Gamblers’ Fallacy

Today morning I was reading how this fallacy affects the human mind and that it has taken with it many a great stalwarts. I drew some analogies with Stock market trading but more about that later.

On 18th August, 1913 stunned crowds around a roulette in Monte Carlo found a ball landing on the black twenty six times in a row and only on the twenty seventh it landed on the red. By that time many who kept increasing stakes looking for a long overdue red occurrence had lost millions and were already paupers. 

This notion feeds on a human perception that there is a “ balancing nature “ somewhere, that if something has been happening more frequently in the past, it will happen less frequently in the future. 

Though highly appealing to the human mind, it is false, especially for random, Independent events.

Lets take another example, if one has flipped a fair coin 21 times the probability of 21 heads is 1 in 2,097,152 but if we interpret it rationally, the probability of the next head (or even tail) is simply ½, yes 1/2 only !

Not only people look for a variance, at times a gambler can even take a reverse stand. He may decide that given this consistent tendency towards heads, a head is a more likely an event. He then see’s some mystical correlation and continues betting on heads. 

Both of these notions are based on a fallacy that Universe somehow carries a memory of the past results, which tend to favour or disfavor the future outcomes. 

Please be sure that the coin or the ball, do not remember that it fell on a black all this while or it flipped head each time and you choosing a Head or a Tail, Black or a Red depends on your personal choice, whether you prefer the first option or the second.

Now lets imagine if you were forced to bet say a 20% of your net worth on the next event, what would you do – Heads or tail , Black or red ? think hard where you stand ?

Now lets stretch it a bit more - Joe and Sam are at the race track betting on horses.

Joe: "You see that horse over there? He lost his last four races. I'm going to bet on him." 

Sam: "Why? I think he will probably lose." 

Joe: "No way, 

Sam. I looked up the horse's stats and he has won half his races in the past two years. Since he has lost three of his last four races, he'll have to win this race. So I'm betting the farm on him." 

Sam: "Are you sure?" 

Joe: "Of course I'm sure. That pony is due, man...he's due!"

Now lets replace the Race track with Stock market , Horse with say share X and lo ….we get stock market trading !!

You would see people spending hours trying to demystify the trends of individual shares, markets etc. based on what they did yesterday, first hour, after lunch or the last hour, before & after Christmas holidays , how much was bought, what was the price rise and what not. They have raised it to the level of a science, but you can draw your own conclusions based on the foregoing.

When we talk about companies, we talk about their businesses, factories, managements, people, finances, product portfolios , future pipelines, and many other such things, these are all interdependent events.

Only the rigor of detailed analyses & in depth understanding can help reduce the odds and increase predictability. 

Thus long term investing is the way forward.

Don’t confuse genius with Bull market

Come a bull market and everything rises. One look at the portfolio gives us a feel of elation, followed by a few satisfied grunts, some pats on our own back, that in addition to our heavy work routines we have successfully used our latent genius to make a significant impact on our wealth. 

This high carries on into the office tea conversations, as also into late evening parties. Everyone is cheerful and all endings are happy.

Not to be left behind even the ladies at kitty parties are in full swing. After sharing a few success stories even start vending advise. 

The next buys slowly come in via these routes. 

Somewhere the wheel turns, blame it on an ill timed political move, some tightening here or there, a president falling sick or some strike in a far off land, whatever, but then the selling starts, in bits which later graduates into a torrent. 

The Kitty party buys you intended to hold only thus long slowly turn into real long term investments.

That’s when the popular Warren Buffett quote comes to mind " Only when the tide goes out do you discover who's been swimming naked".

Thus , whenever doing an honest assessment of one’s potential especially in the investing field or even in your respective businesses, always discount the wind behind your sails. 

To have repeated success we should bring greater objectivity to the table. It will ensure we smoothen the flukes and put the right amount of focus on our strengths as also on the areas of potential improvements.

This rigor of structured analyses leads to wealth not a temporary rise which will soon settle or change course.

