Latest / The Dutch Investors / #84 | What Darwin taught us about Investing

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#84 | What Darwin taught us about Investing · The Dutch Investors

• 0:08
  SPEAKER_00: In 1681, the last dodo bird on Earth died.
• 0:13
  SPEAKER_00: It's a famous story, but we usually get the lesson wrong.
• 0:17
  SPEAKER_00: We think the dodo was stupid or lazy.
• 0:20
  SPEAKER_00: But for thousands of years, the dodo was actually a genius of its environment.
• 0:26
  SPEAKER_00: It lived on the island of Mauritius with zero predators.
• 0:32
  SPEAKER_00: Evolution taught it that being big, slow, and fearless was the most efficient way to live.
• 0:39
  SPEAKER_00: Then the environment changed, and we, sailors, arrived.
• 0:44
  SPEAKER_00: And because the dodo had no filter for danger, it walked right up to them.
• 0:50
  SPEAKER_00: That's a type 1 error.
• 0:53
  SPEAKER_00: Doing something you really shouldn't have done.
• 0:56
  SPEAKER_00: In nature, a type 1 error is a death sentence.
• 1:00
  SPEAKER_00: In investing, we do it every time we buy a very hot company without looking at the debt, the management team, trust the CEO who sounds too good to be true, or don't look at the financials.
• 1:12
  SPEAKER_00: We act like the dodo.
• 1:14
  SPEAKER_00: We walk right into the danger.
• 1:16
  SPEAKER_00: Today we're going to talk about how to stop being a dodo and become a better, more thoughtful investor.
• 1:25
  SPEAKER_00: Let's jump in.
• 1:47
  SPEAKER_00: If you look at the last 100 years of investing advice, it's mostly been about how to beat the market.
• 1:56
  SPEAKER_00: If you just Google investment books, you'll find books like$100 million offers, how to beat the market, or you can be a stock market genius.
• 2:07
  SPEAKER_00: It's all about how to find the next Apple, the next Tesla, the next palantier, the next big thing.
• 2:15
  SPEAKER_00: But if you look at history, there's a better way of doing things, a different approach.
• 2:21
  SPEAKER_00: It's a philosophy used by Pulak Prasat, a fund manager who spent years looking at how Darwin's theory of evolution applies to the stock market.
• 2:32
  SPEAKER_00: He wrote this book, What I Learned About Investing from Darwin.
• 2:37
  SPEAKER_00: And it's not what you expect.
• 2:38
  SPEAKER_00: It's not about survival of the fittest in a competitive aggressive way.
• 2:44
  SPEAKER_00: It's about the art of rejection.
• 2:47
  SPEAKER_00: It's about why the best investors are the ones who make the fewest mistakes.
• 2:51
  SPEAKER_00: Today I'm going to walk you through the Nalanda way.
• 2:55
  SPEAKER_00: We'll talk about Siberian foxes, sea urchins, and why the most productive thing you can do for your wealth is to be incredibly, almost embarrassingly, lazy.
• 3:09
  SPEAKER_00: So let's start with a simple fact.
• 3:12
  SPEAKER_00: You are going to be wrong a lot.
• 3:17
  SPEAKER_00: Even the best investors in the world have a hit rate that's barely above 50 or 60%.
• 3:23
  SPEAKER_00: But Pulak Prasat realized something interesting.
• 3:27
  SPEAKER_00: There are two ways to be wrong.
• 3:30
  SPEAKER_00: You can buy a company that goes to zero.
• 3:33
  SPEAKER_00: It's what we call a type 1 error.
• 3:36
  SPEAKER_00: Or you can not buy a company that goes up 10 times.
• 3:40
  SPEAKER_00: That's a type 2 error.
• 3:42
  SPEAKER_00: You can do things you're not supposed to do, or rather are healthier to avoid, like buying junk food at McDonald's.
• 3:50
  SPEAKER_00: And then there are things you're supposed to do, but don't do, like eating healthy every day, like going to that reunion or keeping in regular touch with your friends.
• 4:01
  SPEAKER_00: Especially the second one, missing out on things, having FOMO, especially in investing, is a big one among investors.
• 4:11
  SPEAKER_00: But in evolution, nature doesn't care about what you missed.
• 4:16
  SPEAKER_00: A lion doesn't die because it missed a single gazelle.
• 4:20
  SPEAKER_00: It dies because it got kicked in the head by a zebra.
• 4:23
  SPEAKER_00: It dies because of a type 1 error.
• 4:28
  SPEAKER_00: Now, Prasat's firm, Nalanda, is built on being a super rejector.
• 4:35
  SPEAKER_00: They look at a company and their first goal isn't to see how much money they can make.
• 4:41
  SPEAKER_00: It's to find a reason to say no.
