The New Science of Investing[Fool on the Hill] June 26, 2000

An Investment Opinion

The New Science of Investing

By Brian Graney (TMF Panic)
June 26, 2000

Summary: Business people are increasingly turning to evolutionary biology to understand companies and the markets. To ensure future investing successes, an investor will need to embrace today's new flexible and diverse analytical frameworks.

In the most recent edition of Scientific American magazine, I came across an article by noted evolutionary biologist Ernst Mayr about the lasting historical imprint of scientist Charles Darwin and how he has influenced modern thought. Since Darwin is a favorite of mine when it comes to historical figures, it's not surprising that the article caught my eye. (Sorry, no free lunch here. It's not one of the articles available for free at the magazine's website. You'll either need to buy your own copy or pick it up at the library to confirm what I'm talking about.)

Central to Mayr's argument about Darwin's contribution to modern thought is that his theories and discoveries helped unite the otherwise polarized worlds of the humanities and the sciences. This was made possible by way of the introduction of a single element: history. Darwin's use of historical narratives to explain evolution was groundbreaking and gave rise to an entirely new academic discipline -- what is commonly known today as evolutionary biology. As Mayr relates in his article, "... by virtue of its methodology and its acceptance of the time factor that makes change possible, evolutionary biology serves as a bridge [between science and the humanities.]"

How is this relevant to the subject of investing? This is The Motley Fool, after all. Well, theories based on biology -- and evolutionary biology specifically -- are increasingly being relied upon as bridges to unlocking and interpreting concepts in the world of business and investing. With a few market-related tweaks, Mayr's article could have just as easily appeared in a current issue of Fortune or Forbes. That's how prevalent biological terminology is becoming in the investing realm.

Witness Cisco Systems (Nasdaq: CSCO) executive Don Listwin's frequent use of the term "ecosystem" to describe today's networking world and the relative place of his company in it. Also, Credit Suisse First Boston analyst and Columbia University professor Michael Mauboussin has invoked the language of Darwinian evolution and applied it to an investor's rational decision-making process, most notably in his article What Have You Learned in the Past 2 Seconds?

Elsewhere, the concept of "viral marketing," which venture capital firm Draper Fisher Jurvetson coined a few years ago to describe the rapid growth of the Hotmail free e-mail service, is by its very name grounded in biology. And in the mutual fund world, IPS Funds manager Robert Loest, among others, has taken to looking at the economy as a complex adaptive system, much like the natural world around us. Of course, this is not an entirely surprising worldview for someone with Loest's background, seeing that he garnered a Ph.D. in biology for himself prior to turning to the professional money management game.

The use of evolutionary biology as a framework for understanding modern business practices may sound unique and abstract, but there is a certain common-sensical element to it. After all, what is natural selection but the very business-like notion of sustainable competitive advantage at work on a biological scale?

For instance, the horseshoe crab may not be the most aesthetically pleasing organism on Earth. But its hard protective shell and its ability to survive for long stretches of time without food have kept it on this planet for the past 400 million years or so. With only a mere 114 years of history, Coca-Cola (NYSE: KO) has a long way to go to catch up to such a critter. However, the soft drink giant has hung around and prospered this long for similar reasons -- namely, its strong competitive advantages and its ability to adjust to a changing environment.

We could go on and on with more nature-to-business analogies, comparing Ford Motor (NYSE: F) to the periodical cicada or Nabisco (NYSE: NA) to the pansy, but you probably get the point. There are parallels here, and many folks are recognizing that a solid understanding of biology can in fact lead to insights into winning investments. And I'm not just talking about pharmaceutical and biotechnology investing, where scientific expertise can play an extraordinarily critical role. Rather, as a way of thinking about the interactions between companies and as a means for understanding why some companies evolve into super value-creators and others simply die off, the lessons of a diverse framework such as evolutionary biology can lend a very useful helping hand.

The usefulness of diverse analytical frameworks is what Berkshire Hathaway (NYSE: BRK.A) vice chairman Charlie Munger was talking about in his well-known 1995 lecture on investing at U.S.C. In that speech, the F.O.B. (in this case, Friend of Buffett) advocated that investors develop a collection of flexible mental models based on various disciplines.

The importance of a subject such as accountancy is rather plain -- in essence, that is the language of business. However, Munger also argued that investors should learn how to view the world through other less obvious lenses, employing such areas as behavioral psychology, engineering, and mathematics, particularly the math of probabilities of Pascal and Fermat. Not surprisingly, Munger is apparently a fan of evolutionary biology as well. He has even gone so far as to recommend two books on the subject, The Selfish Gene by Richard Dawkins and The Moral Animal by Robert Wright, at past Berkshire Hathaway shareholder meetings.

With so many investors and business people turning to biology for explanations these days, how is the individual investor to react?

One way is to avoid that hot-off-the-press copy of 1001 Tips of a Day Trading Millionaire when looking for leisure reading this summer. With that kind of title, such fare probably contains more lessons on how to sell a book than how to invest successfully in stocks. Instead, how about cracking open a copy of Darwin's The Origin of the Species? It may not be the easiest read in the world. However, at under $5 for the paperback copy, it's a flat-out bargain. And it's probably more relevant to how many investors are viewing their stocks and the markets these days.

Related Link:

  • Scientific American website