Weekly Summary
Quote, Mental Model, Twitter thread, Investing explainer.
Quote
“People focus on role models; it is more effective to find antimodels – people you don’t want to resemble when you grow up” ~ Nassim Taleb
Mental Model
Hanlon’s razor: How many times have you blamed someone else for something going against you? When I play cricket and get out, I often blame the umpire for making a wrong decision. When we see football many football teams blame the referee for a wrong decision. If a stock goes head falling it is some external factor’s fault or the promoter’s fault. You blame others even though you know that it is probably not their fault and the problem is pretty straightforward. I’ll quote Napolean here:
“Never ascribe to malice that which is adequately explained by incompetence.”
We like to attribute our failures to someone else, which is a cheap psychological protective mechanism called projection. So we need to remember that before blaming anyone and jumping to conclusions, we should look at the simplest or rather most straightforward answer to the problem. Also, Charlie Munger is a huge advocate of not drowning yourself in self-pity. It is one of the worst emotions. He says it leads us to have a negative mindset. And, we don’t end up taking accountability. This is similar to what Hanlon’s razor teaches us. So to put it in one line: Most of the time nobody is out to get you so don’t assume they are. This is closely linked to Occam’s razor.
Twitter Thread
Investing Explainer
Today we will look at a few ratios and explain them in simple terms.
P/E ratio: The Price to Earning ratio simply is the price the share is offered at divided by its EPS ( Earnings per share). The P/E ratio alone can tell us if the business is overpriced at times for eg. if it is 80-200 P/E you know it is overpriced. But at the same time, a 40 P/E stock can also make you a lot of money if the business is great and has grown. All in all, this is only valuable if the P/E is too high. If it is too high don’t waste your time you can move on to the next business. We are trying to buy a business at a good value so if the asking price is really high you walk away immediately. Note that the P/E alone cannot be looked at as good investment criteria because many times low P/E stocks also underperform as the business underlying is bad. I am going to quote Munger here, “We are trying to buy a wonderful business at a fair price not a bad business at a wonderful price.”
ROCE (Return on capital employed): If I am starting a clothing business Clothing connect and I decide to open up a shop which costs me 10 lakh rupees(including everything). If in a year that shop gives me earnings of 5 lakh rupees. That is a 50% ROCE. Now my competitor FashionHub opened up its store for the same cost. But because it did not provide great customer value his shop only earned 1 lakh rupees. That is a 10% ROCE. Now, which business would you invest in? You’re going to choose Clothing connect because it has a better return. Now the formula for ROCE is EBIT (Earnings before Interest and tax)/ Capital Employed which is Total Assets minus Total current liabilities. Now here in both businesses the Capital employed is the same which is 10 lakh ( the shop being the asset and the liabilities being 0) and the EBIT is simply how much the shop earned. This ratio is useful however bear in mind that you should compare the ROCE of only the companies in the same industry.If you want to read more you can read here.
That’s it for this week. Hope you have a wonderful 2023!!