• 4:44
  SPEAKER_00: Is their debt?
• 4:46
  SPEAKER_00: No.
• 4:46
  SPEAKER_00: Is the management questionable?
• 4:48
  SPEAKER_00: No.
• 4:49
  SPEAKER_00: Is the industry changing too fast?
• 4:52
  SPEAKER_00: No.
• 4:53
  SPEAKER_00: By the time they finish saying no, they're left with only a handful of companies.
• 4:58
  SPEAKER_00: They might miss the next Amazon, the next Netflix, the next Palantir, and they're okay with that.
• 5:06
  SPEAKER_00: Because if you never have a zero in your portfolio, the math of winning becomes a lot easier.
• 5:13
  SPEAKER_00: It's about survival first, returns second.
• 5:17
  SPEAKER_00: Any professor will tell you the risk of these two errors are inversely related.
• 5:24
  SPEAKER_00: Minimizing the risk of a type 1 error typically increases the risk of a type 2 error, and minimizing the risk of a type 2 error increases the risk of a type 1 error.
• 5:35
  SPEAKER_00: Imagine an overly optimistic investor who sees upside in almost every company.
• 5:41
  SPEAKER_00: This individual will make several type 1 errors by committing to bad investments, but will also not miss out on the few good investments.
• 5:51
  SPEAKER_00: On the other hand, an overly cautious investor who keeps finding reasons to reject every investment but is likely to make very few bad investments, but will lose out on some good investments.
• 6:04
  SPEAKER_00: Now let's take a look at evolution.
• 6:07
  SPEAKER_00: For animals, the goal is simple.
• 6:09
  SPEAKER_00: Survive long enough to reproduce.
• 6:13
  SPEAKER_00: In the wild, every creature is both predator and prey.
• 6:18
  SPEAKER_00: Let's start with prey animals like deer.
• 6:22
  SPEAKER_00: A type 1 error for a prey animal is underestimating danger.
• 6:27
  SPEAKER_00: Imagine a deer approaching a watering hole.
• 6:31
  SPEAKER_00: It must drink, but predators could be waiting.
• 6:35
  SPEAKER_00: Lions, leopards, crocodiles.
• 6:38
  SPEAKER_00: If the deer assumes it's safe when it isn't, the mistake will be fatal.
• 6:43
  SPEAKER_00: Over millions of years, prey species evolve to avoid that mistake.
• 6:49
  SPEAKER_00: Watch antelopes, zebras, or wildebeests.
• 6:53
  SPEAKER_00: They constantly jump at shadows.
• 6:56
  SPEAKER_00: They often see threats where none exist.
• 6:59
  SPEAKER_00: That's a type 2 error, avoiding water when no predator is present.
• 7:04
  SPEAKER_00: But evolution prefers type 2 mistakes.
• 7:08
  SPEAKER_00: Missing a drink is costly.
• 7:11
  SPEAKER_00: Misjudging a predator means death.
• 7:14
  SPEAKER_00: You see the same logic in mating behavior.
• 7:17
  SPEAKER_00: Male red deer, called stacks, fight for harems and females.
• 7:23
  SPEAKER_00: But real fights are rare.
• 7:25
  SPEAKER_00: Instead, they roar at each other, walk stiffly side by side, and display their size.
• 7:32
  SPEAKER_00: And these rituals can last up to an hour.
• 7:35
  SPEAKER_00: So why all the theater?
• 7:38
  SPEAKER_00: Well, because a true fight risks injury.
• 7:42
  SPEAKER_00: A wounded stack may never mate again, so stacks avoid the type 1 error, hurting themselves, even if it means committing type 2 errors like backing down when they might have won.
• 7:55
  SPEAKER_00: Predators face the same trade-off.
• 7:58
  SPEAKER_00: Take the cheetah, the fastest land mammal.
• 8:02
  SPEAKER_00: Yet it rarely attacks large animals like water buffalo.
• 8:07
  SPEAKER_00: Attacking the water buffalo would risk injury or waste precious energy.
• 8:12
  SPEAKER_00: Instead, cheetahs target smaller prey, like rabbits.
• 8:17
  SPEAKER_00: They accept many type 2 errors, letting potential meals go so they avoid the type 1 error of a dangerous hunt.
• 8:26
  SPEAKER_00: Across species, evolution has converged on the same rule.
• 8:31
  SPEAKER_00: Avoid the mistake that kills you.
• 8:34
  SPEAKER_00: Accept the mistake that only costs an opportunity.
• 8:38
  SPEAKER_00: Species that ignored this rule sometimes disappeared.
• 8:42
  SPEAKER_00: The flightless dodo, native to Mauritius, had no fear of humans when sailors arrived in the 1500s.
• 8:50
  SPEAKER_00: That's the ultimate type 1 error, and this species was extinct within a century.
