Two of the best books I’ve read in recent years are Sapiens, by Yuval Noah Harari, and The Beginning of Infinity, by David Deutsch.
Neither is related to investing, but they’ve been incredibly valuable in shaping how I think about it. Specifically in regard to the importance of narrative and the nature of knowledge.
Harari argues that much of human interaction — and, by extension, our institutions, organisations, and society as a whole — is shaped by shared myths. These collective illusions help frame our understanding of the world and establish the rules for how we interact.
Think of things like religion, government, law, corporations and even money itself. These are constructs that exist solely in our collective imagination, yet despite their intangible (and sometimes arbitrary) nature, they wield immense power in shaping our world.
The relevance to the share market is obvious. At a fundamental level, prices are determined by the interaction of buyers and sellers, each of which is driven by their own circumstance and influenced by a given mythos.
For some, the narrative will be informed by a hard-nosed analysis of fundamental data, for others it’ll be the study of technical patterns. Some will be guided by what their mate told them at the pub, or something they read on social media. Whatever the mix, the resultant market price will be a reflection of the dominant narrative.
Often the consensus view will eventually be understood to be wrong, as I’ve written about previously. But not always.
So our job as investors is to find a narrative that best matches up with reality. And then, armed with that, exploit opportunities where the prevailing market view doesn’t (yet) align. The idea being that reality will unfold in a way that strengthens and supports our ‘story’ to a degree that it becomes the prevailing perspective.
You could say that good investing is effectively narrative arbitrage.
Phrased like this, it makes the share market seem like nothing other than a tussle between the fevered imaginations of a bunch of emotional apes. Which, I suppose, is probably not an entirely unfair description.
But stories can sometimes capture profound truths about the nature of things, offering deep understanding and some measure of foresight. And, in our context, a good narrative is just another way of saying a good investment thesis.
And what makes a story/narrative/thesis ‘good’ is if it can provide good explanations. This is where Deutch’s ideas on the philosophy of science are applicable.
He argues that good explanations are deep, causal, and falsifiable, providing clarity by addressing underlying principles rather than surface-level details. They not only describe what is happening but also explain why it happens, and under what conditions the explanation might fail.
As such, a strong investment thesis should be:
- Comprehensive and grounded in the fundamental drivers of a business’s success, such as its competitive advantages, addressable market, or management’s execution capability.
- Causal, clearly linking these drivers to specific outcomes, like revenue growth or margin expansion. And, ultimately, a higher share price.
- Falsifiable, with well-defined metrics or milestones that allow investors to test its validity as new information becomes available.
You have to go beyond superficial descriptions.
Simply saying “this company is growing fast” or “the sector is booming” might be true statements, but they lack explanatory depth. They don’t say why these observations should continue to be true, and how that might translate into share price appreciation. And aside from a volatile share price, which can throw you lots of false signals, there’s nothing you can use to gauge the merit of your thesis.
High level observations are a good start, but you need to dig below the surface and weave everything you find into a broader narrative that is rational, self-consistent and testable. And, importantly, your story must continue to evolve as as circumstances change — a reasonable thesis can quickly become a fool’s fairy tale if you fail to adapt to new information and refine your narrative.
At its core, good investing is about crafting and refining narratives that align with reality — not just ones that align with our prejudices and confirm our desires, but those that withstand scrutiny and adapt to new evidence.
It’s not easy, but it’ll help you make better sense of the world — and, in turn, build some serious wealth along the way.
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