• Ryan Reeves

What Really Matters

Investing is a game of information processing. The investors who are able to see reality before others are the ones who will be rewarded. I think the key word here is “reality”. What does it mean to see reality? It might be helpful to invert this. Not seeing reality means deluding yourself. And how do we trick ourselves? In so many ways -- that’s why great investors are obsessed with neutralizing their biases as much as possible. Our biases block us from seeing reality and making good decisions.

For example, a classic thinking error is needing to wait for a stock to get back to your buy price before selling. Let’s say you buy a stock for $100 and it quickly goes down to $80 because the company reported a terrible quarter and a strong competitor reported a blow-out. What do you do? Well, if the reason to hold is because you’re down, you might not be seeing reality clearly. The reality of the stock market is that all of your decisions are two-way doors to use Bezos-esque language. Your decisions are easily reversible (the transaction costs are nil) and so you’re able to change your mind. The only thing that really matters is: are these dollars in the best position (considering all the information I’ve processed) for high future returns?

So rather than worrying about “getting back to breakeven” the more important question is: is this the best place for these dollars? If there is clearly a better idea with less risk and more upside, then waiting for the original stock to get back to your buy price is arbitrary. You’re being locked in by a past decision – a classic sunk cost.

Reality is about seeing the present very clearly and letting that inform the future. Oftentimes, if you’re really seeing the present, compared to others, it’ll look like you’re living in the future. The problem with trying to predict the future is that it’s very difficult to get the timing right. People have known that VR will be important for years and years but predicting when it will be successfully commercialized is much tougher. And there is an opportunity cost to being wrong on timing. If you’re buying a stock based solely on its future potential without any evidence that it’s moving in the right direction, I would call that a “story stock”. These can certainly be good investments but the opportunity risk can be high. The body of evidence is the present reality – the future is an output of the present inputs.

So what am I getting at with all this talk about sunk costs, story stocks and seeing reality? It’s about focusing on what really matters. If investing is a game of information processing, it’s a huge advantage to have a clear picture of reality because you’re less likely to be deluded. If you know that Tesla’s vertical integration allows it to have a huge advantage over legacy OEMs, you won’t be scared off by a short-seller’s hit piece. Knowledge of the present is power.

And now I’ll talk out of the other side of my mouth. I think it’s also important to picture future scenarios. A lack of imagination is a handicap for investors. That is very pie-in-the-sky language but what I’m getting at is the ability to assess a business’s optionality. One question that I’m trying to improve at asking is: if everything goes right, how big of a company could this be?

Essentially the future size of a company is the expected value of how big it could be. For you math junkies, you know that an expected value includes a weighted probability. And a company with a bigger competitive advantage will have a higher probability that everything goes right. That’s why, on a recent podcast, investor Cliff Sosin said that a good mental model for investment success is: (competitive advantage x total addressable market).

Companies that are going after huge market opportunities with gigantic moats have a high expected value. That’s not to say that they will surely be successful – that’s not how probabilities work. But the good investing is the practice of constantly trying to tip the odds in your favor – whether that be by deeper understanding, a new way of looking at things, better elimination of biases, etc.

So what really matters?

To sum it up, we have to be able to understand the present realities as clearly as possible while also devoting time to thinking about optionality of a business. In other words, we have to think like entrepreneurs. They can’t delude themselves. They have to satisfy current demand while investing time and resources into projects that will bear fruit far in the future.

Here’s to thinking like entrepreneurs…

 

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