Sun Tzu and the Art of Investing — Investing Ideas
Backstory
If you didn’t know, “The Art of War” is an ancient Chinese book war strategy book. It was written by the esteemed general Sun-Tzu — Aka Master Sun — around the 5th century BC.
Though the book was obviously intended to promote Tzu as a general and express his war insights, it has been adopted for many other purposes.
For example, Gordon Gecko’s quotes from The Art of War were responsible for a massive increase in The Art of War’s popularity on Wall Street. You know him. The “ Greed is good “ guy. Gecko typifies the wolf archetype, or the Hawk — a real Wall Street apex predator. Of course a lot of the guys on Wall Street wanted to be like Gecko, and the book’s popularity rose.
However in actual fact, the movie does not delve very deeply into Tzu’s The Art of War treatise at all. A quote is used in this scene below,
“ Every battle is won before it is ever fought “
As you can see by the clip, the quote in this context is altogether not about “beating the market” in any traditional sense. No, it is about market manipulation and backdoor, shady dealings. The fund guys are “ throwing darts at a dartboard “ Gecko says. “Like sheep to the slaughter”.
Yet, this is not to say that the quote is misused. Sun Tzu’s treatise is overall a treatise on the importance of mind over matter. Brains over brawn. Above the fray. This means avoiding the chaos and acting on strong fundamental principles and understanding.
The Art of War is all about getting “Above the Fray”.
Throw your entire force
Into the fray
For some gain,
And you may still
Fail.
Did “Wall Street” get it right?
Although Gecko’s “ethics” are questionable, his understanding of the meaning of the quote is sound. The Art of War is the Art of Asymmetrical Warfare. The art of profiting from asymmetrical situations. Situations where reward > risk.
The wise leader
In his deliberations
Always blends consideration
Of gain
And harm.
Of course, the purpose of the Art of War was to educate on warfare not pseudo corporate-warfare. Sun Tzu was a general, meaning he led men into battle, not dollars into investments. This is something to always keep in mind. To adapt Sun Tzu to your purposes is to take his writing metaphorically. Rest assured that when Tzu talks about the “Forms of Terrain” (Ch. 9), he was not secretly referring to the ups and downs of your portfolio.
Art of Investing
As I’ve said, Sun Tzu’s Art of War has been used as counsel in many different fields. In this post I interpret Art of War in terms of modern day investing analogies. Rest assured that you can incorporate Sun Tzu into your life without breaking the law like Gordon Gecko. Incorporate this ancient Chinese wisdom into your life and start winning the war of higher returns!
Avoid Competition and Litigation
One famous quote by Sun Tzu is:
No nation has ever benefitted from protracted warfare.
&
In war,
Prize victory,
not a protracted campaign
Warfare in the business context is akin to competition or even litigation. To be in a high competition environment drives prices down, lowering margins. To engage in too much litigation drains the cash from a company, much like it drains the coffers of a country. Even if a company ends up winning a lawsuit, their resources may still be taxed beyond repair. In war this is known as a pyrrhic victory, and is to be avoided. Therefore, avoid companies which are engaged in lawsuits that they do not have the resources to handle.
Interestingly, moats are a concept borrowed from warfare. An economic moat just means that the company’s market niche is not easily invaded by competition. There is something protecting the company from another company stepping in and taking over. Look for companies with economic moats and thereby avoid costly protracted warfare. I have personally found Morningstar reports to be very helpful in identifying companies with strong moats.
Look for companies which have strong economic moats, keeping their enemies (aka competition) away.
Brands are another wonderful way for a company to maintain market share. Highly successful brands will always be sought after, even if someone else has a cheaper or better product. People just trust brands that they know.
Either way, by successfully building and defending a market niche at little cost, a company can:
March hundreds of miles
Without tiring,
By traveling
Where no enemy is
Warren Buffet knows that people love brands and he made a fortune off of that knowledge. He invested in venerated companies like Coca-Cola, Heinz, and Dairy Queen because he knows that everyone and their grandmother know about those products.
Contrarianism
When able,
feign inability
The key to spotting a good company is spotting those which are able, yet appear not to be. They are undervalued by the market due to their weak appearance.
Though a company may not be feigning inability on purpose, the outcome is the same.
