Not everything that counts can be counted

The individual investor

The hard-to-measure stuff that may be more important

The topic I explore today is investing in face of uncertainty. To define terms, we can turn to Maynard Keynes views written in 1937: “By ‘uncertain’ knowledge… I do not mean merely to distinguish what is known for certain from what is only probable. The game of roulette is not subject, in this sense, to uncertainty… the sense in which I am using the term is that in which the prospect of a European war is uncertain, or the price of copper and the rate of interest twenty years hence, or the obsolescence of a new invention…About these matters, there is no scientific basis on which to form any calculable probability whatever. We simply do not know!” (Bernstein, Against the Gods – The Remarkable Story of Risk 1996) p229

When we are searching to find a wonderful company to invest in, many of the most important things to consider are uncertain. That is, a lot of what counts can’t be counted. There is no scientific basis on which to form any calculable probability.

How Warren Buffett approaches this

Let’s start with a quote from Warren Buffett from 1987: “Whenever Charlie and I buy common stocks… we approach the transaction as if we were buying into a private business.”

He explains: “We look at the economic prospects of the business, the people in charge of running it, and the price we must pay. We do not have in mind any time or price for sale. Indeed, we are willing to hold a stock indefinitely so long as we expect the business to increase in intrinsic value at a satisfactory rate.”

In a nutshell: “When investing, we view ourselves as business analysts – not as market analysts, not as macroeconomic analysts, and not even as security analysts.” (Lawrence A. Cunningham, The Essays of Warren Buffett: Lessons for Corporate America, 1998) p63 cited as (Buffett, 1998).

Assessing the economic prospects of a business and the people in charge of running it, is essentially a judgment call based on uncertain knowledge.

The hard-to-measure stuff that may be more important

There is a marvelous quote that makes you stop and think. Einstein is widely believed to have said: “Not everything that can be counted counts, and not everything that counts can be counted.” It seems however that the author was a Professor of Sociology named William Bruce Cameron who wrote these words in the 1960s.

In this post I am focusing on the second half of these words of wisdom: Not everything that counts can be counted, the title of this post.

I love the following quote from Charlie Munger’s Herb Kay Memorial Lecture, ‘Academic Economics: Strengths and Weaknesses, after Considering Interdisciplinary Needs,’ at the University of California at Santa Barbara, 2003.

He weighs in on two issues, both parts of the Cameron problem.

In the lecture Munger says: “A special version of this “man with a hammer syndrome” is terrible, not only in economics but practically everywhere else, including business. It’s really terrible in business. You’ve got a complex system and it spews out a lot of wonderful numbers that enable you to measure some factors. But there are other factors that are terribly important, [yet] there’s no precise numbering you can put to these factors. You know they’re important, but you don’t have the numbers. Well practically everybody (1) overweighs the stuff that can be numbered, because it yields to the statistical techniques they’re taught in academia, and (2) doesn’t mix in the hard-to-measure stuff that may be more important. That is a mistake I’ve tried all my life to avoid, and I have no regrets for having done that.” (Emphasis added)

Overweighing the stuff that can be numbered is counting things that don’t count.

Mixing in the hard-to-measure stuff that may be more important is the problem of not being able to count all the things that count. It’s in this stuff where uncertainty lies.

Dealing with uncertainty

George Soros highlights the problem. “It is difficult to accept uncertainty. It is tempting to try and escape it by kidding ourselves and each other, but that is liable to land us in greater difficulties.” (Soros, The Crash of 2008 and What it Means, 2008,2009) P230

Or consider the following from Peter Lynch: “It’s also important to be able to make decisions without complete or perfect information. Things are almost never clear on Wall Street, or when they are, then it’s too late to profit from them. The scientific mind that needs to know all the data will be thwarted here.” (Lynch, One Up on Wall Street 1989,1990) p69

Completing our discussion of things that can’t be counted

There is a way that investors can deal with pure uncertainty. The first step is simply to recognize the problem. Let’s not kid ourselves. In a way it’s comforting for the average investor that investing legends like Warren Buffett, George Soros and Peter Lynch and all professional money managers, hedge fund managers and Wall Street veterans face the same problem.

The second step is to have a sound investment process (what Ben Graham calls principles of operation). The third step is control over our human foibles (what he calls ‘firmness of character’)

At the end of his career in 1974 in the midst of what may still be the greatest bear market since the 1930s, Benjamin Graham gave a speech to securities analysts. It was styled “Renaissance of Value”, and was reprinted in Barron’s September 23, 1974, and is quoted by Roger Lowenstein. Graham remarked that investing did not require genius: “What it needs is, first, reasonably good intelligence; second, sound principles of operation; third, and most important, firmness of character.” (Lowenstein, Buffett, The Making of an American Capitalist 1995,2008) p160

Just three things: reasonably good intelligence, a sound investment process and character.

Warren Buffett has an investment process. It is readily available to all investors. He has described it in great detail in decades of Berkshire Hathaway letters to shareholders. To get a rough idea of how Warren Buffett carries out his business analysis which is fraught with uncertain knowledge, take a look at my post The tenets of companies Buffett invests in This gives some idea of how he goes about his business analysis and how he assesses management. Much of this stuff you can’t put numbers on.

Of course, there is more to it than reading one post. Below I have included a number of other posts about our search for superb businesses. The main idea of today’s post is simply to make the point that the judgment we make as investors takes place in a cloud of uncertainty.

As investors we are not only looking for wonderful companies to buy shares in, but we also want to buy them at bargain prices, prices at a discount to fair value. We have to also recognize that all estimates of fair value, even when based on the most rigorous Discounted Cash Flow (DCF) analysis, are also freighted with real uncertainty. Warren Buffett describes DCF: “We generally think the value of a company is the PV [present value] of cash flows until judgment day.” Think of the uncertainty inherent in that kind of assessment.

As for the third step, control over our human foibles, I invite readers to dig into the subject of investment psychology with my post Investment psychology explainer for Mr. Market – introduction 

What we haven’t looked at

What we haven’t looked at in this post is the subject of overweighing the stuff that can be numbered, as Charlie Munger puts it. This is the counting things that don’t count and variations on that theme. Readers wanting to dig into this subject might take a look at my post The Achilles heel of the quantitative analysis of stocks

Conclusion

The comforting thing about uncertainty is that everyone is in the same boat. Many investors hang on pundits and analysts’ opinions on the outlook for commodities, the impact of AI, how the economy will unfold in the next year or five or ten years. These things are unknowable. Let’s not kid ourselves. The key is to have a sound investment process that will carry the investor through thick and thin and educate ourselves about investment psychology.

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For readers wishing to dig a little deeper into the art of identifying and analyzing companies to invest in, you might take a look at the following posts.

Stocks – avoid stepping in the bad stuff

How to distinguish a superb value creator from an also ran

How to identify great companies to invest in – Part l

How to identify great companies to invest in – Part ll

How to identify great companies to invest in – Part lll

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Other posts on investment psychology

This post is part of a series. Readers are invited to read Investment psychology explainer for Mr. Market – introduction This will give you a better understanding of some of the terms and ideas and give you links to other posts in the series.

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You can reach me by email at rodney@investingmotherlode.com

I’m also on Twitter @rodneylksmith

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