I am a fan of mental models. The champion for multi-disciplinary thinking is none other than Charlie Munger, the intellectual partner to Warren Buffett at Berkshire Hathaway.
One of the useful mental models is inversion. Charlie Munger got the idea from German mathematician Carl Jacobi, who said, “invert, always invert.”
Munger believes that some problems are best solved by flipping them over, or to work backward rather than forward.
Let’s apply this to growth stocks.
If I ask you what are the best growth stocks to buy?
You might be thinking of the next big thing, trying to guess the new trend or the players who would dominate the future.
Some ideas that comes to mind include tech companies such as Apple, Amazon, Facebook and Google.
Or it could be electric cars, cannabis and fake meat stocks.
These are companies that are pushing the frontiers of our economy and society. Hence, they are what most people would classify as growth stocks (if they succeed).
But we need to think differently from most people if we want to achieve better investing results.
We need to invert the thinking – instead of asking what would change in the future, ask what would NOT CHANGE in the future.
Change is risky. Yes, many of these companies are innovative but it also means they can succeed wildly or fail dramatically. Instead of investing in changes, invest in things that won’t change!
That’s the key idea behind Buffett’s picks. Things like Coca-Cola, banking and credit card processing have not changed over the decades.
In the book, University of Berkshire Hathaway, the authors documented Buffett and Munger’s wisdom while attending the AGMs and here are what Buffett have said about investing in businesses that don’t change:
Buffett added that they are slim in their ability to predict where change will lead. Thus, they are much better at products where change will not mean as much: soft drinks, candy, shaving, chewing gum. “There’s not a whole lot of technology going into the art of the chew.”Berkshire Hathaway AGM 1996
Buffett added that there is a big difference between identifying a growth industry and minting money. He noted that AT&T’s return on equity over the years has been poor. Change has hurt the company more than it has helped.Berkshire Hathaway AGM 1999
Too many people are focused on what are going to change, such as AI is going to change humanity, self-driving cars are going to destroy jobs, yada yada…
I’m not a technophobe. In fact, I like technology. But that doesn’t mean I am going to risk my capital to bet on something uncertain.
Hear from a technopreneur, Jeff Bezos, on trying to spot the next trend.
“I very frequently get the question: ‘What’s going to change in the next 10 years?’ And that is a very interesting question; it’s a very common one. I almost never get the question: ‘What’s not going to change in the next 10 years?’ And I submit to you that that second question is actually the more important of the two — because you can build a business strategy around the things that are stable in time. … [I]n our retail business, we know that customers want low prices, and I know that’s going to be true 10 years from now. They want fast delivery; they want vast selection. It’s impossible to imagine a future 10 years from now where a customer comes up and says, ‘Jeff I love Amazon; I just wish the prices were a little higher,’ [or] ‘I love Amazon; I just wish you’d deliver a little more slowly.’ Impossible. And so the effort we put into those things, spinning those things up, we know the energy we put into it today will still be paying off dividends for our customers 10 years from now. When you have something that you know is true, even over the long term, you can afford to put a lot of energy into it.”
No wonder, Jeff Bezos is the American entrepreneur Buffett admires most. Probably because their thinking are alike.
But admiration doesn’t mean Buffett would invest. He stuck to his investing principle.
I had very very very high opinion of Jeff’s [Jeff Bezos] ability when I first him, and I underestimated him… I’ve watched Amazon from the start. I think what Jeff Bezos has done is something close to a miracle … The problem is when I think something will be a miracle, I tend not to bet on it. It would have been far better obviously if I had some insights into certain businesses.Warren Buffett in Berkshire Hathaway AGM 2018
Justin Sun, TRON (cryptocurrency platform) founder and CEO of BitTorrent, won a charity bid of $4.5 million to have a private lunch with Warren Buffett.
“The automobile industry is a field with immense competition and lots of aggressive players. Since Ford, the US has had over two thousand automobile manufacturers, and now only three are left and none of them are currently doing well. As much as the automobile industry changed the world in a good way, no investors nor businesses benefited from it. On the contrary, the whole industry is stuck in endless competition. The same is true with consumer electronics. With smartphones, Apple is the only major winner, even Samsung hasn’t been able to make that much earnings.
Tesla is facing a lot of competition, and these businesses with large cash reserves would rather file for bankruptcy than quit. For Tesla, the future is full of uncertainties. Mr. Buffett said “Close your eyes and imagine what the news headlines’ gonna be in ten years. Think about the most likely one, not the one you want to see the most.”
Ok, maybe you are a little more convinced by now. But you may also wonder what are some examples of business that don’t change.
Recently I had this conversation with Ruiming from The Woke Salaryman about this idea of investing in things that don’t change. Being a cyclist, he told me he bought WD-40 because he was oiling the bike with it.
You must be familiar with the brand too. But you probably didn’t pay too much attention to it – how can this kind of product be a listed company in the first place!?
But look at the share price…
Maybe you think it is luck or a biased sample and you argued Google share price also went up a lot.
Yes, software eats world, but the world eats pizza.
Google and Domino’s pizzas IPO about the same time in 2004. Pizzas did better than softwares. Pizzas are still pizzas while Google had made so much changes in order to stay ahead.
I’m not saying Google is a bad company but to highlight that you can have less glamorous companies outperforming too, and it could have been an easier bet than one that requires constant innovation and changes.
If you need one more example, how about the first ever Chinese stock that crossed 1000 yuan per share – Kweichow Moutai – China’s national liquor. This Baijiu recipe doesn’t change overtime. In fact, the more classic the more heritage it has!
Of course, this mental model alone is not enough to make an investment decision. You need to think about other things such as the competitive landscape, growth prospects and valuations.
Nonetheless, this is a very useful mental model for you. If you think that buying growth stocks is to buy into the changes in the future, think again. You are betting on a lot of uncertainties. Are you really willing to risk your capital on long shots? Invert that thinking and start over. It might help you find an ideal investment you never have thought of before.