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Jae Jun
Jae Jun
Articles (197)  | Author's Website |

The Yellowstone Factor: Minimizing Downside Risk

Mohnish Pabrai's take on the Yellowstone factor and how to minimize risks when facing catastrophic financial events for investors

May 17, 2018

With the weather warming up, kayaks on the water and RVs heading towards Yellowstone, Mohnish Pabrai (Trades, Portfolio) wrote about the Yellowstone factor, and it is short and sweet.

Mohnish Pabrai (Trades, Portfolio) knows his geography.

"Yellowstone National Park is volcanic in nature, yet not one cone or caldera is visible. In the 1960s, this mystery was finally solved: The entire park -- 2.2 million acres -- is the caldera. It is the largest active supervolcano on Earth. Yellowstone started erupting about 17 million years ago, and it has a cycle of erupting roughly every 600,000 years. The last eruption was 630,000 years ago, so it's about 30,000 years past due on the next big one."

Although Yellowstone is closer to the West Coast, if it explodes, the entire country will be devastated. There's always talk about volcanoes being overdue, to the point where it's like crying wolf.

But that is the reality of the Yellowstone factor in life and in the markets.

  • It's a catastrophic event that is highly unlikely to happen. But it also means that the probability of it happening is not 0%.
  • The Yellowstone factor alone implies that not a single business has a safe future.

Other categories that fall into the "Yellowstone" category include:

  • War.
  • Terrorism.
  • Fraudulent financial statements.
  • Dishonest management.
  • Disruptive innovation.

The goal isn't to have an accurate probability of each happening. It also does not revolve around precise math.

Pabrai also mentions that he doesn't need to use spreadsheets to know a good investment.

Seeing as how Old School Value sells spreadsheets, my counter is that we provide a framework, a manageable field of investment ideas and helping you find the true value range.

This is much like when you go car shopping. There's a sticker price (the stock market price), but the true price you pay is within a certain range. And unless you look at cars all day, every day, you won't know what that good range is. And that's where you should use tools to quickly get through this step instead of getting paralyzed.

With investing, back-of-envelope calculations and internal rules of thumbs are very important. There simply aren't enough data points available to work out the exact odds.

So what's the way to quickly minimize risk?

  1. Invest in what you know or comfortable with. This will help you stay in control.
  2. Buy well-run and good businesses to put the odds in your favor.
  3. Buy with a margin of safety so that even if you lose, you don't lose much.

With three simple (but tough) rules to follow, your portfolio will be balanced to withstand the Yellowstone factor, if it does come to occur.

About the author:

Jae Jun
Old School Value is a stock grader, value screener and valuation tool for busy value investors.

Visit Jae Jun's Website


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