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How Buffett shot down a $5bn investment proposal with one quick sum

At least as a starting point for further analysis, investors should not be afraid of being only roughly right as opposed to exactly wrong

23/09/2021

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One satisfying sequences touched on in our conversation with author Andrew Elliott in a recent episode of The Value Perspective podcast related to the age of particular types of communication – in essence, the first email was sent about 50 years ago, the first printing press operated around 500 years ago, the first evidence of writing is some 5,000 years old and the first cave paintings date back roughly 50,000 years.

In other words, four key moments in human communication can be traced back through history in multiples of 10 – a relationship that both offers context and helps to pin all four dates in our minds. After all, as we noted in Strategies that count, the human brain is not wired to cope with big numbers and so it makes sense to try and identify ways to help us quickly tell, say, our millions from our billions.

Having addressed issues of scale in his book Is That a Big Number?, Elliott moves on to consider risk and probability in What are the Chances of That?. “There is a contrast between how we think about things individually and how we think about them collectively and statistically,” he says. “When the National Lottery was launched in the UK, there is a reason why they focused on the marketing line ‘It could be you’.

“Well, yes, it could be you and for a few people it has been – but it is also a more attractive message than the arithmetical odds of what was around 14,000,000 to 1 to begin with and is closer to 45,000,000 to 1 now.” For context, that is akin to you walking blindfold onto a football pitch into which someone has somewhere placed a pin. If you stop, bend down and pick up the pin first time you win. So ... do you feel lucky?

‘Best guess’ land

Improving your feel for the numbers involved in something so you can make a better decision is at the heart of another of our podcast conversations – this time with US poker player and author Annie Duke. “We are taught in math that there are right answers and there are wrong answers – that ‘two plus two equals four’ is correct, whereas ‘two plus two equals 100’ is wrong,” she notes in Put more ‘educated’ into your guess.

“So when you ask someone to tell you the likelihood something will happen, they feel like they are in ‘two plus two equals four’ land when in fact they are in ‘Tell me your best guess’ land. What we are asking is, if you had to really think, what would be your best guess about how often this would occur? And, importantly, this is not about right or wrong but about building up a clearer view of the future.”

As Duke, goes on to point out, there is almost nothing you could be guessing at that you know nothing at all about – for example, how heavy is the laptop I am typing this article on? You cannot know for sure but you could pick a range and then going through the estimate process could lead you to look up helpful information – checking Google to find the average weight of a laptop, say, or seeking views from other people.

‘Landmark’ numbers

To this end, it helps to have a few of what Elliott calls ‘landmark’ numbers to help add context and so make sense of the barrage of data with which investors are bombarded every day. And to prove the point, we are calling on none other than Warren Buffet – courtesy of a great little anecdote we found tucked away in a couple of paragraphs of Roger Lowenstein’s Buffett: The Making of an American Capitalist.

Buffett spent almost four decades as a director of the Washington Post but, according to Lowenstein, only rarely made any comments at board meetings. One time, however, a young MBA-type was offering an overview of what US consumers were spending in each part of the media and entertainment industry and suggested the relevant figure for home entertainment was $5bn.

Buffett was sceptical to say the least – arguing that number could be roughly broken down to 20 million teenagers spending $20 every month of the year. Even if that $5bn was true, some quick mental arithmetic – five billion divided by 20 million = 20 x 12, give or take – suggested it was hardly sustainable. “That was how his mind worked: numbers, numbers,” writes Lowenstein. “Needless to say, the Post did not go into video.”

It should go without saying that precision has its place in investment but, when it comes to decisions where you do not or cannot have all the facts, investors – at least as a starting point for further analysis – should not be afraid of being only roughly right as opposed to exactly wrong.

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