Understanding the Universe of the

Unknown and the Unknowable

Sanjay Bakshi4 March, 2012

Many years ago, in 2000, Warren Buffett was addressing the stockholders of BRK. Recall this is a period just after a bout of “irrational exuberance” in financial markets. Buffett asked the audience to value an internet stock.

“If I taught a course in

investments, my final exam

would be to value this

Internet stock.”

“And if they came up with an answer, they'd flunk. And if they came up with a blank sheet of paper, I'd probably give them a B. “And if they said how the hell could you ask something so dumb? I’d give them an A.”

W i d eranges of outcome

Mr. Buffett knew that when ranges of outcome are wide, and when outcomes are completely unknown and unknowable, its futile to use traditional tools of financial analysis.

“SCENARIO ANALYSIS” in

W i d eranges of outcome

One foolish tool to use in such situations, is “scenario analysis wherein financial modelers visualize multiple scenario analysis, assign probabilities to arrive at the “expected value” and then make capital allocation decisions based on such “analysis.” That’s the functional equivalent of the 5.5 foot tall statistician who drowned in water which was, on average, only 5 feet deep! He forgot that the RANGE of depth was between 2 feet and 8 feet!

So, forecasting is a dangerous game when ranges of outcome are wide. In fact, when it comes to social sciences, it would be more accurate to say that forecasting is a dangerous game. Period.

“There are two classes of forecasters:Those who don't know and those who don't

know they don't know.”- Galbraith

“The stock market has

forecast nine of the last

five recessions”-

paul Samuelson

Bill Maher on Think Tanks and Predictions:

http://www.youtube.com/watch?v=VcJohfS4vTQ

Author Burton Malkiel made fun of chartists by comparing their profession with having sex: “Like a Don Juan or a Casanova, the chartist has an unending series of short affairs with stocks. First there is observation, a watching of the head and shoulders, the neckline, and the shape of the bottom. Flirtation may involve some resistance or some support. As involvement increases, congestion builds. There may be penetration of old tops, or a violation of former lows. These give way to mounting excitement and then climax, followed by the warm afterglow of profit taking.”

“There are 60,000

economists in the U.S., many

of them employed full-time trying to

forecast recessions and interest rates..

“...and if they could do it successfully twice in a row, they'd all be millionaires by now...as far as I know, most of them are still gainfully employed, which ought to tell us something.” - Peter Lynch

“We do not have an opinion about where the stock market, interest

rates, or business activity will be a year from now.”

“We've long felt that the only value of stock forecasts is to make fortune tellers look good. We believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children.”

“Imagine how much harder

physics would be if electrons had feelings!”

– Richard Feynman

And yet, when it comes to making predictions, we just cannot resist! We borrow our models from the field of physical sciences and apply them to an unknown, unknowable, and unpredictable field of social science where contagious human emotions often produce unpredictable, low probability-high impact events (black swans). We ignore these nuisances by hiding under the shelter of assumptions like “human rationality” and “frictionless markets” and “bell curves.”

Social scientists suffer from what’s called “physics envy.”

“Economics should emulate physics’ basic ethos, but its

search for precision in physics-like

formulas is almost always wrong.”

“In physics it takes three laws to explain 99% of the data; in finance it

takes more than 99 laws to explain about 3%.”-

Andrew Lo

http://mitworld.mit.edu/video/794/

“In physics, Maxwell’s theory and quantum mechanics allow you to predict the way an electron spins about its own axis inside a hydrogen atom to an accuracy of twelve decimal places. Something that accurate isn’t just a model—it’s a law. In economics, by contrast, there are no laws at all, only models, and you’re immensely lucky if you can predict up from down…”

http://www.ederman.com/new/docs/beware.hbr.pdf

Myron Scholes Robert merton

2 Nobel laureates who blew upWhy do smart people do dumb things?

The value of $1000 invested in the hedge fund Long-Term Capital Management, of $1,000 invested in the Dow Jones Industrial Average, and of $1,000 invested monthly in U.S. Treasuries at constant maturity.

http://en.wikipedia.org/wiki/Long-Term_Capital_Management

Buffett video on LTCM. Three points that he makes, which I want to elaborate upon:

1. Over-reliance on mathematics and models from physical sciences- physics envy.

Two very different reactions to worst

case scenarios

2. Modeling worst case scenarios based on past experience.

It turns out, as Cass Sunstein talks about in his book, that when visualizing the probability of a worst case scenario people use the availability heuristic.

