MULTIDISCIPLINARY

THINKING
Cost of machinery: Rs 10 cr.
Expected life of machine: 10
years
Annual savings: Rs 2.50 cr. p.a.
Expected residual value of
the machine: Rs 1 cr.
Cost of capital: 15% p.a.
Accept or reject?
Accept or reject?
Which
Tool
Did
You
Use?

DCF
 Why
did he
do it?
 Mental Models

Competition [Microeconomics]
Prisoner’s Dilemma [Game Theory]
Return on Capital [Accounting]
Opportunity Cost [Microeconomics]
Contrast Effect [Psychology]
Commitment & Consistency [Psychology]
To a Man with a Hammer, Everything Looks Like a Nail
 A mental model is
a representation
inside your head of
an external reality
 Pattern Recognition or
“Functional Equivalents”

“What does this remind me of?”

and

“Why does it remind me of it?”

http://www.thebrain.com
“The man who does
not read great
books has no
particular advantage
over a man who
cannot read them.”
— Mark Twain
Model from Mathematics:

Proof by Contradiction
Example # 1: Buffett on
Absurdity of Dotcom
Valuation
Warren Buffett
Example # 2: Ralph Wanger
on Disk Drive Industry
Ralph Wanger
Example # 3: Harry Markopolos
on Absurdity of Bernie
Madoff’s Investment Returns
Harry Markopolos Bernie Madoff
 Falsification is
Powerful Way to Think
 “The test of a first-rate
intelligence is the ability
to hold two opposing
ideas in mind at the same
time and still retain the
ability to function.” - F.
Scott Fitzgerald
Watson: “Do you have a theory.”

Holmes: “Yes. A tentative one.”

 “How often have I said to you that when you have
eliminated the impossible, whatever remains, however
improbable, must be the truth?”
Model from Mathematics:

Reductionism
 Example of Reductionism

30x + 10y = 90

divide both sides by 10

3x + y = 9
You can never make any
explanation that can be
made in a more
fundamental way in any
other way than the most
fundamental way.
Model from Mathematics:

Inversion
 Example:

What is the Probability of Landing

Heads at Least Once in 10 Coin Flips
 “Invert,
always invert.”
— Carl Jacobi
Example: Earnings
Required to Justify
Current Valuation
Example: Ask, How to Fail?

Then Don’t Do Those Things

 “Instead of thinking
how to make your
business better, think
how to ruin it, and then
simply avoid those
things.”
“We should make a list
of everything that
irritates the customer,
and then we should
eliminate those defects
one by one. That is the
way to compete in the
service business.”
“All I want to know is
where am going to
die, so I never go
there.” — Charlie
Munger
“You don’t have to pee on an electric fence to learn
not to do it.” — Charlie Munger
Example: Management
Checklist
Model from Statistics

Mean Reversion
“Many shall be restored
that are now fallen and
many shall fall that are
now in honor” - Ben
Graham Quoting
Horace
 Positive feedback:
Negative feedback: Nuclear Chain
Bathroom Gyeser reaction
 “Bull markets and
Bear markets can
obscure mathematical
laws, they cannot
repeal them.” –
Buffett
 “In the short run the
market is a voting
machine, but in the long
run its a weighing
machine.” - Ben Graham
Low prices and high
volumes feed on
each other

Dominant
newspaper
(Circulation and
advertising feed on
each other)
Positive Feedback
Model from Game Theory

Zero Sum Game

 Models from
Evolutionary Biology
 Models from
Architectural Engineering
“ A structure has been
defined as ‘any assemblage
of materials which is
intended to sustain loads’,
and the study of structures
is one of the traditional
branches of science. - J.E. Gordon
 “When you build a bridge, you insist it can carry 30,000
pounds, but you only drive 10,000-pound trucks across it.”
— Warren Buffett
To acquire general wisdom,
you need:
1.A checklist of mental
models
2.A good search engine in
your brain i.e. a system of
relating experience to the
models on your checklist
About 20 models
from psychology
will become
behavioral finance
Why do you need a
checklist?
Because the human
mind is like the
human egg
Is commodity price
rise bad for
commodity users?
“You’ve got to have
models in your head.
And you’ve got to
array your
experience – both
vicarious and direct
– on this latticework
of models...
“You’re not to going to get very far in
life based on what you already know...
“You’re going to get ahead in life in what
you learn after you leave here.”
THANK YOU