Investment
Three ways to win
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When Leonardo da Vinci was sketching out his design for one of the earliest parachutes in the year 1483, he no doubt understood the consequences of such a device failing. It would not have taken Leonardo much time at all to realize that two would be better than one.

Today, skydivers nearly always jump with a main parachute and a reserve. The theory is as follows: if one parachute has, say, a 1 per cent chance of failing; then by carrying two, the chance of failure reduces to 0.01 per cent, one hundred time less. We are even more conservative. Should we ever find ourselves jumping out of an aeroplane, we would not be satisfied with two parachutes: we would want three.

This is how we approach equity investing with a primary focus on capital preservation at all times. We are not satisfied with one, or even two ways in which we can profit from an investment. We want three. For the same reason that skydivers choose multiple parachutes, the more ways in which we can win on an investment, the lower the probability of loss.

The combination of three different ways in which we can win on an equity investment results in a highly-favourable probability distribution of potential outcomes. If we are wrong on one, or even two dimensions of the thesis, our downside should still be somewhat limited if we are right on the third. While if we are correct on two, or even three dimensions, then the upside should be large. Limited downside with large upside are the bets that investors should spend their time seeking to identify.

 

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