Mind tends to over-weigh

what’s easily available to it

And Vice Versa

“People assess the frequency, probability,

or likely cause of an event by the degree to

which instances or occurrences of that event are readily

“available” in memory.”-Daniel

Kahneman

Accordingly, people over-estimate the likelihood of a worst case scenario because a very bad bad scenario happened recently because one of the things are more available in our minds are recent events.

Immediately after a horrible scenario (e.g. terrorist attack, major market crash), people’s feel more scared than than is warranted.

The second reaction - that of utter neglect - happens when a bad scenario is not readily available - either because it happened a long time ago (ignorance of history - Benjamin Disraeli Quote), or in fact has NEVER happened before.

“It hasn’t happened for a long time, so it won’t happen.” Earthquake and volcano eruptions. We under-react to to the possibilities of negative black swans because they haven’t happened for a long time or have never happened before.

I mean think about it. How can we model something in the future by assuming things that have never happened before?

In other words, we are over-confident. That’s what happened to LTCM. They underestimated the probability of a negative black swan.

“In all my experience, I’ve never been in an accident of any

sort worth speaking about…”

“I have seen but one vessel in distress in all my years at sea. I never saw a wreck and have never been wrecked nor was I ever in any predicament that threatened to end in disaster of any sort.”- E.J. Smith, 1907, Captain, RMS Titanic

The Titanic gets hit by a negative black swan

So people get overconfident because they under-estimate the probabilities of negative black swans.

Would you like to jump out of this plane with this parachute which opens 99% of the time?

Normal human tendency

90% of drivers think that they are better than average drivers

I am 90% sure that empty 747’s weight is between ____ and ____ tons.

Ans: 177 tons

I am 90% sure that the moon’s diameter is between ____ and ____ kilometers.

Ans: 3,476 kms

Most of you got it wrong. Why? Because the worldview you formed was not broad enough! You were free to choose the range of outcome that would have guaranteed that you were at least 90% right! But you did not. Instead, you chose scenarios that were too narrow.

The world is going to surprise you by revealing scenarios that you simply do not visualize in forming your world views!

The third point Buffett made was that guys behind LTCM were modeling the future of stock markets using models which assume assuming a “bell curve” world which severely underestimates the probability of black swans.

In a world described by the bell curve (also called “mild randomness”), most values are clustered around the middle - fully 95.4% are within 2 sigmas from the mean. The average value is also the most common value. Outliers contribute very little statistically.

If 1,000 random people gather in a stadium and the world's tallest man walks in, the average height doesn't change much.

But if Bill Gates walks in, the average net worth rises dramatically.

At $80 billion, 99.9% of total wealth of this crowd will come from one man. Indeed, all the others would represent no more than the variation of his portfolio’s value over the past few seconds.

Bell Curve Power Law

Height follows the bell curve in its distribution. Wealth does not. It follows a L-shaped distribution called “power law” where most values are below average and a few far above. In the realm of the power law, rare and extreme events (the black swans) dominate the action.

The power law universe experiences “wild randomness” causing one single observation to impact the aggregate and the average.

Banks are exposed to negative black swans

So are financial markets

Expectations in a Bell Curve

Universe

After about 22 sigmas, one hits a googol, which is 1 followed by 100 zeros after it.

A level described as 22 sigma has been exceeded with the stock market crash of 1987 and European interest rate moves of 1992.

Nilesh Shah’s analysis - out of 5,300 days, if you remove 53 best days, the returns go to zero.That’s 1% of the days. All of the return is in 1% of the days.

