Beyond the Money #1: Systems Thinking With David Gardner

Behind every methodology, there is a thought process involved, a deeper way of thinking that drives decisions. It's the great "why" behind the action. Tune in to the Rule Breaker Investing podcast, as Motley Fool co-founder David Gardner explores three of his favorite types of thinking.

In this segment, David explains the first, systems thinking. This is the bird's eye view that shows the big picture, in order to understand the inner workings of the market. Thinking in systems and recognizing the elements of this process will ultimately aid investors in making wise decisions that turn investments into profits.

Make sure to tune in to the other two parts of this series:

Beyond the Money #1: Play Things Forward by Thinking in Systems

Beyond the Money #2: Recognizing Patterns in Investing

Beyond the Money #3: How Associative Thinking Builds Confident Investors

A full transcript follows the video.

This podcast was recorded on Oct. 7, 2015.

David Gardner: And it is in fact this love of thinking, about thinking how to think, the meta-game of thought that I want to spend a little bit of time this week. Specifically I want to review three types of thinking and illustrate them for you each. Three of my favorites. By no means am I student. I did take Shakespeare in college, I mentioned that. I never took any class on cognition. So please don't view me as anything more than a fellow noob, a fellow traveler on the path of life just trying to figure out how things work.

But I've definitely started to aggregate my thoughts around three buckets of standard forms of thinking that I find very helpful for me as an investor. And so let's cover the first one right now. The first one is systems thinking. There's a wonderful book called Thinking in Systems written by Donella Meadows, kind of regarded as one of the forerunners of the whole systems thinking movement.

She wrote the book, she was an MIT systems professor in the 1990s, she wrote the book partly back then, but died suddenly unfortunately in 2001. Never finished her book and then an associate started to get all the rest of her thought together and compiled it into this book which was published in 2008. So little storytelling around Donella Meadows's book. But systems thinking something that you may have heard about, something you might well do sometimes subconsciously, sometimes very consciously. I bet some of you know a lot more about systems thinking than I do. But let me give a couple of examples of systems thinking.

First of all just to define this one, because this is a little bit more technical than my other two. Donella Meadows defined it as a system is an interconnected set of elements that is coherently organized in a way that achieves something. So that was her definition of a system: an interconnected set of elements that is coherently organized in a way that achieves something. It's more than the sum of its parts.

So for example, a body is a system versus just the individual cells. A university, the system more than the sum of its parts, its individual students. An ecosystem versus an individual plant or animal. A living being is a system she would say, but it loses its systemness when it dies. So that's a little bit about what a system is. And when you start thinking in systems, it involves largely try to get up above what you're looking at and seeing how those cog wheels are spinning and what they're striking, and how the whole thing works.

And while it's easy often for us to do this in our professional or hobby lives about things that we know really well, sometimes we get so inured to how things are, or we get so down in the weeds it is hard for us to get up above and see the system. And I think that I'm a systems thinker. Again I'm not a practiced particularly or certainly studied systems thinker, but I think some of things that we do with this podcast in our investment approach indicates systems thinking.

So two quick examples. I would say the very concept of rule breaker like the very name of this podcast, really our investment approach -- that is a system, right? We're looking at how the world works and we're saying here's the story of business, I sometimes say. Every great company starts, it needs to provide a better solution, maybe a better product or service. Usually it comes along and disrupts the status quo. We call those "the rule breakers."

They're breaking the rules of how things are done and in time they hope one day to move from breaking the rules to making the rules. Rule breaker to rule maker. That's a narrative I just gave you a story. It's in my head, it's a model. Maybe you see it. Maybe you agree with it, maybe you don't. But I think we can both agree that's kind of a system that we have in place. The very concept of being opposed to the majority in a self-conscious way and asking, "Why will that be valuable?" If everybody's doing one thing we're going to do something else. That's systems thinking inherently.

And then let me give a second example, which goes back to one of my earliest podcasts when I was talking about the six signs of rule breaking, and the sixth sign in particular which is that we're looking for our stocks to be called overvalued. We want there to be a general perception, even better if it's on the headline of Businessweek or a big Wall Street Journal article, taking down this company, calling it out whatever it is as overvalued. We want that.

Why do we want that? Well that means that there's a lot of money on the side lines. Probably a little bit more scared money, as a big negative article's written about how overvalued that stock is. If the perception is that something is dramatically overvalued, then of course most people aren't going to be investing in it. Their money stays outside it. But usually in my experience things are called overvalued because they're really good. It's just that people think it's trading for way too much.

There's no profits yet, "Google hasn't even figured out how to make money yet" was one of the big arguments about Google back in the day. How's that company ever going to make money? So as people don't invest in it, but if that excellent thing is truly excellent and continues to perform over time, what naturally happens is converts start showing up and they start saying, "Well you know, I missed it early, but I'm going to buy some shares now."

And that's what ultimately drives stock market pricing and great stocks over time. That's more systems thinking, right? That's looking specifically for an attribute based on how we see the system functioning.

And I meant to close my systems thinking one by saying that if you can do this well, what you're going to be able start doing is playing things forward, right? If you're looking at the system and you can see the full manufacturing right from the start of the conveyor belt right to the end, you're going to be able to predict what things are going to look like at the end, because you're able to see the system and you just play it forward. And most people don't do that very well or aren't even looking to do that. So you can get a little edge here by playing things forward with your systems thinking. That's your slightly more awesome superhero power you'll be gaining from form of thought number one.