you a headache, makes you feel weak, etc. This makes you sleep in the day to cope with the stress and all the other problems. Now in the night you will again fall asleep late.
This feedback loop that was created was negative.
What happens is that this feedback loop is an endless cycle unless it is broken. We need to find a way to turn this negative feedback loop into a positive one.
How do you get high temperature?
In his book The Education of a Speculator ,Victor Niederhoffer says:
One of the common features that all life possesses is a mechanism for maintaining orderly conditions. This tendency is called homeostasis. In system theory, it is called negative feedback … A Common homeostatic behavior in humans is temperature regulation. If the temperature rises above the 98.6 F optimum for normal human activity, sensors on the skin detect it and signal the brain that a rise has occurred. The brain relays the information to the effectors that increase blood flow to the skin. This induces perspiration. The loss in heat, caused by evaporation, lowers the body temperature. When the body cools below a certain point, a comparable mechanism is set off, this time reducing blood flow and causing shivering. This activity generates heat through physical activity thus raising the body temperature.
In Sports
Feedback loops are very important in sports. The only way to know if one is improving or not is when they perform an action, get feedback, alter it and improve. It is as simple as that. If at any point as a sportsperson you feel like everything that you are doing is perfect you need better feedback. Everyone is always making some or the other mistake and can improve in some way. I don’t care whether it is Ronaldo, Messi, Kohli or whoever.
These athletes who are great are great because they constantly get feedback loops on their health, fitness, performances, skill, technique and they keep altering/changing their game based on that.
This is a positive feedback loop.
It can go sideways as well if a player does not alter his actions even when there is evidence that what he is doing is wrong. This is just arrogance. This ruins your game and your mentality.
In Investing
Everyone says holding on to cash is a bad idea. For most companies this is true. Not for the ones which invest a lot of cash into other businesses. Warren Buffett hold the cash for a long period that is generated from his businesses that he owns gives. Then when times are bad he picks up a lot of businesses which are undervalued and then again uses those earnings to buy more companies. This is a feedback loop which has been happening for some time now.
Prof Sanjay Bakshi wrote a mail to his students in MDI explaining feedback loops in markets,
In my view, its not correct to always view positive feedback loops in business as destructive, though they well might be. For example a run on a bank can bring it down on its knees in a very short time period and it can spread (systemic risk) to other banks. Similarly stock market bubbles can be thought of positive feedback loops – high prices feed optimism which feeds high prices – it does not last for ever, but it can last for a long long time.
I think you’re on the right track when you visualize a positive feedback loop as a mechanism which is nested inside a negative feedback loop. To illustrate, why do bear markets follow bull markets? Because over the long run, markets operate inside a negative feedback loop with built-in corrective mechanisms. When prices run too far away from underlying values, there are forces that pull them back. For example, when stocks become too cheap in relation to the replacement cost of the underlying assets, there is no incentive to create new capacity and industry consolidation is likely to take place wherein the strong players in an industry, instead of creating new capacity, buy out competitors.
Conversely, when stock prices rise so high that they become much more than the replacement cost of the underlying assets, strong incentives are created by those high prices, to create fresh capacity. So shortages follow gluts follow shortages…. – hence a negative feedback loop.
But what caused the speculative bubble in the first place? Why do people suddenly become euphoric about an industry or a sector and invest in it in unison? That part of the answer is better explained by positive feedback loops.
Its also important to view positive feedback loops as means of explaining some of the extreme business successes. I gave two examples in class of the dominant newspaper, and Wal-Mart. But one can think of others. For example, in some industries, the first mover has a big advantage. He goes and captures a very large part of the market and obtains scale economics. And once he’s done that, it becomes very difficult to dislodge him.
If you want to read more about feedback loops read this and this.
Interesting find
PPFAS on investing with conviction.
That’s it for this week!
Enjoy your weekend!