Mental Models discussed in this podcast:
- Normal Distribution (Statistics)
- Resulting (Read: Annie Duke’s book)
- Efficient Market Hypothesis
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Show Outline
How coronavirus has modified the distribution of investment returns
- Typical investing outcomes – single distribution of possibilities
- High likelihood of a single point of returns (say 6%)
- Low probability of super high returns (>12%)
- Low probability of super-low returns (<0%)
- Today’s environment has a bimodal outcome for many companies directly impacted by the coronavirus shutdown.
- Instead of a single point of high probability outcomes, we have two center points. (15% and -80%)
- One may be around 15-20% annualized returns, but the other is highly negative and bounded by the zero-based outcome of the bankruptcy of the company.
- “The market has priced it in.”
- It is almost impossible for the market to accurately price in a bimodal distribution of potential returns.
Summary:
Investors today are likely underestimating the potential for bankruptcy of their favorite companies. Regardless of the long-term return of underlying assets, bankruptcy is possible when debt covenants are breached or a negative liquidity event occurs.
Both are possible outcomes in today’s investing environment as most companies are not well situated for handling a long period of zero revenues. (Not zero profits, but zero revenues)
