Warren Buffett’s letters to shareholders is a goldmine of investing wisdom. Like him, Jeff Bezos too has written letters to his shareholders since Amazon went public in 1997. A unique thing about Bezos’ letters is that every year, he used to attach his original 1997 letter. Every year. It’s like telling his shareholders: see I told you back in 1997 how we would operate according to a certain philosophy and here we are doing that. Bezos’ successor Andy Jassy has continued the tradition of attaching the 1997 letter to his.

One of the lessons I learnt by reading Bezos’ letters is the importance of experimenting. By definition no one knows whether an experiment will succeed or not. When the experiments succeed the outcomes could be huge. And when they fail, hopefully the costs are minimal. So each experiment is by itself an asymmetric bet- huge upsides and limited downsides. So by having many experiments going on, Bezos thinks that they are placing themselves in the path of good luck. One big win can pay for many failed experiments. For example- AWS, a successful experiment, is alone worth maybe a $1 Trillion. Whereas the Fire Phone, a failed experiment, that cost Amazon $170 M. It’s like one AWS can pay for 5,800 Fire Phone projects!

Now, experiment, luck, chance are not words associated with money. I mean- you work all your life and save money and the last thing you want is someone to come and experiment with it. That is why all Mutual Fund ads use words like safety, security, peace of mind, durability, strength to give you the assurance that nothing adverse will happen to your money. I was watching a speech by Mr. E.A. Sundaram and he said something like they invest fairly conservatively. Their clients are already rich and the last thing they want is for some young investment manager to come and lose all that money for them. So Mr. Sundaram’s investment philosophy per my interpretation and in my words would be something like: aim for index beating returns with less/very less risk.

Pulak Prasad and Terry Smith among several others are two investors who don’t invest in businesses that are in a race and you have to figure out who will win the race; rather they invest in businesses that have already won the race. For example it’s hard to figure out how much market share Hero would have vs Bajaj vs TVS. But it is as evident as day light who is the market leader in premium motor bikes. So you may invest in a business like Eicher Motors when its share price is relatively cheap.

However when you invest conservatively you will make mistakes of omission. For example, in his book Pulak Prasad says that they missed out on investing in Eicher because they avoid turnarounds. Hence even though Eicher is/was a fantastic business, they missed out on a potential 100 bagger.

When anybody calculates their performance (IRR), it will show them based on what they did and not what they missed. For example, when Nalanda says that they have a return ratio of 17% CAGR over a long time, it is a measure of what they did and not what they omitted. Errors of omission are invisible. Errors of omission can be very costly. (CDSL, Suzlon, Saregama are some examples of my own errors of omission.)

We humans have the power to ignore what is uncomfortable especially when it is not visible. It’s called cognitive dissonance. So we can fool ourselves into looking at last year’s performance and ignoring errors of omission. But good thinkers like Pulak Prasad acknowledge errors of omission and don’t wish it away. It will hurt them but they will acknowledge it in their letters and other communications (like Pulak Prasad did in his book). However, they make peace with the fact that a conservative approach to investing will lead to errors of omission. In case you are wondering what is the difference: in cognitive dissonance you suppress the thoughts in your head about errors of omission whereas in making peace you acknowledge those mistakes, learn from them while also realizing that mistakes are inevitable. You can hope to make fewer mistakes but not zero mistakes.

Coming back to the importance of experiments. I decided to give the Bezos approach a try. So I started investing small sums of money in different businesses. By small I mean say 1%. The idea was to learn about these businesses and at some time in the future I would reassess these investments. If they turn out to be promising opportunities, I would invest more. And if not, I could always sell them.

So where am I in this journey?

Short answer: Just putting this idea to practice now.

Long answer: Last year, as I was reading Pulak Prasad’s book I came across this idea: If you try to reduce errors of commission, you will end up with errors of omission. And if you try to reduce errors of omission, you will end up with errors of commission. Warren Buffett for example tries to reduce Errors of Commission and hence ends up missing something like Wal Mart or Google. Jeff Bezos on the other hand, avoid Errors of Omission and hence ends up committing a $170 M mistake like the Fire Phone. I wrote a blog on this sometime back.

So, reading Pulak Prasad’s book helped me crystallize this idea better in my head. And that is when I realized that maybe I should give Bezos idea a try. Like I said: 1 successful experiment like AWS can pay for 5,800 unsuccessful ones like Fire Phone.

Hence going forward, I plan to create a long tail of investments that I think are interesting. And evaluate those ideas after a year to see if I should invest more or do nothing or exit. In fact, my own track record seems to suggest that businesses that I understood well, earned lesser returns than businesses where I invested with lesser understanding but as my understanding and conviction improved those investments delivered better returns.

The downside of this strategy is:

1. Time and money invested in a new unknown business (to me) is time and money not invested in businesses that are well known (to me).
2. You may end up with a long tail of businesses and it may get cluttered like a zoo. Hence it is important to set a 1 year deadline to decide to either invest more or exit. Staying at the same allocation should not be an option. (At one point of time, Peter Lynch had 1400 stocks in his portfolio. And he listened to a presentation on The Body Shop and decided to invest a small portion in it, only to realize that The Body Shop was already in his portfolio. Hopefully, a 1 year deadline should help help us avoid that. 🙂 )
3. Higher chance of losing money. Different industries have different dynamics and it will take months or years to understand and appreciate them. And since the investments are made with minimal research the chances of losing money are higher. But the chances of learning something new are also higher.

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Last Friday, I was presenting to a group of friends and I presented on a publishing business. I told them that it was a business where my investment is just 1% and that is when a small friendly debate started on whether one should invest only after one fully understands the business or have a lighter approach like the one I described above. (I used to be the first kinds and I am now trying the second approach.)

I thought it was an interesting idea and one that needed to be written about.