• 8:56
  SPEAKER_00: Natural selection doesn't calculate probabilities, but across millions of years, it has embedded a simple strategy in animal behavior.
• 9:08
  SPEAKER_00: Warren Buffett figured this out at a young age.
• 9:12
  SPEAKER_00: He famously said, rule number one is never lose money, rule number two is never forget about the first rule.
• 9:21
  SPEAKER_00: Let's take a simple investing example.
• 9:24
  SPEAKER_00: Imagine there are 4,000 public companies.
• 9:28
  SPEAKER_00: Suppose 1,000 are good investments and 3,000 are bad.
• 9:35
  SPEAKER_00: Now meet this genius investor who claims he's right 80% of the time.
• 9:41
  SPEAKER_00: Sounds incredible.
• 9:42
  SPEAKER_00: But here's the catch.
• 9:45
  SPEAKER_00: Because there are far more bad companies than good ones, even this great investor still makes many mistakes.
• 9:54
  SPEAKER_00: Out of the thousand good companies, he correctly picks 800.
• 9:59
  SPEAKER_00: 80% of a thousand is 800.
• 10:03
  SPEAKER_00: But from the 3,000 bad ones, he still accidentally picks 600.
• 10:11
  SPEAKER_00: So in total, he selects 1400 companies.
• 10:15
  SPEAKER_00: But only 800 are actually good.
• 10:19
  SPEAKER_00: That means when he invests, the probability he picked a good company is 57%.
• 10:26
  SPEAKER_00: So even someone who is right 80% of the time still ends up with 43% bad investments.
• 10:35
  SPEAKER_00: Now, there's another key insight.
• 10:38
  SPEAKER_00: If the investor focuses on avoiding bad investments, so reducing type 1 errors, his success rate jumps dramatically from 57% to about 73%.
• 10:53
  SPEAKER_00: But if he focuses on not missing good opportunities, so reducing type 2 errors, his success rate barely improves.
• 11:02
  SPEAKER_00: So the lesson is quite simple.
• 11:05
  SPEAKER_00: Great investors aren't just great stock pickers, they're mostly great rejectors.
• 11:12
  SPEAKER_00: They win mostly by avoiding bad investments and not chasing every good opportunity.
• 11:20
  SPEAKER_00: Now let's talk about the Siberian fox.
• 11:24
  SPEAKER_00: In the 1950s, a Soviet scientist named Dmitry Believ wanted to see if he could turn wild silver foxes into pets.
• 11:34
  SPEAKER_00: He didn't select for looks.
• 11:36
  SPEAKER_00: He didn't care if they had pretty fur or big eyes, he only selected for a single thing: tameness.
• 11:43
  SPEAKER_00: If a fox didn't try to bite him, when he opened the cage, he bred it.
• 11:49
  SPEAKER_00: Within just a few generations, these foxes started changing.
• 11:54
  SPEAKER_00: Their ears flopped over, their tails started wagging, they even started responding to their names.
• 12:01
  SPEAKER_00: By selecting for just one core trait, tainess, the scientists got all the other dog-like traits for free.
• 12:11
  SPEAKER_00: In investing, we try to track 40 different metrics.
• 12:16
  SPEAKER_00: We look at PE ratios, technical charge, macro forecasts, outlooks, fundamentals, management quality.
• 12:26
  SPEAKER_00: Can be quite exhausting.
• 12:29
  SPEAKER_00: Now, Prasat argues we should be like the Soviet scientist.
• 12:34
  SPEAKER_00: We should pick one tame trade and stick to it.
• 12:38
  SPEAKER_00: And for him, that trade is ROCE, return on capital employed.
• 12:44
  SPEAKER_00: It's a simple measure of how much profit a company makes on the money it puts in.
• 12:50
  SPEAKER_00: If a company has a high ROCE for 20 years, it's most likely a tame fox.
• 12:56
  SPEAKER_00: It tells you the management is disciplined.
• 12:59
  SPEAKER_00: It tells you the customers love the product.
• 13:02
  SPEAKER_00: It tells you the competition probably won't kill them.
• 13:06
  SPEAKER_00: You don't need to overanalyze the rest.
• 13:08
  SPEAKER_00: If the tameness trait is there, the quality is most likely there as well.
• 13:16
  SPEAKER_00: I want to discuss maybe the most important thing in this episode.
• 13:21
  SPEAKER_00: Why do sea urchins last forever?
• 13:25
  SPEAKER_00: I know that's the question you've been wondering, right?
• 13:28
  SPEAKER_00: We often think that to survive, a company has to be cutting edge.
• 13:33
  SPEAKER_00: But think about the sea urchin.
• 13:36
  SPEAKER_00: They have been around for 450 million years.