In a universe described by the bell curve, experiencing “mild randomness”, one single observation, such as a very tall person, may seem impressive by itself but will not disproportionately impact the aggregate or the average.

Such randomness that disappears under averaging is trivial and harmless because you can diversify it away.

In a universe dominated by power laws, where black swans proliferate, winners tend to take all and the rest get nothing.

There’s Steve Jobs, Bill Gates, and a lot of software writers living in a garage.

There’s Domingo and a thousand opera singers working in Starbucks.

there’s JK Rowling, and a million starving fiction writers. If you pick 1,000 random authors and then add her to the population, 99% of total book sales will be attributable to her.

In the power law universe, Winner Takes All

So the big lesson is that you have to acknowledge the presence of black swans - both positive and negative, and organize your life accordingly. You cannot rely on models based on the wrong worldview of a bell curve universe.

Another big lesson is that its virtually impossible to predict black swans - both positive and negative.

Let me show you a couple of very interesting experiments.

This is Joshua Bell - one of the world’s most highly regarded violinists.

http://en.wikipedia.org/wiki/Joshua_Bell

He is playing Vivaldi Four Seasons.

http://www.youtube.com/watch?v=iNcYT7jpH9E

People pay hundreds of dollars to watch him play.

One day Joshua Bell played the violin at a subway station in Washington D.C - incognito - on behalf of The Washington Post.

See this: http://www.youtube.com/watch?v=hnOPu0_YWhw

Read this: http://www.washingtonpost.com/wp-dyn/content/article/2007/04/04/AR2007040401721.html

Now this is not a controlled experiment. One can claim that the commuters were busy, had other stuff on their minds etc etc.

This is one of best controlled experiments in social science I have read about..

http://www.nytimes.com/2007/04/15/magazine/15wwlnidealab.t.html

Web-based experiment. More than 14,000 participants registered at Music Lab (www.musiclab.columbia.edu), and were asked to listen to, rate and, if they chose, download songs by bands they had never heard of.

Now this is where it gets interesting. The experiment split the participants into two groups.

In the first group consisting of 20% of participants, people saw only the names of the songs and bands. They did not see what other participants were doing. In this blind world people simply rated and downloaded songs independently.

In the second group consisting of the remaining 80% of the participants, people also saw how many times the songs had been downloaded by previous participants. But this second group — “social influence” condition — was further split into eight parallel “universes” such that participants could see the prior downloads of people only in THEIR OWN universe.

All the artists in all the universes started out identically, with zero downloads — but because the different universes were kept separate, they subsequently evolved independently of one another.

So what happened? First, in all the social-influence universes, the most popular songs were much more popular (and the least popular songs were less popular) than in the first, independent group.

Second, songs that became hits were different in different universes, just as cumulative-advantage theory would predict. Introducing social influence into human decision making, in other words, didn’t just make the hits bigger; it also made them more unpredictable.

When people tend to like what other people like, differences in popularity are subject to what is called “cumulative advantage,” or the “rich get richer” effect. This means that if one object happens to be slightly more popular than another at just the right point, it will tend to become more popular still. As a result, even tiny, random fluctuations can blow up, generating potentially enormous long-run differences among even indistinguishable competitors...

Thus, if history were to be somehow rerun many

times, seemingly identical universes with

the same set of competitors and the same overall market tastes would quickly

generate different winners:

Madonna would have been popular in this world, but in some other version of history, she would be a nobody, and someone we have never heard of would be in her place.

So the first big lesson here is that while the world is increasingly going to be dominated by black swans, predicting them will be an exercise in futility. Second, luck will play a huge role in outcomes and you better give it the credit its due.

So how in the world do we understand the universe of the unknown and the unknowable?

Let me share the lessons I have learnt in this respect from 5 role models.

Role Model # 1:John Templeton

In 1939 Templeton borrowed money to buy 100 shares of each penny stock selling at $1 or less per share. His investment almost quadrupled in the space of 4 years. Let me let his biographer tell you that story…

click for sound.

