Sunday, January 31, 2010

Snow balling - the art of making close calls

One of the many things that Private Equiteers lose sleep over are close calls - viz., calls where they are indifferent to the alpha and beta errors (viz., they cannot decide if the investment opportunity is poor enough to let it pass without a blink or compelling enough to justify a scamper).

As a sheer coincidence, I have been reading Snowball about the life of Warren Buffet for the last two weeks. The book is a nice read and a strong recommend from my side. This one is extremely special since it potrays him as an ordinary human being with the pulls and pressures from various walks - the sacrifices his wife and family made, the mistakes he made with investments and of course, the surprising gamut of emotions that lies behind this witty, numbers driven legend.

We keep coming across this all the time in real life as well - it seems most people handle this by procrastination or asking for more and more data (which only serves to deepen the agony because data after a certain point is hardly conclusive. For every good reference you get, there is a so-so reference as well).

Buffet seems to build on the same pithy-ism that Lincoln used many years ago "Reputation is like fine China. It takes a lot to build but one small mistake can make it come crashing down."

Warren Buffet's take on this is simple. If the investment goes wrong, what is the worst damage that can happen to your reputation ? Or in other words, if the company throws up a year later, are people going to tell you " See, I told you so; The guy/company was no good.." or are they going to say " hmm... the guy was good..may be just tough circumstances".

Remember, that an investor can never substitute a manager just like the converse is true. A lot of investors expect positivities to flow in to further their "alpha" like market multiples, new innovations, growth beyond the company's comfort zone etc. Buffet's take on this is simple : Do not budget for these - if they happen, it is a windfall. But do not plonk money on the table assuming angels from heaven will come and help the investment grow. Simply put, do not expect significant increases in managerial capabilities drive investor's alpha.

Hmm..Simple but powerful insights. I guess the difference is in execution, as always.

~Varadha (varadha.r1@gmail.com)

1 comments:

Anonymous said...

there is always a thinking that everything has a value at a price but what we fail to understand is that there is nothing which can make up for reputation. If there is something I admire about Infosys, it is this quality of theirs which they consistently display.