Continuing in our discussion on Mental Models, today I will address the valuable proposition of thinking in Derivatives. No no no…I’m not going to devle into some deep and boring area of mathematics. It’s just an analogy. Let me illustrate.
First, an “event” takes place. From that event a cause and effect can normally be attributed. The event is obvious and apparent to the general public (i.e.- some form of news), but not everyone is always aware of the cause and effect as these may require some additional form of investigative thought. But the ball doesn’t stop there. Beyond the realm of cause and effect there lies yet another dimension…one that 99% of the masses don’t perceive. Hold on…we’re going somewhere…I promise.
It’s like this. It’s easy to see the world in terms of addition. Afterall, 4 + 4 = 8. There’s the answer…it’s simple. What more needs to be understood, pondered, etc…? If you go a step further though, others see life through the lens of multiplication. Now 4 x 4 = 16. That’s where the cause and effect are discovered. But in the next bound…that’s where the great minds see exponentially…4^4 = 256! That’s where profit is, where great ideas are revealed, and where it’s like you’re looking at the future in a slowed down, frame-by-frame mode.
Let’s look at an example (in business of course):
Looking back, many an investor missed out on enormous returns when “ripping” music began to takeoff as a trend around 2000. Some people saw Napster as the obvious choice as it began to boom in popularity. Others saw mp3.com as it was the place where music was actually being purchased on the net. Still others saw PC makers as the play because they were producing the units with the hardware that ripped the music. But the real beneficiaries were the Elantec’s of the world, those that produced that actual laser diode drives (the key component of the cd/dvd burners). When it was all said and done…the results were as follows:
- Napster: uhhhh, I think we all know that it didn’t make much money
- MP3.com: it IPO’ed at $28 a share and ran up to $105, a $6.9 billion market cap
- PC Makers: they averaged a 200-300% growth rate
- Elantec: went from $3 a share to over $200 (that’s almost a 6,700% rate of return!)
Moral of the story…push the limits and look beyond the obvious to what lies ahead of the curve. Think in…