- Date: 21st Dec 2017
- Subject: Thoughts around Investing
What is a Science?
Science as per Wikipedia is a systematic enterprise that builds and organizes knowledge in the form of testable explanations and predictions about the universe. Science is associated with consistent, independent and timeless outcomes. A science can be studied in a textbook, and when applied in an experiment, it will always deliver an expected result under same conditions.
What is an Art?
An Art can be defined as the ‘expression or application of human creative skill and imagination’. Across painting, music and literature, people find Art as a way to express themselves and create something uniquely different, that communicates to other humans. It somehow combines both technique and emotion.
So is Investing a Science, or an Art?
When I speak of Investing, I differentiate it from Trading and refer to stock purchased for a holding period greater than 1 year, bought based on fundamentals analysis.
The Science: Investing appears to be a Science when we look at the quantitative side of things. The analysis of the balance sheet, income statements and calculation and understanding of the key ratios, as well as interpreting them seems to be a fairly scientific exercise. Companies can fairly quickly be bucketed under Poor, Average and Good using quantitative techniques, based on data about the past.
The Art: However the qualitative side of investing is not so well defined. It is also very important.
- Which sector is the firm from? Is this sector doing well overall and are prospects good?
- How good is management in this firm?
- Is the firm encouraging a second line of leadership and executives?
- How are the products of the firm? What is the USP of the firm? The moat? How does it compare with peers?
- What’s the future for this firm given these realities? How do we value this firm? If there is a valuation gap (mispricing) when will this gap be filled by the market?
- What are the risks, uncertainties and bad scenarios for this firm?
- What are the exit criteria for the firm?
- As an investor, can I control my emotions like fear, pride, regret, laziness and greed? The psychological part of investing, that which involves your emotions, your expectations, your attitudes and your habits, is a crucial part of the recipe for success. How does one react to market news and fluctuations? Can I generate and stick by my ideas long enough to find success? Or would I prefer to follow the herd?
- Finally with so many complex inputs, and unknowns, I feel intuition plays an important part in key decisions. This too is more Art than Science as it is more judgement and not quantifiable.
- In addition each investor brings to the table his own set of strengths and biases. This helps him identify successful investing ideas only in certain situations. This can be a core strength of an investor if it is well understood.
So we can see that this part of Investing certainly has a technique, involves a lot of judgments and interpretations and is quite an Art. The objective of course is to protect and grow wealth, so its an applied Art.
The Brain –
So we can see that while the core of Investing is scientific and quantitative, this has over it a thick wrapping of human judgement, emotion and real life uncertainties.
Can a Computer Do Good Investing?
Here is a famous quote by the legendary investor Peter Lynch. “Investing in stocks is an art, not a science, and people who’ve been trained to rigidly quantify everything have a big disadvantage.”
My feeling is that computers can handle the quantitative side of investing well. This is of course based on the fact that computers are powered by good programming and applications.
The Art or qualitative part of investing is very hard to program and incorporate into a computer.
However there are a bunch of newer technologies such as Machine Learning, fuzzy logic and Artificial Intelligence. It’s quite possible that some of these techniques can be adapted to help in Investing and may even become quite good.
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