Lesson #21: How to Analyze a Business, the Sherlock Holmes Way

One of the most important book that every value investor should read is Peter
Bevelin’s Seeking Wisdom: From Darwin to Munger. But there is another book that
Bevelin has compiled called A Few Lessons from Sherlock Holmes, which is just brilliant.
Through this book, Bevelin has distilled Arthur Conan Doyle’s Sherlock Holmes into bite-
sized principles and key quotes. In fact, this book is much more than a collection of quotes. It
is a way to learn the powers of observation, understand the limits of our mind, and counter
the narrative fallacy.

Sherlock Holmes is the epitome of rationality, and when it comes to making businesses
decision, a rational thinking goes a long way in keeping you out of trouble.

Thinking is mostly an automatic process for every body but while making critical decisions in
life (and in business of investing) one needs to come out of the autopilot mode and learn the
art of thinking clearly. Sherlock Holmes give us a framework, a blue print if you will, of
thinking.

Bevelin writes in the book…

“What distinguishes Holmes from most mortals is that he knows where to look and what
questions to ask. He pays attention to the important things and he knows where to find them”

At the start of the book, Bevelin quotes mathematics and science writer Martin Gardner
saying this about Sherlock Holmes –

“Like the scientist trying to solve a mystery of nature, Holmes first gathered all the evidence
he could that was relevant to his problem. At times, he performed experiments to obtain fresh
data. He then surveyed the total evidence in the light of his vast knowledge of crime, and/or
sciences relevant to crime, to arrive at the most probable hypothesis. Deductions were made
from the hypothesis; then the theory was further tested against new evidence, revised if need
be, until finally the truth emerged with a probability close to certainty”

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There you have it! The entire process of solving a mystery is what the above paragraph
contains –

In short, the three necessary qualities for good detective work are –

1. Observation – Gathering evidence

2. Deduction – Drawing inferences from evidence and working on them
3. Knowledge – Processing the evidence, testing the hypothesis, and arriving at the truth
in light of what you know (and don’t know)

Drawing Parallels with Business Analysis

Is the work of an investor or an analyst working diligently through a company’s analysis any
different than that of a detective in search of the ultimate truth in a crime? I believe not.

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And thus, Bevelin’s work on Sherlock Holmes is a great guide for anyone wanting to
learn how to analyze businesses to pick the right kind of stocks for long-term
investment.

When tried to distill out the most important ideas from this book and this is what I ended up
with (click on the image below or click here to see a bigger version)…

…a hand-made poster that now adorns my wall and which suggests a series of checklist
points that can be of immense help while analyzing businesses.

Just consider these five big ideas from Sherlock Holmes contained in the above poster (and
the relevant texts from Holmes’ books, in blockquotes, below), which is also what another
brilliant detective (in the investment world) and thinker Charlie Munger suggests us to do –

1. Know Human Nature

(What motivates people and what interests them – a great tool while assessing managements
and crowd behaviour)

“Human nature is a strange mixture, Watson. You see that even a villain and murderer can
inspire such affection that his brother turns to suicide when he learns that his neck is
forfeited”

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2. Learning Never Stops
(Be a learning machine, asks Charlie Munger)

“Education never ends, Watson. It is a series of lessons with the greatest for the last”

3. Reason Backwards
(Invert, always invert, Munger advises)

“The essential factor in this method consists in working back from observations of conditions
to the causes which brought them about. It is often a question of deciding the doings of
yesterday by the records found today”

4. Cultivate Multidisciplinary Thinking

(Build a latticework of mental models, suggests Munger)

“Breadth of view…is one of the essentials of our profession. The interplay of ideas and the
oblique uses of knowledge are often of extraordinary interest”
“One’s ideas must be as broad as Nature if they are to interpret Nature”

5. Don’t Make the World Fit Your Tools

(Don’t be a man with the hammer, asks Munger)

“The advances on the laboratory side and the perfection of instruments have added much to
our powers of diagnosis, but they have given some men the idea that they are everything and
the use of one’s eyes and hands is looked on as old-fashioned. The man whose first idea in an
obscure thoracic case is to have an x-ray plate taken and who cannot “bother” with physical
signs does not deserve the name diagnostician”

Road Map on How to Think

In his testimonial, Nassim Taleb says this about A Few Lessons from Sherlock Holmes…

“We Sherlock Holmes fans, readers, and secret imitators need a map. Here it is. Peter
Bevelin is one of the wisest people on the planet. He went through the books and pulled out
sections from Conan Doyle’s stories that are relevant to us moderns, a guide to both wisdom
and Sherlock Holmes. It makes you both wiser and eager to reread Sherlock Holmes”
It’s brilliant, this slim 73-page book that culls the essence of the world’s greatest detective’s
teachings. Peter Bevelin demonstrates what students of Holmes have always known – that the
adventures of the fictional detective are not just entertaining tales, but a road map on how to
think, do research and hit upon a solution to a problem, whether it pertains to crime, or life, or
investing.

“You know my methods. Apply them!” Holmes said in The Hound of the Baskervilles, which
was published in 1902. More than a century later, that advice remains of great importance if
you want to become a better thinker and investor.

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