• 13:41
  SPEAKER_00: They survived the extinction of the dinosaurs.
• 13:45
  SPEAKER_00: They even survived ice ages.
• 13:48
  SPEAKER_00: So why is that?
• 13:50
  SPEAKER_00: It's because they are robust.
• 13:53
  SPEAKER_00: A robust company isn't necessarily the fastest growing one.
• 13:58
  SPEAKER_00: It's the one that can survive a mess.
• 14:00
  SPEAKER_00: It's the one that can survive an apocalypse.
• 14:04
  SPEAKER_00: Prasat looks for companies with zero debt.
• 14:08
  SPEAKER_00: Debt is like a biological mutation that makes you fragile.
• 14:13
  SPEAKER_00: And we want anti-fragile.
• 14:15
  SPEAKER_00: It's fine when the sun is shining, but the moment the environment changes, interest rates go up, recession hits, that debt becomes a death trap.
• 14:26
  SPEAKER_00: And we want to avoid those types of errors.
• 14:30
  SPEAKER_00: He also looks for companies in boring industries.
• 14:33
  SPEAKER_00: If you're in tech, you have to reinvent yourself every couple of years.
• 14:38
  SPEAKER_00: That's a high-risk evolution.
• 14:41
  SPEAKER_00: But if you're in a slow-moving industry, you can just keep being a sea urchin.
• 14:47
  SPEAKER_00: You don't have to be a genius, you just have to be the one who doesn't die.
• 14:53
  SPEAKER_00: Which brings me to the final segment, the art of doing nothing.
• 14:59
  SPEAKER_00: There's a story about 24 rabbits that were released in Australia in 1859.
• 15:06
  SPEAKER_00: And for a long time nobody cared.
• 15:09
  SPEAKER_00: They were just rabbits.
• 15:12
  SPEAKER_00: But compounding is a sneaky thing.
• 15:15
  SPEAKER_00: It starts slow and then it explodes.
• 15:19
  SPEAKER_00: But by the 1920s, just a little over 60 years later, there were 10 billion rabbits.
• 15:28
  SPEAKER_00: Investing is exactly the same.
• 15:32
  SPEAKER_00: Because the real wealth isn't made in the first five years.
• 15:36
  SPEAKER_00: It's not even made in the first 10 years.
• 15:39
  SPEAKER_00: It's made in the last five years.
• 15:43
  SPEAKER_00: It's made 25 years from now.
• 15:47
  SPEAKER_00: But most of us are too busy to let that happen.
• 15:51
  SPEAKER_00: We see a 20% gain and we want to lock it in.
• 15:55
  SPEAKER_00: We see a scary headline in the news and we want to protect our capital.
• 16:00
  SPEAKER_00: Prasat's biggest lesson is to be very lazy.
• 16:05
  SPEAKER_00: Once you find a robust, high ROCE company, your only job is to stay out of the way.
• 16:13
  SPEAKER_00: If the business hasn't changed, you shouldn't change either.
• 16:17
  SPEAKER_00: Because compounding is like those Australian rabbits.
• 16:21
  SPEAKER_00: It only works if you leave the gate closed and let nature take its course.
• 16:28
  SPEAKER_00: So, if we take a page out of Darwin's book, What Does a Successful Investor Look Like?
• 16:36
  SPEAKER_00: They look a lot like a survivor, because they're not the loudest person in the room.
• 16:42
  SPEAKER_00: They aren't trading every day.
• 16:44
  SPEAKER_00: They spend 99% of their time saying no to things that look like dodo birds.
• 16:51
  SPEAKER_00: They use a simple filter, like ROCE, to find quality instead of chasing every new trend.
• 17:00
  SPEAKER_00: They prioritize robustness, anti-fragility, and zero debt so they can survive the extinction events that will happen in the market every few years.
• 17:14
  SPEAKER_00: And they have the discipline to be lazy, very lazy.
• 17:20
  SPEAKER_00: So, your task for this week is simple.
• 17:23
  SPEAKER_00: Look at one thing you own.
• 17:26
  SPEAKER_00: Ask yourself, is this a sea urchin that can last forever?
• 17:30
  SPEAKER_00: Or is it a dodo bird walking towards his death?
• 17:35
  SPEAKER_00: If it's a dodo, well, it's up to you what to do with it.
• 17:40
  SPEAKER_00: Thanks for listening to the Dutch investors, and if you found this useful, please make sure to give us a 5-star review.
• 17:47
  SPEAKER_00: That really helps us out.
• 17:50
  SPEAKER_00: This episode was inspired by Pulag's Prasat's What I Learned About Investing from Darwin.
• 17:56
  SPEAKER_00: Definitely check out the book.
• 17:59
  SPEAKER_00: And as always, stay curious, keep learning, and happy investing.