In my last article I talked about how we could cultivate the routine of asking probing questions in order to think on another level. Asking the question “who doesn’t know that” is an idea I got from Howard Marks (Trades, Portfolio). While I think that is a good approach, I would also like to address this second level thinking idea from another angle, which I am fortunate enough to learn from one of the book recommendations from my hero Charlie Munger (Trades, Portfolio). This book is called Living Within Limits by Garrett Harding.
In essence, this approach involves one of Munger’s big ideas – disproving evidence. It is harder than Howard Marks' (Trades, Portfolio) approach but it is also more thought provoking and deeper.
Now let’s jump right into an example. In Chapter 24 of Living Within Limits, Harding told the story of an earthquake in Guatemala. Here are his original words and the bolded words are the application of second-level thinking by inversion and disproving assertions.
On 4 February 1976, at 3:05 A.M., an earthquake struck Guatemala, killing 22,778 and injuring 76,504, according to the accepted statistics. The quake measured 7.5 on the Richter scale: this would be reckoned a strong quake, but not a devastating one had it occurred in the United States. But in Guatemala nearly 100,000 people were killed and injured; the dead alone amounted to 0.37% of the population of 6.2 million, or 13% of the yearly population growth (at 2.8% per year). Why was the loss so great?
A detailed study of a village of 1,577 Indians was revealing. The greatest mortality was suffered by people who lived in adobe casitas (“little houses”) roofed with heavy wooden timbers. More than 85 percent of the population was housed. People in shacks made of cornstalks and mud-chinked slats fared much better. (Expensive reinforced concrete homes were best, but there were few of these in this village.)
The cost of adobe homes is low in money but high in “sweat equity” for those who do their own work. Cornstalks and slats are cheaper in both money and labor. Because of these differences, mortality in the village, and throughout most of Guatemala, was complete correlated with socioeconomic status.
So what should we say killed those 22,778 Guatemalans? The earthquake? But most of them would have survived had they lived in reinforced concrete houses. Since concrete costs money, should we attribute the deaths to poverty? But the poorest people of all, living in cornstalk or slat shacks, survived the best. Why didn’t most people live in the simple abodes? Because increasing population had nearly exhausted the resources of the biotic environment – photosynthetic products like trees and cornstocks. Should we then attribute the earthquake deaths to overpopulation?
It is interesting to note that the association of economic status with mortality rate in 1976 was the reverse of what it had been in the great Guatemalan quake of 1918. Earlier, with a much smaller population, the ratio of photosynthetic products to human population was much more favorable, and the poor could easily find cornstalks and the like to use in making their shanties. The “colonials,” the richer element of the population, could afford to hire poor people to make adobe houses for them (concrete was not in fashion). In the 1918 earthquake the rich suffered greater mortality than the poor. In spite of this fact, and perhaps because few saw the relation of housing to earthquake mortality, by 1925 the prestige and comfort of living in a cooler adobe house motivated ever more poor people to invest sweat equity in producing houses like those of the colonials. For this they ultimately suffered.
This is one of the best examples that I have ever encountered in terms of thinking differently and better. Although it has nothing to do with investment per se, it offers a great path of thinking that we can follow in doing investment analysis. In the above example, Harding basically revoked all the superficial answers to the cause of the deaths by citing invalidated evidence. All it required was a little more digging. What’s more remarkable is the comparison between the two earthquakes and figure out what are the differences and why.
I won’t go so far into another investment example to illustrate the point. However, I highly encourage the reader to spend 15-30 minutes to go through this exercise once for an aspect of an investment idea. For example, let’s say you are analyzing Apple (AAPL, Financial) and you want to get an idea of why iPhone 6 and 6 Plus are selling so well. Is it because the 6 Plus is bigger? Is it because they are much better than iPhone 5s? If you have come out with an answer, try your best to find disconfirming evidence. You may be surprised by what you find out.
