I too subscribe to view that basing one’s investment decision on pure mathematical model is never a good idea as one is buying a part of business which has number of attributes which are not quantifiable and fairly dynamic. I think most of us will be on same page on this aspect. Now as Abhishek very rightly metioned, business dynamics change and things can go in a drastically different directions than anybody would have imagined.this is precisely the reason one should always look for “margin of safety” while buying businesses which will ensure that there is at least no loss of permanenet capital in the worst case scenario.
However, after ensuring enough margin of safety, whatever is the opportunity set available, how do we allocate capital? Do we divide capital equally amongst all or take some educated guess and allocate higher capital to some stocks than others? Is there a higher probability of business A being more valuable than businessB?If so why ?
Whatever understanding I have developed till now, tells me that some business have inherently better business economics than others and hence have higher probability of generating high value over longer period of time. Now do these business have some overarching charateristics that logically as well as quantitatively explain higher probability of sustained value creation.? I think the answer may be positive and we may be able to find such few characteristics and quantify them.
So in nutshell, eventhough with this kind of excercise we may not be able bring in “certainty” we can surely bring in higher probability of allocating higher capital to more value generating business than others in the portfolio. So this kind of excercise is not useful asa first step in stock selection but may come handy in a subsequent step while making capital allocation decision.
However in order for this to work, prerequisite is one buys stock which are fundamentally strong, has good past track record, decent management and is bought at substantial discount to intrinsic value.