Profound wisdom favoring Long Term Equity Investing !

All those who invest in the stock market should remember & understand these lines -

In the 20th century, the United States endured 

- two world wars and 

- other traumatic and expensive military conflicts; 

- the Depression; 

- a dozen or so recessions and financial panics; 

- oil shocks; 

- a flu epidemic; 

- and the resignation of a disgraced president. 

Yet the Dow rose from 66 to 11,497.

Warren Buffett 

and is 15,300 as i write this post ....

If anyone comes around and gives you another Doomsday forecast ...plenty ...just tell them to take a hike .....

Of course the story is being STOCK SELECTIVE instead of a general rise which we experienced earlier due to structural adjustments ..so you need to work hard for that ..but nothing comes easy ....not as easy as the pink papers want it to sound !

there still will be phases of a general rise ...of course but for superior returns you will have to work harder !

cheers !

Warren Buffett Hopes shares of his investment IBM Languish And Underperform For The Next 5 Years

Strange are the ways of Warren Buffett.....hoping for an underperformance that too for 5 years ...

Indians would say satheya gaya ...NOT REALLY !

This past year, Warren Buffett made a rare foray into tech investing, with a substantial purchase of IBM shares.

He explains .....

This discussion of repurchases offers me the chance to address the irrational reaction of many investors to changes in stock prices.

When Berkshire buys stock in a company that is repurchasing shares, we hope for two events: First, we have the normal hope that earnings of the business will increase at a good clip for a long time to come;

and second, we also hope that the stock underperforms in the market for a long time as well.

Let’s use IBM as an example. As all business observers know, CEOs Lou Gerstner and Sam Palmisano did a superb job in moving IBM from near-bankruptcy twenty years ago to its prominence today.

Their operational accomplishments were truly extraordinary. But their financial management was equally brilliant, particularly in recent years as the company’s financial flexibility improved. Indeed, I can think of no major company that has had better financial management, a skill that has materially increased the gains enjoyed by IBM shareholders. The company has used debt wisely, made value-adding acquisitions almost exclusively for cash and aggressively repurchased its own stock.

Today, IBM has 1.16 billion shares outstanding, of which we own about 63.9 million or 5.5%. Naturally, what happens to the company’s earnings over the next five years is of enormous importance to us.

Beyond that, the company will likely spend $50 billion or so in those years to repurchase shares.

Our quiz for the day: What should a long-term shareholder, such as Berkshire, cheer for during that period?

I won’t keep you in suspense. We should wish for IBM’s stock price to languish throughout the five years.

Let’s do the math. If IBM’s stock price averages, say, $200 during the period, the company will acquire 250 million shares for its $50 billion. There would consequently be 910 million shares outstanding, and we would own about 7% of the company. If the stock conversely sells for an average of $300 during the five-year period, IBM will acquire only 167 million shares. That would leave about 990 million shares outstanding after five years, of which we would own 6.5%.

If IBM were to earn, say, $20 billion in the fifth year, our share of those earnings would be a full $100 million greater under the “disappointing” scenario of a lower stock price than they would have been at the higher price. At some later point our shares would be worth perhaps $1 1⁄ 2 billion more than if the “high-price” repurchase scenario had taken place

The logic is simple: If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise.

You benefit when stocks swoon. Emotions, however, too often complicate the matter: Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day’s supply.

Charlie and I don’t expect to win many of you over to our way of thinking – we’ve observed enough human behavior to know the futility of that – but we do want you to be aware of our personal calculus.

And here a confession is in order: In my early days I, too, rejoiced when the market rose. In the end, the success of our IBM investment will be determined primarily by its future earnings.

But an important secondary factor will be how many shares the company purchases with the substantial sums it is likely to devote to this activity. And if repurchases ever reduce the IBM shares outstanding to 63.9 million, I will abandon my famed frugality and give Berkshire employees a paid holiday.

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ps : this post isnt original, rightly so, as i am using what Warren said to highlight a long term strategy but incisive & highly educative , so reproduced for its educative value !