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Foolish Book Review: "The Black Swan"

Nassim Taleb ends his new book, The Black Swan: The Impact of the Highly Improbable, by thanking the reader for reading his book. I think it only fitting that I begin this review by thanking Taleb for writing this entertaining, informative, and often challenging book. And it is the latter characteristic that makes this book especially worthy of any serious investor's time.

In my own case, there were times reading the book when I felt as though I was being personally chided for my shallow, uninformed, and often misinformed view of the world. But that is precisely why I loved this book and believe that Foolish investors should give it a read: By the end of it, the book had changed how I thought about certain aspects of the world around me. By extension, it also forced me to revisit some of my investing assumptions.

Lesson Number No. 1: Beware of the "black swan"
The book takes its title from the story that says prior to the discovery of the Australian back swan, everyone in the world assumed all swans were white. The importance of the black swan - something that falls outside the realm of regular expectations -- is that a single such sighting can invalidate a general statement (i.e. "All swans are white.").

Common knowledge, just like certain industries, markets, and products, can simply collapse. Granted, they don't often do it overnight, but industries that once seemed unassailable do go bust, and the reason they often do is because of black swans.

Consider the case of Bethlehem Steel. In 1989, it was lauded on the cover of BusinessWeek as the best managed company in America. In 2001, it was bankrupt, the victim of a new mini-mill technology that fell outside of its experience but was employed to devastating effect by companies such as Nucor.

The same was true of the Swiss watch industry which, in the early 1970s, was decimated by the likes of Texas Instruments and Sanyo, which employed quartz technology to manufacture low-cost, accurate watches. The net effect was that 50,000 Swiss mechanical watchmakers were put out of work virtually overnight.

The examples could go on and on. Computers, lasers, and even Pfizer's (NYSE: PFE  ) Viagra (which was originally developed as a drug to treat hypertension) are all examples of black swans. The latest example, of course, is the Internet. As Google (Nasdaq: GOOG  ) has amply demonstrated to the advertising, newspaper, and television industries, even new applications of existing technologies can catch executives and investors flat-footed.

Lesson No.  2: Beware of the unknown unknown
One important lesson imbedded in these historical analogies is that what we don't know is frequently more important than what we do know (or think we know). This seemly innocuous statement is actually quite profound. Here's why. Throughout the book, Taleb offers compelling evidence that people -- especially so-called experts -- tend to overestimate what they know and underestimate the uncertainty that is derived from those things they don't know.

For example, how often have you heard experts in a given field make bold, confident statements? A case in point is the energy industry. These days it is not uncommon to hear specialists in the field say that oil, coal, and natural gas will remain the main source of energy for the next 30 years. Such statements can easily lead investors to believe ExxonMobil (NYSE: XOM  ) , Sasol (NYSE: SSL  ) , and Chevron are, and will remain, solid blue-chip investments for the foreseeable future.

The problem is the people making these predictions don't know what they don't know. For example, how much do they know about synthetic genomics, such as BP (NYSE: BP  ) is now investigating? Is it possible that "designer bacteria" and biomass -- and not oil -- could be a major source of our energy in the future? Or is it possible that one of the nanotechnology companies that Harris & Harris (Nasdaq: TINY  ) has invested in could produce a breakthrough that could revolutionize solar energy and make it cost-competitive with coal?

The only honest answer is that we don't know if any of these things - or, more likely, something out of the blue -- will happen. What we do know is that black swans do happen. Just ask the fund managers at the Goldman Sachs (NYSE: GS  ) quant fund that lost 8% of its value in July due to what the manager called a "perfect negative storm." In reality, he and the investors in the fund were victims of a black swan.

Lesson No. 3: Beware of fire hydrants
One of the other things that I really enjoyed about this book was its ability to challenge conventional wisdom. One of my favorite examples was Taleb's claim that too much news -- especially financial news -- is not only bad for you, but can actually be toxic.

To make his point, Taleb shared the story of a widely publicized study in which a large number of people were provided with fuzzy pictures of a fire hydrant. Counter-intuitively, the people who were given more pictures (each of which became progressively clearer) performed worse at guessing what the object was than those who were given fewer pictures.

One reason this occurred is because the people who were given more information often formed a wrong opinion of what the object was early on, and then clung to that idea tenaciously, even in the face of new and better evidence.

One takeaway from this analogy is that people often treat financial news in a similar manner. Rather than accept the new information at face value, people instead select portions of the news to support what they think they already know. I know I have been guilty of this sin in the past.

There are a number of solutions to this problem of seeing only what we want to see. One approach is to actively seek out viewpoints that contradict our own. Better yet, you can actually start from the premise that you are wrong. This is one of the reasons I now make it a habit to read the "Dueling Fools" series whenever it profiles a stock I own. I want to read what people with a different opinion are thinking about the stock and why. I visit Motley Fools CAPS for the same reason.

Foolish Bottom line: Ignoramus et ignorabimus
My favorite line from the book is one attributed to Emil du Bois-Reymond, who said, "ignoramus et ignorabimus" -- we are ignorant and will remain so. On its face, the statement sounds highly insulting and for too many people it undoubtedly is, but after reading The Black Swan I am convinced that this is simply an unfortunate fact of life.

The bottom line is that we can't know what we don't know. And while it might seem hard to operate in such an environment, acknowledging that you don't know everything can actually give you a leg up on those people who instead prefer to proceed through life confidently knowing the wrong things.

The difference between embracing your ignorance and holding your misconceptions in front of you as a shield won't allow you to prevent black swans, but it can help you learn how to profit from black swans as well as turn some black swans into gray swans -- which aren't nearly so damaging.

Interested in other Foolish book reviews? Check out these articles

Harris and Harris is a Motley Fool Rule Breakers selection, Sasol is a Global Gains recommendation, and Pfizer is an Inside Value pick. Check out our entire suite of newsletters by clicking here.

Jack Uldrich does not know what he doesn't know, but that hasn't stopped him from trying to learn more. He owns stock in Harris & Harris. The Fool has a very knowable disclosure policy and you can read it here.

Read/Post Comments (2) | Recommend This Article (32)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 12, 2009, at 1:17 PM, prginww wrote:

    I love how Taleb's black swan dismisses the notion that everything distribution must look like a bell curve

  • Report this Comment On March 14, 2009, at 10:33 AM, prginww wrote:

    Taleb is obviously a very intelligent, well-educated guy BUT I found him very pompous and arrogant in his writings, and the book was not enjoyable for that reason. He thinks that he is the only one who knows anything and dismisses most others: "Pride goeth before a fall".

    I understand math well, but the math and statistics in the book are too dense for me and probably most readers.

    In the end, I was hoping for some investment tips to avoid these Black Swans and make profits, but there were never any specifics.

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