“It is the unemotional, reserved, calm, detached warrior who wins, not the hothead seeking vengeance and not the ambitious seeker of fortune.”
-Sun Tzu, The Art of War
I stumbled upon the quote above the other day and I really liked it, because I think it has a lot of wisdom. If you think about it from the personal life perspective, it for sure is more helpful to stay calm, unemotional and detached during a heated argument with a friend, a colleague or when making important choices. We can probably all agree that being “hothead seeking vengeance” is counter-productive in such situations.
But then I thought, would Sun Tzu’s advice be helpful in other situations, such as investing? The words “seeker of fortune” struck me and I immediately thought of the rushed Tesla or Zoom buyers nowadays. On the flip side, if you recall the principles of value investing, being “unemotional, reserved, calm, detached warrior (investor)” sounds awfully familiar- not reacting to market turmoils erratically, staying rational and objective when analyzing a company, exploiting Mr. Market’s mood swings rather than subjecting to them. The question is, would Sun Tzu be a value investor and can we learn from him?
Who was Sun Tzu?
Sun Tzu was a general, military strategist and philosopher in ancient China who lived around 500 BC. He is the author of military strategy book “The Art of War”, which had been forgotten for centuries, but was rediscovered, translated and subsequently implemented in modern warfare around the year 1900.
Why am I you telling you about a general, when our goal is to make money on the markets? Because Sun Tzu wrote his book about strategies and tactics of war in such a way that people realized his principles and wisdom is implementable in other areas as well- for example business, which is very similar to warfare strategy in many regards.
Japanese companies implemented The Art of War as early as in the 1960 and a lot of Western companies followed suit. The book has been translated to many languages and I have decided I would like to show you main ideas from the some of the chapters to enhance our value investing knowledge.
The Art of War (Investing)
Chapter 1: Estimates
Sun Tzu begins his introduction by estimates and stressing the fact that war should be “thoroughly studied”. In our case, it’s no different- it is quite self-evident that to become a successful investor, one must study their craft, learn about companies, business and markets as much as possible. It also has one very important implication- learning never stops. Even Warren Buffet still learns to this day and we shouldn’t think there is some final level where we know everything and don’t have to learn. The only constant is change- the best example is Warren Buffet, who is direct successor of Benjamin Graham (the father of value investing), but who has also been improving value investing approach his whole life.
If you compare it to the way some people (even professional) invest- randomly allocating money to companies, because the price has risen or because there is some hype around it (*cough* Zoom *cough*), there is a huge difference and you decide, which approach is more rational.
Chapter 2: Waging War
One of my favorite chapters from the book, where Sun Tzu describes measuring, balancing and allocating resources. Winning a war isn’t cheap and it’s a big part of general’s work to plan out the spending and resources needed. The chapter looks like if it was written by an accountant, and rightly so.
To draw a parallel, investing is exactly like that- measuring companies’ cash reserves, debt levels, profitability and the allocating money into it if it’s viable. Sun Tzu understood the importance of thorough preparation and measurement before taking action, and so should we first measure twice and then buy, as incorrect measurement leads to losses.
Again, there are investors who literally gamble with their money, don’t measure anything, but invest simply because a company has a nice logo or made the news recently- we want to avoid that.
Chapter 4: Dispositions
Sun Tzu draws a line between offense and defense and then between things you can control and things you cannot control. In war, you can only control you troops, but not the enemy’s, the weather or other conditions, and you have to adjust your decisions based on that.
In investing, the only thing you can control is what companies you buy and when. You cannot control how much the companies make in profits, how much they sell etc.- you can only observe. So can you also only observe the price- sometimes it’s fair, sometimes it’s low, and sometimes it’s completely crazy. You as an investor have control only over what companies you buy based on their results you observe and whether the price is low enough, considering wide enough margin of safety.
Chapter 6: Strengths and Weaknesses
Kind of a self-explanatory, but still- Sun Tzu explains how a good general recognizes his own personal and also armies strengths and weaknesses in order to create situations favorable for his own victory.
In value investing, it’s no different- you have to know what your strength and weaknesses are to have success. Namely, you have to know which industries or types of companies you understand best or not that well, whether you have or lack some special knowledge or maybe you cannot handle your emotions that well when the market swings. You have to know all that and adjust accordingly.
Chapter 10: Terrain
In the warfare context, it is obvious that fighting in the mountains is different than fighting in a field and that is different than fighting in a thick forest. Sun Tzu stressed the importance of understanding the terrain you will find yourself in.
When we invest, we must understand the “terrain” we are in, which directly influences our investments. We also have to understand to long-term, more broad terrain, which in our case are for example extremely low interest rates, which makes the market inflated, pushes prices higher and created opportunity for bubbles to arise and also we need to understand to understand the short-term terrain- for example the Covid-19 situation, what it means for the economy and companies within, what it means in terms of structural changes.
The bottom is line you cannot only focus on a single stock and treat it like a play chip in a casino, but you have to understand the surrounding conditions which directly influence the stock, and thus your returns as an investor.
Sun Tzu’s book is ultimately very complex and has a lot of room for interpretations, given the ancient language used, translation and also the artistic and metaphorical way the book is written. I am sure if you read the book, you will find many more correlations and parallels with value investing, but I thought I would keep it simple and as relevant as possible for this time.
Given what we read about Sun Tzu’s way of approaching to strategy, I think he would definitely be a value investor if he lived today and I also believe his ideas reinforce our notion of value investing and how to go about it.
I will be very glad for any comments or remarks you might have, therefore feel free to contact me at any time.