Investing Axioms

Deductive reasoning and messy social world aren’t a good fit. Without the underpinning of universal natural law, an axiomatic approach seems impossible. Void ab initio. Plodding empiricism is all I can realistically aspire to.

However, there’s an irresistible charm to deductive reasoning. Postulating self-evident truths and layering logic to create a Euclidean superstructure feels so elegant. Even if it doesn’t hold up to empirical scrutiny, it’s good for ego and tenure. I’m not immune to such silliness. After all, my essays rest on two axioms: humans are buggy, world is messy. Why not go further down this path?

Here are a few investing axioms, which I hold as self-evident and generally if not universally valid:

People don’t change

Harsh, but true. The promoter who gypped shareholders in 90s still does so in 2020, notwithstanding intervening promises to the contrary. The classmate most prone to RG-giri in college still isn’t trustworthy. A mythical beast that can’t make money in its second decade will never get there. This axiom is useful in a positive sense too. Fundamentally decent promoters who’ve done way more good than bad in their life can be trusted to do right thing, even if there’s an occasional lapse in judgment.

Corollary: collective variant of this axiom is ‘institutional inertia rules’.

Never one cockroach

Cockroach refers to breach of trust, not error of judgment. If inventory or receivables look iffy, reported financials are wholly made-up. If company won large, dubious local government tender that peers didn’t even participate in, every line item has two books of accounts. No company screws over minority shareholders exactly once. If one group company has a dodgy past, entire conglomerate has a dodgy present. This one’s my most useful axiom, both a time-saver and a life-saver. One cockroach and I’m done. Forever, as people don’t change! 

Investing requires income

Essence of investing is to evaluate a stream of future cash and gauge what I’ll pay for it today. If there’s no cash, it’s not investing. Uncertainty around stream of cash is fine, but it can’t all come from a greater fool at the very end. If you’re an afficionado of buying shiny relics or counterfeit currency for monetary gain, you’re not investing. My disagreement with you isn’t semantic.  

Corollary: stocks are businesses.

Reductionism is impossible

Whenever I’ve applied Toyota’s famous ‘Five Whys’ analysis to the social world, I end up at ‘buggy humans, bah’, with a why or two to spare. Beyond a point, I don’t really know why any of my businesses make the kind of money they do, let alone why they should continue to do so. That’s why I find questions like ‘which businesses will be greatest beneficiaries of new normal’ to be unanswerable. I can neither isolate constituent parts of my messy social world, nor causal relations between one part and another. Plausible explanations can be far from correct. Seeking causality in a world that’s mostly unknowable ends in analysis-paralysis, made-up stories and poor judgment.

Corollary: forecasting is futile.

Patterns guide odds

Not being able to unravel causality doesn’t imply a random world and a helpless me. It only implies that I have to be highly selective, careful and humble in my attempt to make sense of it. History suggests that certain patterns of behaviour go hand-in-hand with certain outcomes, especially at extremes. Take my business, as an illustration. Higher odds of investing success correlates with a few recurring patterns, in terms of businesses, risks, institutional setup, fees, valuations, temperament or timeframe. I’d be well advised to stay on the right side of such patterns than on the Russian-roulette side.

Mean reversion rules

Patterns are a reliable guide to odds only if we’re careful to study all of it, not merely a convenient subset of it. Shit averages out. Good and bad. Lucky and unlucky. Upcycle and downcycle. Cheap and expensive. Not merely in a passive, statistical sense. Inbuilt feedback loops actively create a self-limiting effect over time. Covid can’t kill all of us without killing itself. Supply response kills commodity booms. Excesses in lending bubbles get found out, stemming confidence and capital. Managerial aggression eventually blows up, leading to changes in aggression or managers or both. This is why market’s a weighing machine over the long run. This axiom’s key to investing longevity, as it fosters caution over complacency through phases when real danger is maximum and perceived danger is minimum.

Corollary: this too shall pass.

I’m the gating factor

Professor N Ravichandran, in his strategy courses, taught that the question that matters is never how lucrative an opportunity is, but why a particular company is better qualified than others to take advantage of that opportunity. It’s the same in investing. Opportunities are inexhaustible because human bugginess is. The fly in the ointment is my own bugginess. I have to constantly ask myself where and how I am less buggy than others. Except for a narrow domain where I’ve applied concentrated effort for over a decade, I shouldn’t even try. Sure, there’s money to be made buying tech options or investing in exotic lands, but not by me.

Internal consistency is the goal

The flaw in my deductive reasoning trip lies in the destination. Deduction ends in QED. I can’t claim anything close to proof in a social world where nearly everything is unknowable and the little that’s left is fuzzy. How do I know if I’m done? If everything just fits – patterns, people, behaviour, business, industry, financials, valuation, situation at hand vs frame of reference in my head – without any anomalies or loose ends, my construct is as robust as it can get. Further effort will not meaningfully improve my decision. If you show me a business I’ve never encountered, I’ll keep cranking at the problem until my understanding feels internally consistent. Not reaching there in a reasonable timeframe suggests that I am better off avoiding the situation. More generally, internal consistency is the true test of any investing process. It shouldn’t merely deliver outcomes consistent with it’s objectives, but feel consistent across its different tenets, over time and across situations. To survive decades without dissonance, it should gel with who I am and how I think. In a messy world, the goal is coherence, not proof.

Corollary: dissonance spells doom.

I believe, but cannot prove, that I can deduce a sensible, effective, coherent investment approach starting from the above axioms. Euclidian investing, anyone?

[This essay is part of the series "Buggy Humans in a Messy World". Views are personal. Ideas are at best unoriginal and at worst plagiarized. For anything sensible, credit goes to people around me. For any nonsense, blame is solely mine.]