There is a paradox at the core of fundamental investing: the future is unpredictable and yet to value an asset one needs to have a view of the future.
What appears ‘obvious’ today, may be very different in the future
Let’s say you want to buy a store-front property on the main street in your suburb or town. You do thorough research. You find that foot traffic has been growing, vacancies are low, and rents have been rising comfortably above inflation. The town is prosperous, drawing income from diverse industries. Buying the property seems like an obvious choice. A few years pass and a new shopping centre is built a few miles away. The foot traffic on your street starts to decline and a few weaker businesses are forced to shut down. Vacancies rise, rents fall. Property owners hold out for a better price, and property valuations slide slowly. Would you invest in that storefront property now? And if yes, at what price?
The future is fundamentally unpredictable
You know your town and the property in question very well. You know how much money it makes today. Yet, its future cash flows are truly uncertain. Could empty storefronts drive away even more traffic, causing additional empty storefronts? Or will lower rents attract new business, leading to a return in foot traffic?
The dynamics of national and global industries are even more complex. There are many more competitors, suppliers, distributors, technologies, products, regulations, currencies, changing demographics and shifting lifestyles.
Even if it were possible to build an intricate model of the world, it would still be impossible to predict industry dynamics beyond the very short term. Unpredictability is inherent not only in the economy, but also in many other natural ecosystems, from plankton in the Baltic sea to predator-prey networks in national parks. Some scientists suspect that unpredictability is a fundamental property of life.
A successful investment strategy must address the investor’s paradox
The unpredictability underlying the investor’s paradox is fundamental and inescapable. A successful investment strategy must work with this unpredictability and address the investor’s paradox.