The big lesson here is that under the right kind of conditions, uncertainty can be your friend.

Role Model # 2:Ben Graham

Protection vs. Prediction

“When you build a bridge, you insist it can carry 30,000 pounds, but you only drive 10,000-pound trucks across it. And that same principle works in investing.” - Buffett.

In American roulette there are 38 slots numbered 1-36, 0, and 00. Pay-out is

35:1

The idea of margin of safety can be understood by thinking about what happens on a roulette table in a casino.

If you bet Re 1 on your lucky # 7 and if the ball lands on # 7, you win Rs 35,

otherwise you lose Re 1.

You wager Rs 1,000 on a single number, say number 7.

Probability of ball landing on 7 = 1/38 = 2.63%. Probability of not landing on 7 =

37/38 = 97.37%

Event Payoff Probability Expected Value

Ball lands on 7 36,000 2.63% 947.37

Ball does not land on 7 0 97.37% 0

947.37

Amount Bet -1,000

NPV -52.63

What happens when Margin of Safety is -ve and you practice wide diversification?

Suppose you bet Rs 1000/38 or Rs 26.32 on each of the 38 numbers to “spread your risk”

Event Payoff Probability Expected Value

Ball will land on one of your numbers 947.37 100% 947.37

Amount Bet -1,000.00

NPV -52.63

In fact diversification hurts you when margin of safety is negative

In the earlier case when you bet Rs 1,000 on a single number, at least you had a small chance of getting lucky and winning Rs 35,000. In the fully diversified strategy, you will ALWAYS lose.

Lesson: Diversification does not work when Margin of Safety is absent.

Is a Value Investor

1. Each bet has an expectancy of a profit even though some will inevitably result in a loss2. Wide diversification3. Cap on Max Bet - position sizing

The big lesson here is that one has to create “favorable odds” and Graham had a solid process of evaluating financial statements and stock market data to do that. For example, he taught me to look at cash bargains where the value of the company in the market is less than the value of cash on its balance sheet.

Summer of 2000

“In many cases low-priced common stocks give the owner the advantage of an interest

in, or “call” upon, a relatively large enterprise at relatively small expense.”

Graham also developed the same technique that Templeton had used. He called it “Low Price Common Stocks”

The arithmetical advantage of low-priced issues arises out of the fact they can advance so much more than they can decline. Its common to see a stock rise from 10 to 40 than from 100 to 400. Why?Preferences of the speculative public which generally is more partial to the low priced issues. Why do buyers of low-priced issues lose money? The public buys issues that are sold to it, and the sales effort is put forward to benefit the seller and not the buyer. The reason may be either because the companies are in bad financial condition or because the common stock is low-priced in appearance only and actually represents a full or excessive commitment in relation to the value of the enterprise.

A pseudo-low price is accomplished by the simple artifice of creating so large a number of shares that even at a few rupees per share the total value of the common issue is excessive.

“A low-priced stock of the genuine variety will show an aggregate value for the issue which is small in relation to the company’s assets, sales, and past and prospective profits under favorable business conditions.”

“It will ordinarily have sold in the past at several times the current low price. None of these points are likely to hold for the “intentionally low-priced” issue, with its millions of shares outstanding.”

Genuine Low Priced Common Stock Pseudo Low Priced Common Stock

“Many of the security analysts are handicapped by a flaw in their basic approach to the problem of stock

selection. They seek the industries with the best prospects of growth, and the companies in these industries with the best management and other

advantages.”

“The implication is that they will buy into such industries and such companies at any price, however high, and they will avoid less promising industries and companies no matter how low the price of their shares.

“This would be the only correct procedure of the earnings of the good companies were sure to grow at a rapid rate indefinitely in the future, for then in theory their value would be infinite.

“The truth about our corporate ventures is quite otherwise. Extremely few companies have been able to show a high rate of uninterrupted growth for long periods of time. Remarkably few, also, of the larger companies suffer ultimate extinction.

