Necessary but not sufficient conditions in investment decisions

July 8th, 2020

In evaluating claims around causality, there are 3 broad constructs that play a role: conditions that are necessary (but not sufficient) for an outcome; conditions that are sufficient and conditions that are both necessary and sufficient. The below are 2 simplified sentences that highlight the complexities involved in necessary but not sufficient conditions.

“The job description said that they were looking for someone with a Master’s degree. I’ve got my MA, but I cannot understand why they did not hire me”.

“If you want the chairman to like you,” he said, “you’ll have to show how impressed you are with his ideas.” Well, I turned myself into an ego-stroking machine, but it’s pretty clear I have yet to win him over.”

Investing is all about making choices and decisions based on frameworks where, to our mind, conditions necessary may be present but these in itself may not be sufficient for us to take a decision. In all our interactions with investors we highlight 3 or 4 key attributes of each of our portfolio businesses :

_ Ability to throw up free cash flow year on year consistently
_ Good track record of corporate governance
_ Dominant competitive advantages which have been deepened over time
_ Stellar and judicious capital allocation

While these attributes are necessary conditions, they are not in themselves sufficient conditions. Each of these businesses also have to be able to demonstrate attributes such as adaptability, great culture, depth in leadership, resilience displayed through multiple market cycles and shocks and finally not least – valuations that provide a favourable tilt on the risk return scale.

Each of these then become necessary and sufficient conditions that make for a very compelling case. Not just this, factors such as how a new business stacks up against existing names and whether the overall quality of the portfolio is being enhanced are also important variables.

In thinking about our process, ideas typically may fall into one of these 5 buckets. The “pass” bucket is almost always full. We are always watchful for an investment that falls into the “certain” bucket, though these are rare and manifest around company specific shocks and/or external shocks such as the pandemic. However, most of our focus and work are on businesses that are somewhere between possible and likely.

Our focus on knowing what to avoid -practiced with discipline, helps us to address thosebusinesses without the necessary and sufficient conditions which are a “pass”. For the restof the businesses, its really about a journey from “possibility” to ”likelihood”.

This journey and the eventual outcome of it coming into the portfolio then is aboutunderstanding and focusing on both necessary and sufficient conditions. Most times, manyof the attributes are intangible and cannot be expressed in a spreadsheet. Two stand out traits that have emerged through this pandemic are agility and empathy. Empathy has been best epitomised by the MD of one of our portfolio businesses when he recently said : “In a crisis, you don’t run a company, you serve a family”. These variables require a nuanced understanding which is where the nature and dynamic of our team acts as a great strength for us.

It is our constant endeavour to continue to hone our process so as to derive the best possible outcomes. We would hope that why, what and how we do things become the necessary and sufficient conditions for us to build a resilient and durable franchise for decades to come.

Posted by Siddharth Mehta, Founder & CIO