Omissions

Supported by Greenhaven Road Capital, finding value off the beaten path.

People view acts of omission—the absence of an act—as far less intrusive or harmful than acts of commission—the committing of an act—even if the outcomes are the same or worse. Psychologists call this omission bias, and it expresses itself in a broad range of contexts.

That’s from Tobias Moskowitz’s Scorecasting. The opening chapter is about how referees tend to ‘swallow their whistle’ and let the players play. The action is decided on the field.

Fans, again, tend to, be okay with this because as one referee put it, “People aren’t paying to see us.” We want the great athletes battling it out. But while this omission tendency works in sports it doesn’t work in investing.

Marc Andreessen explained errors of omission nicely. If an investment doesn’t deliver, all that’s lost is 1X the money and time. However, if an investor misses an opportunity “you can lose 1,000x because that’s the upside of what you could have gotten. All of the mistakes I care about are mistakes of omission.”

For a long time, I thought that when investors wanted good deal-flow it was to avoid a market mechanism. People get better deals at garage sales than on eBay because there are more bidders. Now I see that the deal flow involves the chance of a good price but also any price at all.

Missed opportunities can be quite large. During the 2019 DJCO meeting, Charlie Munger said that the family fortune would be twice as large if not for a mistake of omission in the 1970s. The viewer gets the sense that Munger is frustrated less by the dollar loss and more by the mental misstep. Buffett too, notes that omissions are his “biggest mistake“.

To make this mistake, Buffett advises, focus on what really matters to a business.  Leases, contracts, patents, etc.  “are not the things that count.” Rather, “What counts is…whether you’ve really got a fix on the basic economics and how the industry’s likely to develop.”

Venture investor Bill Gurley saw this with Google. The team was well qualified, confident, and in a growing market. Gurley’s problem was the price and he neglected to invest. But, “I go back and the learning is that if you have remarkably asymmetric returns you have to ask yourself, ‘How high could up be and what could go right?’ because it’s not a 50/50 thing. If you thought there was a 20% chance you should still do it because the upside is so high.”

To get the Buffett’s fundamentals or Gurley’s ‘how-high?’ it helps to argue well. At Lux Capital, Josh Wolfe assigns, “a devil’s advocate, someone to identify why we shouldn’t do the deal, ask a priori what could go wrong.” They debate issues because the consensus ones tend to be the ones they’ve been most wrong about.

Omissions in investing are easy to see thanks to prices. Money is an easy metric but there are opportunity costs everywhere. Thanks for reading.