“For most, history is one of vicissitudes, of ups and downs, of change in their relative standing…”

Long Term Sucks

Being in the right place at the right times pays well

Long Term Sucks

Current Chart

Being in the right place at the right times pays well

Long Term Sucks

Being in the right place at the right times pays well

Long Term Sucks

Being in the right place at the right times pays well

A Simple Screen

Simone Tata, Chairperson of

Trent & Stepmother of

Ratan Tata, Chairman of the

Tata Group

Another lesson in dealing with uncertainty was learnt when, out of sheer luck, I discovered a company called Trent

Class project.

cash bargain + uncertainty about diversification = investor disappointment.

Takeover bid that never happened

But, the retail boom happened and….

Trent’s Stock Price Chart

strong parallels to another situation that I will describe later.

The big lesson here was that if you buy cheap things then even if you fail to get the value out, you could get lucky and get a handsome exit.

Dealing with value traps

Another lesson learnt from Graham

Stock selection criteria

if the stock does not give you 50% in 3 years, sell it - its most likely a value trap. Nice rule to deal with uncertainty

Role Model # 3:Warren Buffett

“I'll be happy to accept a

lottery ticket as a gift – but I'll

never buy one”

The big lesson from Buffett is the idea of free lottery tickets.

Buffett bought growth stocks of fantastic business at prices which implied no or very low growth. So either he did not pay for the high quality growth or he paid too little. So that was one way he dealt with uncertainty

Partner with Great Managers

Quite early in his career, Buffett figured out the importance of investing with great managers. Over the years, he has collected 53 companies run by great managers.

He pampered them and they let him ride on their coat tails…

Role Model # 4

The big lessons from Taleb was to organize your life so that you minimize your exposure to negative black swans and maximize your exposure to positive black swans

After reading and thinking about his philosophy I have become very averse to certain types of business prone to negative black swans - i call them “accidents waiting to happen.”

For example the banking industry.

Or using leverage in buying stocks.

I also have become sensitized to the idea of getting exposure to positive black swans. Three key questions:

1. Are there areas where positive black swan lurk? Yes! For example take the movie business, or the book publishing business, or the drug discovery business or the venture capital business or the private equity business. While these businesses have their specific risks, they also have exposure to positive black swans.

3. While there may not be a way to predict positive black swans, is there a way to increase your chances of spotting them? Yes. The role of luck.

2. How can one get exposure to positive black swans on very favorable terms as described by Templeton, Graham, and Buffett?

Role Model # 5

“Chance favors the prepared

mind.” - Louis Pasteur

Serendipity - one of the most beautiful words in the English language.

http://en.wikipedia.org/wiki/Serendipity

You find something when you’re not looking for it.

do not ignore the importance of accidental discoveries - events, meetings, chance happenings - keep an open mind to all possibilities.

“Almost all of the scientific discoveries

that have had tremendous impact on our culture were

accidents in the sense that they were

discovered while searching for

something else.” -Arlene Goldbard,

Blogger.

“Because of hindsight bias, histories of economic life and scientific discoveries are written with straightforward story lines: someone set out to do something and succeeded, it’s all about intention and design.”

But in truth, most of what people were looking for, they did not find. Most of what they found, they were not looking for.”

“Penicillin was just some mold inhibiting the growth of another lab culture.

It was a discovery that would change the course of history. The active ingredient in that mould, which Fleming named penicillin, turned out to be an infection-fighting agent of enormous potency. When it was finally recognized for what it was, the most efficacious life-saving drug in the world, penicillin would alter forever the treatment of bacterial infections. By the middle of the 20th century, Fleming's discovery had spawned a huge pharmaceutical industry, churning out synthetic penicillins that would conquer some of mankind's most ancient scourges, including syphilis, gangrene and tuberculosis.

Lasers at first had no application but were thought to be useful as a form of radar

The Internet was conceived as a military network.

Despite massive US’s National Cancer Institute-funded cancer research, the most potent treatment—chemotherapy—was discovered as a side-effect of mustard gas in warfare (people who were exposed to it had very low white blood cell counts).

