Friday, July 31, 2009

May the force be wth you - Part 2 ( Industry Strikes Back)

I have at numerous instances in life encounter people who argue with me that education is not a necessary condition for success. The classic example that they quote is of Dirubhai Ambani. Look at what he achieved as a school dropout. Didn’t Bill Gates also drop out of college to start Microsoft in a garage?

It is important to understand what a outlier event is or survivor bias is. I think it is critical for every individual to understand some basic statistics. The principle of normal distribution and basic probability.

To believe that Dirubhai Ambani who is essentially a outlier event beyond the six sigma levels reflects the mean is a folly. The average graduate would do better than a average under-graduate and taking it forward a average post grad would do better than an average graduate.

So what does this have to do with investing and my previous post on Porter’s model for industry analysis.

It for me answers why it is important to understand a industry structure.

There are industries where the dice is loaded against the participants in the industry. Ex Airlines where it is rare to find profitable companies. There are industries like commodity companies which follow cycles and it is difficult for a individual company to break out of cycle.

Does this mean that all participants in these industries are doomed? The answer is no. However the dice is loaded against the company. There could be a great airlines company which could be extremely profitable but would essentially reflect the outlier and not the mean of the industry.

So while analysing a company it is important to understand the industry structure under which operates so as to get a fair picture of what are the forces acting against or for the company.

As Buffett says “"When a manager for a reputation for brilliance tackles a business with a reputation for poor fundamental economics, then its the reputation of the business that remains unchanged”.


Anonymous said...


Your blog posts are incisive and informative. Might seem like a nitpick but Buffet should be spelt "Buffett". May not be meaningful for many but for us Buffett followers, I am sure it means a bit.


Daniel M. Ryan said...

There's a case to be made for the opposite approach: investing in the outlier that thrives in a stale or declining industry. There are, however, special risks in doing so and a post like yours does encourage watching out for them.

Ninad Kunder said...

Hi Anon

:-) You are right some sins are not redeeemable. Have taken note and done the needful.



Ninad Kunder said...

Hi Daniel

I agree with you in finding value in outlier events involving fallen heros.

I think the mistake that all of us make is equating a outlier to the mean.