Value Investing

A Gentle And Practical Introduction To Value Investing

A Gentle And Practical Introduction To Value Investing by Jana Vembunarayanan, Seeking Wisdom

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The Joys Of Compounding

If, in some cataclysm, all of investing knowledge were to be destroyed, and only one sentence passed on to the next generations, what statement would contain the most information in the fewest words? Without blinking my eye I would pass on the definition given by Benjamin Graham who is the father of value investing.

A Gentle And Practical Introduction To Value Investing

An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative. Benjamin Graham

We will decipher the meaning of this definition later in the course. For now I’m going to play a game by copying the definition by hand. In the process of copying I would deliberately make a single character mistake. The copied statement with a single character mistake is given below.

An invettment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative. My copy with a single mistake

This copied text is given to my friend who will copy it by hand and deliberately make a single character mistake at a different place. He passes his copy to his friend and this continues 150 times. The copy produced by the last person in the chain will appear as given below.

Bo jowftunfou pqfsbujpo jt pof xijdi, vqpo uipspvhi bobmztjt, qspnjtft tbgfuz pg qsjodjqbm boe bo befrvbuf sfuvso. Pqfsbujpot opu nffujoh uiftf sfrvjsfnfout bsf tqfdvmbujwf. Copy of 150 th person with 150 mistakes

If I show the last copy to a stranger and tell him that there is a relationship between this and the original definition produced by Benjamin Graham. How would he react? He would think that I’m mad and most likely he’ll run away.

The rules I used to play this game, copying with a mistake, is what evolution, in the name of mutations , played for three billion years. The diversity of life we see all around us is a result of that. What’s this got to do with value investing? Hang on to your thoughts and I’ll make it all clear before the end of this lecture.

Evolution: Who colored the mice in Arizona?

In the deserts of Arizona, million-year-old black lava flows are inhabited by rock pocket mice. In this region, the mouse can be seen in two colors dark black and sandy-colored. The dark color mouse are found most often in black lava rocks. And white color mouse are found most often in sandy-colored habitat. Take a look at the image given below. Before the lava flows all the mouse were sandy-colored. A curious mind should ask couple of questions (1) how did some mice manage to change from sandy-colored to black? (2) how did the mice organize itself according to its surroundings?

A Gentle And Practical Introduction To Value Investing

For the mouse to change from sandy to black color three things needs to take place. They are (1) mutations (2) natural selection and (3) time. Let us look at each one of them in detail.

Mutations: In order to reproduce, organisms must make copies of their DNA . The copying of DNA is a complex biochemical processes. And mistakes happen during the copying process. These mistakes are mutations and they are the source of all the varieties (plants, bacteria, fish, lion, monkey, and humans) that we see around us. The game that I played above contained one kind of a mistake a typo or copying error. But during a DNA copying process many kinds of mistakes are possible.

If we think of DNA as being like a written text, then the categories of mutations are just like the familiar kinds of word processing errors. The DNA of a given species ranges from millions to billions of permutations of the four letters A, C, G, and T. The most common mistake is the substitution of an incorrect letter—a typo. But there are many other kinds of events that also occur, such as deletions and insertions of blocks of letters. Copy and paste errors also occur? these result in duplication of text. Groups from just a few letters on up to entire genes, or large blocks of genes, are duplicated at a significant frequency. Blocks of DNA letters are also rearranged—by inversions and the breakage and joining of parts of text. As a result, in every new individual, there are some new mutations. – The Making of the Fittest

In a mouse there is a gene called MC1R and when mutated turns the color of the mouse from white to black. What is the probability of this gene to mutate? In a gene the place where mutation can occur is called as a site. In a mouse, on average a mutation can occur in 2 out of every billion site. There are two copies of MC1R gene. And each MC1R gene has 10 sites. This tells us that there is about a 1 in 25 million chance of a mouse having a blackcausing mutation in the MC1R gene. This shows how accurate DNA copying is. But it’s not perfect.

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