Look at today’s biggest medical moneymakers: Viagra was devised to treat heart disease and high blood pressure.”

The big lesson here is that the way to increase your chances of spotting positive black swans is to get exposure to the areas where they lurk and allow serendipity to play its role.

“Go where events flow

fastest. Surround yourself with a

churning mass of people and

things happening.”

That’s the big part of living in a big city- you maximize the probability of chance encounters…

People ask, “But WHY is she in the right places at the right times?

Because she has made the EFFORT to be in MANY places at MANY times.

Fate has given her a lucky break, but she has earned it. She has POSITIONED herself for it.” She has followed Louis Pasteur’ advice to have a prepared mind to benefit from chance.

“It is a fundamental assumption of the

Work Ethic that people ought to have goals and should struggle

toward them in a straight line.” - Max

Gunther.

“We are counseled to fix our eyes on our goals, looking neither to the right nor to the left, refusing to be distracted. This is supposed to be the sure route to success. But here is a puzzling fact. It turns out that lucky men and women, on the whole are not straight-line strugglers. They not only permit themselves to be distracted, they invite distraction. Their lives are not straight lines but zigzags.” - Max Gunther

“The lucky... are aware that life is always going to be a turbulent

sea of opportunities

drifting randomly past in

all directions.”

“If you put blinders on yourself so that you can see only straight ahead, you will miss nearly everything. This is what the unlucky typically do. They stick to preplanned life routes even when they are going nowhere or are actually plodding downhill to disaster.”- Max Gunther

Search strategy: Do not ignore serendipity!

The Rabbit Runs Faster than the Fox because the Fox is only running for his dinner while the rabbit is running for his life.

Ideas can come from screens, company management interaction, reading “news” - ignore macroeconomic, focus on company specific - management interviews or make up ur own news by looking at fundamental, slow but long-term changes happening to companies.

ideas come from reading books from multiple disciplines, even Aesop fables.

ok, so now we come to the last point of my talk.

How do we create favorable odds while seeking exposure to positive black swans? I will tell you how I have approached this question in a while but in the meantime I want to tell you about my 6th role model in understanding the universe of the unknown and the unknowable.

Richard Zeckhauser

http://en.wikipedia.org/wiki/Richard_Zeckhauser

Role Model # 6

“The right way to think is the way Zeckhauser plays bridge. It's just

that simple. And your brain doesn't naturally know how to think the way Zeckhauser knows

how to play bridge.”

So how does Zeckhauser think about the universe of unknown and unknowables?

http://www.hks.harvard.edu/fs/rzeckhau/unknown_unknowable_PUP.pdfhyperlink

Investing in the Unknown and Unknowable

He starts by differentiating between Risk Vs. Uncertainty. Probability of Permanent Loss of Capital Vs. Unpredictability about the future.

Sometimes even the identity and nature of possible future states are Unknown e.g. the value of a research pipeline in pharma.Welcome to the world of Unknown and Unknowable

Most investors treat as if Risk = Uncertainty

Markets hate uncertainty.

Mr. Market is Often Wrong

You should shun risk but seek uncertainty on “favorable terms”

You should seek out positive black swans on favorable terms

“Most investors – whose training, if any, fits a

world where states and probabilities are assumed known – have little idea of

how to deal with the unknowable. When they recognize its presence,

they tend to steer clear…”

That will create a buying opportunity

All Black Swan Events (Negative as well as

Positive) are uU

e.g. Banking is prone to Negative Black Swans

Venture Cap and Private Equity is prone to Positive Black Swans

“Unknowable situations have been and will be associated with remarkably powerful investment returns.”

“There are systematic ways to think about unknowable situations. If these ways are followed, they can provide a path to extraordinary expected investment returns.”

“The opportunity to get a 10 or 100 multiple on your

investment as often as you lose virtually all of it is tremendously

attractive.”

