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Drop your familiar tools - An investors guide to rethink models

In 1949 smoke jumpers faced a situation in Montana’s Mann Gulch where fire broke out and was fast spreading and high winds caused fire to explode all over the place. The fire was racing very fast just 100 yards behind the smokejumpers who were there to control the fire.


Wagner Dodge the Crew foreman who managed to survive the fire storm did a remarkable thing. When fire is fast approaching from the back the usual response would be to just run and escape from the fire and not to counterintuitively think of anything else because your “Amygdala” would have taken over and you would be in panic.


Dodge did the counterintuitive thing which was he created a “Escape fire” which is he lit matchsticks and threw it at the grass front of him, this was one of the most counterintuitive things to do and left his crew in a state of confusion and awe. when escaping a fire why would you throw matchsticks to start a fire forward and run towards it ? Well, the answer is that it was a remarkable insight and improvisation by dodge to start the “Escape fire” When the fire is fast approaching from back there was no more grass to feed on as the grass would’ve been already burnt which then will reduce the intensity and help the smoke jumpers to move to a safe spot.


Another important insight is that just before Dodge threw matchsticks in front to start an Escape fire he ordered the crew to drop their heavy equipment. The crew had been running uphill with 20-pound packs carrying axes, saws, shovels etc. If you’re running for life the most obvious thing to do is to cut down your weight your carrying, 2 of crew members dropped their equipment and ran over to ridge of safety. Others who ran with their tools and were caught by the flames, 13 of them died in this incident.


Later investigations in similar situations revealed that without their tools and backpacks, the crew could have moved 15-20% faster. Most would have lived had they simply “Drooped their tools” It’s the very Unwillingness of people to drop their tools that turns some of these dramas into tragedies. Rather than adapting to unfamiliar situations, most of the people became rigid under pressure and “regress to what they know best”. The above is a metaphor of how the lack of unwillingness to drop familiar tools will cost you more than retaining them.


what does this episode of smoke jumper’s teach us about investing?


In business schools you would’ve been taught to think about equity valuations using a DCF or other mathematical models that predict the future growth and discounting it back to the present value or a few ratios like P/E ratio and ratios like EV/ EBIDTA etc. These are the favorite tools of an equity investor where we buy and sell based on these parameters, not only in business schools but also in most academic books we see such models promising to find values.


What about situations like Covid-19 when the markets were in a free fall ? What about the current situation where people say buy at any price? When there is a BLACK SWAN event which we cannot predict what do we do? I know few investors who said let’s buy because the P/E looks cheaper and a few others who kept saying I'm not buying because my "DCF MODEL" says its still over valued, these investors however did regret later of not deciding.


When situations are extraordinary like what happened in the Gulch most of us “regress to what we know best” that is to rely on models or throw darts and buy anything at sight or not act because of our models. It would never occur to think counterintuitively to sell weak positions and buy more of better performers based on judgment. Most investors say they never hold cash but I always hold cash which is another way of saying no matter what BLACK SWAN event arises we are always prepared. Which is how at situations like covid-19 when the market dropped drastically, we were able to buy and gain an edge over other investors who were still clinging to their Familiar models.


To become a better investor, we need to learn to “DROP FAMILIAR TOOLS” and “RE-THINK” our own assumptions. When circumstances change our tools of valuations and processes should be changed, but what's stopping us from changing our familiar tools ?


Dropping your familiar tools creates an existential crisis – That’s what happened with the smoke jumpers, when Wagner Dodge told his crew to drop their tools and run, they couldn’t because dropping tools would be like shedding their identity as a fire fighter, even one had his tools clinging to his hands later. Similarly, as investors when we are told don’t use P/E or a DCF we are left in an identity crisis which makes it very hard for us to shed our tools.

Discarding your equipment means admitting failure – Its so hard to adopt a new tool quickly which means giving up and admitting failure, and causes a vicious cycle of fear and anxiety. We waste 20 years of our time with the wrong tools and thoughts rather than wasting 2 years to find the correct tools.


Another familiar tool an investor faces hard to let go is “Euphoric buying” or “FOMO” These are mental tools which we never let go. It’s very counterintuitive and hard to just sit in the sidelines and watch other investors make money and wait patiently for an opportunity. What would dropping these “Mental Tools” mean? Learn to adopt new tools like Patience and creating a war-chest when others are impulsively buying. Learn to drop excel sheet analysis and adopt a Multi-disciplinary thinking approach which is more flexible and adaptable at most circumstances.



A few points to keep in mind on how to think of this problem


Learn to Re-Think everything we have been doing until now even the most obvious ideas and tools, be it our clustered tools of thinking ourselves as a “Growth investor”, “Value investor” etc.


Mental tools of an investor are the same as physical tools of a smoke jumper. Dropping mental tools of an investor is just like dropping back packs of a smoke jumper we face an identity crisis but its in the best interest to drop it which will help you to save yourself in many circumstances.


Question even the most obvious assumption and tools, one tool I questioned is - Is intrinsic value true or a reliable measure to calculate fair value? this led me to become more critical of the notion of Intrinsic value which most investors hold as a “Holy Grail” in their mental tool box in buying companies. Although I follow Warren buffet, I have some reservations in this because the same Buffett has mentioned that we cannot predict anything and intrinsic value requires you to predict.


Re-frame from dropping your familiar tools as existential crisis to an act of survival and an act of changing beliefs to get better outcomes.


A study from the book Think-again shows that better predictors updated their beliefs more frequently than others. which is to say beliefs should be constantly updated, so are the tools of thinking.


while we don't want to own an old 1997 model car anymore, why do we still hold beliefs that were formed in 1997 ?


Nassim taleb says in Black swan - Platonic fold is the gap between reality and your own idea of reality and its best to know when the models ceases to exit. So always know the limitations of your models and tools in reality.




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