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The Multiplication Rule


formthirteen
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I try to follow the "the multiplication rule", so I thought a discussion around the concept would be interesting:

https://fundooprofessor.wordpress.com/2015/11/28/multiplication/

 

“Our failure here illustrates the importance of a guideline – stay with simple propositions – that we usually apply in investments as well as operations. If only one variable is key to a decision, and the variable has a 90% chance of going your way, the chance for a successful outcome is obviously 90%. But if ten independent variables need to break favorably for a successful result, and each has a 90% probability of success, the likelihood of having a winner is only 35%. In our zinc venture, we solved most of the problems. But one proved intractable, and that was one too many. Since a chain is no stronger than its weakest link, it makes sense to look for – if you’ll excuse an oxymoron – mono-linked chains.”

 

Warren Buffett:

We wouldn’t have liked those 99:1 odds – and never will. A small chance of distress or disgrace cannot, in our view, be offset by a large chance of extra returns.

 

Charlie Munger:

And the one thing that all those winning betters in the whole history of people who've beaten the pari-mutuel system have is quite simple. They bet very seldom.

 

It's not given to human beings to have such talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it—who look and sift the world for a mispriced be—that they can occasionally find one.

 

And the wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don't. It's just that simple.

 

Douglas Adams

“The major difference between a thing that might go wrong and a thing that cannot possibly go wrong is that when a thing that cannot possibly go wrong goes wrong it usually turns out to be impossible to get at or repair.”

 

This concept simplifies the investment process. However, as Buffett points out, you should not write off low-probability events with high consequences.

 

I agree that the best way of mitigating risk is buying good businesses:

“When we looked at that business – basically, my partner, Charlie, and I, we needed to decide if there was some untapped pricing power there – whether that $1.95 box of candy could sell for $2 to $2.25. If it could sell for $2.25 or another $0.30 per pound that was $4.8 million on 16 million pounds. Which on a $25 million purchase price was fine. ”

 

Keep it simple, and be paranoid.

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