“Significant expected excess

returns to investments have

three characteristics:

(1) uU underlying features

(2) complementary capabilities are

required to undertake them, so the

investments are not available to the general market,

and (3) it is unlikely that a

party on the other side of the

transaction is better informed.

“A great percentage of uU

investments provide great returns to a

complementary skill.”

“For example, many of America’s great fortunes in recent years have come from real estate. These returns came to people who knew where to build, and what and how. Real estate developers earn vast amounts on their capital because they have complementary skills.

Venture capitalists can secure extraordinary returns on their own monies, and charge impressive fees to their investors, because early stage companies need their skills and their connections. In short, the return to these investments comes from the combination of scarce skills and wise selection of companies for investment.”

“Individuals with complementary skills enjoy great positive excess returns from

uU investments. Make a sidecar

investment alongside them when given the

opportunity.”

Sure, but i am a spoiled brat - spoiled by Templeton, Graham, and Buffett. How can I get into such situations on what these gentlemen call “favorable odds?”

“The investor rides along in a sidecar pulled by a powerful motorcycle. The more the investor is distinctively positioned to have confidence in the driver’s integrity and his motorcycle’s capabilities, the more attractive the investment.”

No one, but Buffett gets deals like this.

“The major fortunes in finance, I would

speculate, have been made by people who

are effective in dealing with the unknown and unknowable. This will probably be truer still

in the future.”

“The more difficult a field is to investigate, the greater will be the unknown and unknowables associated with it, and the greater the expected profits to those who deal sensibly with them. Unknowables can’t be transmuted into sensible guesses -- but one can take one’s positions and array one’s claims so that unknowns and unknowables are mostly allies, not enemies.”

Uncertainty Can be a Friend in the uU world

Lessons so far

Uncertainty can be a friend and enemy

Avoid negative black swans and position yourself for situations where uncertainty is your friend i.e.

seek out positive black swans

Make sidecar investments alongside wealth creators who have complimentary skills and ability to source deals not available to others.

But how do we get favorable odds as described by Templeton, Graham, and Buffett? How do we get lottery tickets for free?

Let me answer that introducing to you a man

Has turned $1.5 mil into $3.8 billion in 22 years of M&A deal making and

running businesses

Ajay Piramal

He did that by buying out pharma companies at cheap valuations from multi-national pharma companies rushing to exit from India in 1990s.

Growth

Sale to Abbott

$1,000 invested with Ajay Piramal

in 1988 has become approximately

$200,000 by 2010

200 bagger

Return of 28% p.a.Sensex Return: 17%

He gets deals which no one else does.

He gets deals which no one else does.

Current Stock Price = Rs 440.

Cash per share (net of debt) = Rs 500.+

Five businesses for free: CRAMS, Critical Care,OTC, Piramal Life, India REIT (all five have

uU characteristics)+

Lacto calamine, Ipill, Saridon, supraactiv - having substantial private market values

Then why is the market valuing it less than cash? A big part of the reason is to do with the uncertainty about the future plans for cash deployment. EVEN AJAY PIRAMAL does not know which business will he go into (Uncertainty). How can an analyst, wedded to tools of traditional financial analysis like DCF evaluate this stock?

Just as was predicted by Zeckhauser, ““Most investors – whose training, if any, fits a world where states and probabilities are assumed known – have little idea of how to deal with the unknowable. When they recognize its presence, they tend to steer clear…”

The parallels with Trent situation.

But my point is that we we have to recognize that uncertainty can be a friend and enemy, and we have learnt to avoid negative black swans and are seeking to gain exposure to positive black swans having uU characteristics, and moreover, if we are seeking to make sidecar investments alongside wealth creators with a solid track record, and who have complimentary skills and ability to source deals not available to others, and then if we are able to get a partnership interest with such a man with five businesses having uU characteristics thrown in for nothing, the probability of permanent loss of capital seems remote, and the probability of luck favoring us is reasonable.

While, there is plenty of uncertainty, there is little risk.

Will be be proven right? I do not know, the answer is uncertain. As always, time will tell.

Thank you.

Thank You