An investor analyzing a company with its past 10 or 15 years of data may find many amazing companies with a robust track record, taking past results as a cue to further extrapolate those amazing results of the past into the future has severe consequences.
As Nassim taleb says in "Black Swan" A turkey being fed for 1000 days doesn't know its going to die on the 1001st day (thanks giving day).
We cannot extrapolate the past into the future, Nassim taleb adds further that Black swans are relative to knowledge, which depends upon your expectations. While the 9/11 event was one of the biggest historical terror attack it was known to the perpetrators but not to the American army or the air force or the people inside the building. So the Black swans are relative to the expectations that we are safe and we will remain that way, the turkey doesn't know its going to be butchered but the butcher knows it.
Vijay Malaya was one of the best industrialist in India, he was flaunted as a risk taker with entrepreneurial spirit, all this were peoples view of mallaya from the past 20 years of his journey. People were taking the past known of mallaya and predicting the future unknown. Indian banks were like the turkey being fed for 1000 days and on the 1001 day boom , He escapes India !!!!
who is the sucker here ? definitely the banks, because the preparatory of the event knew it in advance, but the Black swan was relative to the expectations of the banks. There are so many instances in scams that its very much impossible to plan a scenario for such an event and most banks when giving loans doesn't provide provisions for a businessman who will be an exile.
Lets see another case of Franklin Templeton, It was one of the oldest institutions managing people's money in India, and it had AUM of 1.16 Lakh cr. So people were willingly ready to put money into the schemes based on its past record until one fine day it closed down 6 debt schemes. Nobody was able to predict such turn of events, but a recent complaint was filed that one month prior to closure insiders have sold their funds. we know who are the suckers here ! its us who put the money.
Lets take a look at another case of Yes bank where the black swan event was a total surprise but looking at hindsight it might look imminent, below is the financials of the bank for past 10 years before it blew up. As an investor you would assume yourself smart by learning from the history of Yes bank and take a look at the robust metrics of the bank and would extrapolate that into the future using fancy spread sheet models and would assign a forward looking P/E multiple and ROA for the bank.
Now look at the chart below all financials were good and analysts were recommending a target price of 1000 rs a share (analyzing fundamentals) before all hell broke loose. This is a humble admission that we cannot predict anything and most of predictions fail, but how could an investor safeguard against such events ? That’s the art of survival or being exposed to positive black swans and lesser exposure to negative black swans.
Look at the GNPA and NNPA trends, we knew something is wrong but most investors were in denial and false beliefs like a normal event and those who exited at the signs of first trouble saved their capital vs the ones who were rationalizing in denial lost almost 90 % of their capital.
Being the smart precision loving analyst the investor buys yes bank with price target fixated on metrics like P/B and NPA's and ROE. One fine day the news comes out and the cover is blown and get butchered like the turkey. That's how fragile our scientific spread sheets and models are which never accounts for any black swans. We totally rely on the past known and extrapolate into the Future unknown.
Most of the positive black swans take a very long time and simmer like technology, compounding of returns in your PF, but when it comes to negative black swans they happen all of a sudden in 1 day and the impact of the destruction is very big and painful, think of how long japan took to recover from the Hiroshima and Nagasaki event. Which brings us to an interesting conclusion that it’s more rewarding to be exposed to a positive black swan like a tech boom and to be safe guarded against negative black swans like a Yes bank or a DHFL case.
As an investor how not to be turkey
Don't take the past data and extrapolate into the future, as an investor we should look at past and be a little cynical about the future. Be dissatisfied with the current knowledge which gives the investor an ever searching for truth mindset.
Prefer empirical data vs. the theoretical and precision filled ones. Spread sheets imply that there are no Black swan events and its a linear world which makes the investors suckers.
Keep an open mind especially when the outcomes are unknown, it may throw opportunities, The investors who were prepared and had a reasonable amount of experience and objectivity were exposed to a positive Black swan event like Tech boom in 1999-2000 and some were even prudent to exit making a fortune.
Prepare than predict - Black swans are mostly tail events, Covid-19 was an unexpected event and for the investor who was prepared by holding cash it could have changed his fortunes. One thing is to safeguard ourselves from the Black swans and other is to make use of them by being positively exposed.
Always remember the future will be full of surprises as all the Black swan events do not have a antecedent. We try to look for a similar events in the future from past events, a gentle reminder to ourselves could be the next Black swan event or virus will not be like COVID because no one knows.
Beyond a point no one knows anything should be message, so don’t blindly believe authority or anyone.