When to Bet Big, and When Not To
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It was mid-1974.
Fred Smith, the founder of FedEx had a problem at hand. FedEx was a young company, just three years old, and primarily due to rising fuel costs, found itself millions of dollars in debt and on the brink of bankruptcy.
As per demands from oil companies that provided fuel to run FedEx’s planes, every Monday, the latter was required to prepay for the predictable weekly usage of jet fuel. It was one of those Fridays and FedEx had just well-nigh $5,000 in its wall account, while it needed $24,000 for the jet fuel payment for the coming week.
FedEx’s key investors had refused to ladle it out, as the visitor was once in a poor financial condition. Its senior executives had lost hopes.
One of them, Roger Frock, who recounted this story in his typesetting Changing How the World Does Business, wrote, “…when I arrived when in office on Monday morning, much to my surprise, the wall wastefulness stood at nearly $32,000.”
When he asked Fred where the funds had come from, he responded, “The meeting with the General Dynamics workbench was a thorax and I knew we needed money for Monday, so I took a plane to Las Vegas and won $27,000.”
Roger was shocked and asked Fred, “You midpoint you took our last $5,000! How could you do that?”
“What difference did it make?” Fred replied. “Without the funds for the fuel companies, we couldn’t have flown anyway.”
The $27,000 was not the solution to all of FedEx’s problems, but Fred viewed it as a hopeful sign that things would go up from there. He used the money as motivation to obtain increasingly funding, and sooner raised flipside $11 million.
After stabilizing financially, he helped launch a uncontrived mail razzmatazz wayfarers to uplift the company’s visibility. By 1976, FedEx produced its first profit of $3.6 million. A few years later, it went public and has been thriving overly since.
Anyways, the reason I have shared Fred’s story with you is to lead you to a couple of ways to squint at this incident –
- You squint at how ingenious he was to have saved his young visitor from a disaster. If he had not won at the casino that day, FedEx may have not been in existence today.
- You squint at how unwise he was to have bet the last $5000 in casino. If he lost at the casino that day, FedEx would have been in a deeper problem and may not been in existence today.
Like Fred told his colleague, in any case, whether he won or lost, FedEx would have been staring from inside a deep financial hole, not knowing how to come out of it. It was a matter of life and death for FedEx, and so the founder played the gamble.
I checked and found that the odds of winning at blackjack – the game Fred played at the casino – can be as upper as 42%. Which means, the odds of losing can be 58% (using vital math and excluding any technicalities of the game). In Fred’s case, these odds did not matter much considering if he had lost, he would not have lost just the $5000 he bet, but his visitor that was worth way more. And so, he played, and by chance, won.
Most decisions we make in life are not like that, when we must bet all or large part of what we have on the ‘chance’ to survive and get out of our troubles.
While making such decisions, gingerly an ‘expected value’ intuitively is an constructive way to decide what nomination to make – play the game or not.
“What is expected value?” you may wonder.
In the 1989 AGM of Berkshire Hathaway, Warren Buffett was asked well-nigh his tideway to risk and investment visualization making, and he replied –
Take the probability of loss times the value of possible loss from the probability of proceeds times the value of possible gain. That is what we’re trying to do. It’s imperfect, but that’s what it’s all about.
As an equation, it reads thus –
Success in investing = (Probability of proceeds X Value of possible gain) – (Probability of loss X Value of possible loss) = A positive number
Michael Mauboussin describes this concept as expected value. It is unquestionably a very simple concept.
In essence, you don’t have to be right a lot, you just have to be right well-nigh your big bets at the right time. Here, while the probabilities matter a lot, so do the consequences i.e., value of possible gain/loss.
It is important to get that equation right.
If you are willing to buy a stock, say, priced at 60-70x P/E or more, thinking the probability of it going higher is good, moreover remember the magnitude of a period of weakness/slowdown in business. Such expensively priced stocks ride on upper expectations, and the consequences of a small slip could be really bad.
Given that we often tell ourselves false stories to stave the truth, with our minds overcast by denial, optimism and negative decision-making tendencies, the expected value idea can help us stave the landmine of expensive, hot and bad stocks that imbricate a large ground in stock investing.
Buffett says –
In order to succeed you must first survive.
In one way, Fred Smith would not have well-set with Buffett when he gambled FedEx’s future on a game of blackjack and got it right in doing so. In another, he would have well-set with Buffett and thus realized that if FedEx had to succeed in the future, the visitor had to survive that Friday when he played the gamble to win $27000.
When it comes to your own visualization making in life, you must decide when you must act like Fred did (rare such situations) and when you must not.
Telling someone you love that you love her/him and want to marry, is one such situation like Fred’s. You say it and may squatter rejection. You don’t say, and your love story may end there too. So, you must bet.
Quitting your job that’s taking a toll on your life and happiness is flipside such situation. You quit and may get into a financial problem (which can be managed by saving unbearable surpassing quitting and living frugally). You don’t quit, and the emotional and physical toll may just get increasingly burdensome. So, you must bet.
Interestingly, I have been through both these situations. I bet it all and, luckily, did not lose.
When it comes to investing, however, I stave such bets.
The stock market is not a casino. Unlike a casino, the longer you play here, the increasingly are your chances to win (survive and thrive). But it’s important to –
- Play by a process and stick with it through the cycles.
- Think and act like owner of businesses and not renter of stocks.
- Use the expected value model to decide which businesses you want to own (where the expected value wordplay is positive) and which ones you must stave (where the wordplay is negative).
Taking well-nigh the nature of stock market, Charlie Munger in his speech “A Lesson on Elementary, Worldly Wisdom As It Relates To Investment Management & Business” that he gave at the USC Merchantry School in 1994, said –
It’s not given to human beings to have such talent that they can just know everything well-nigh everything all the time. But it is given to human beings who work nonflexible at it — who squint and sift the world for a mispriced bet — that they can occasionally find one. And the wise ones bet heavily when the world offers them that opportunity.
They bet big when they have the odds. And the rest of the time, they don’t. It’s just that simple.
Whatever you do, like Fred did or like Charlie advised, aim to survive.
After all, survival, gambling or not, is the only road to riches.
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