To clarify this let’s look at a hypothetical scenario. A company reports what appears to be a devastating loss. News outlets expedite the disastrous impact on the company’s stock price. Yet, you take a closer look and see that the loss is because of something entirely out of the company’s control, and something which will only occur one time. You perceive that the company is still on an upwards trajectory, and you invest. By the next year, lo and behold, positive news has buoyed the company. You sell at a profit.
By doing the above, you successfully spotted a company which feigned inability when able. By doing so, you profited.
Another great quote for the contrarian investor is:
Water shuns the high,
And hastens to the low
Don’t buy expensive stocks! Not unless the company is truly worth it. Be like water my friends. Hasten to the low priced stocks, those which are valuable.
Being like water also means doing something else called rebalancing. That is moving money out of assets which have gained in value, and moving them into assets which have lost value. Thereby you can benefit from the cycles of the market. This is something advocated for by the investing greats such as contrarian Benjamin Graham.
Overall:
Appear at the place
To which he must hasten;
Hasten to the place
Where he least expects you
Potential Energy
Sun Tzu focuses heavily on the concept of potential energy. For example, the energy of a boulder at the top of a hill or of a bow-and-arrow pulled back tight, ready to fire.
A rushing torrent,
Carries boulders,
On its flood;
Such is the energy of its momentum
On “rolling logs and boulders” Tzu writes:
By their nature,
On level ground
Logs and boulders
Stay still;
On steep ground,
They move;
Square, they halt;
Round, they roll.
One application of this concept is compound interest. Compound interest involves reinvestment of interest payments, by which interest is paid on earlier interest. In this way, the interest payments begin to build momentum, much like a rushing torrent.
There are many ways to earn compound interest. For example, high interest savings accounts and certificates of deposit are safe and accessible ways to benefit from compound interest. Similarly, dividend reinvestment programs (DRIPs) are a fantastic way to take advantage and turn your investment from a stagnant pond into a rushing torrent.
Identify Potential Energy in Corporations
Another profitable application of potential energy has to do with the Price/Revenue Ratio (similar to Price/Sales). By taking a look at the Market Cap of a company, and comparing this to its Revenue, you can derive a measure of potential energy. While revenue is not altogether that exciting to Bay St., earnings make them go berserk.
A company with a high price/sales ratio is full of potential earnings. They just need to move the revenue boulder and let it roll down the hill. AKA: realize profits. Investing in companies with high price/revenue ratios which are making inroads on their profit margins is a great way of leveraging potential energy. One way that companies can leverage high revenues is by moving into businesses with higher profit margins, or by reinvesting earnings into profitable segments of the company.
Look for companies with high market-cap/revenue who are making smart moves like this.
These are all matters,
of potential energy
The Trend is Your Friend…
Admittedly, the trend has not always been touted as a friend on this site. And yet, if you are quick enough to recognize the trend, momentum investing can bring you wealth.
Speed
Is the essence of War
It takes true skill to realize the subtle signs that a trend is gaining momentum. These are signs which go under the radar of the common person. Master Sun says:
To see sun and moon
Is no
Perception;
To hear thunder
Is no
Quickness of hearing
Cultivate the ability to see the subtle clues a trend is gaining ground that the common person does not perceive. Therein lies your advantage. Thereby you can make the trend a very lucrative friend.
Now, admittedly spotting trends is no easy task. However, there are many established trends in the stock market which have to do with established economic factors. This video by TD on stock market rotations is a great way to start understanding sector rotation. By learning to understand these trends for yourself at a deep level, you can get in before the media or the analysts start to hype the public up!
The firmer your understanding of established market/business trends, the quicker and more confident you are, the more you stand to gain.
A swooping falcon
Breaks the back of its prey;
Such is the precision
Of its timing
In Conclusion
Heed my plan
Employ me
And victory is surely yours
There you go. You are now well-versed in the Art of Investing. Although these quotes do apply well to investing, many others don’t make sense in an investing context whatsoever.
Remember: Art of War was written 2500 years ago on bamboo strips with soot from a fire. Nonetheless, we all know that true wisdom is timeless. Therefore, take what you can from this very mysterious book.
If you are interested in reading the book for yourself, I recommend the “Penguin’s Classics Deluxe Edition” translated by John Minford. This is the version from which I got these quotes. In addition, this version has commentary from a diverse group of historical and contemporary figures.
As always
Happy Investing
- InvestingIdeas.ca
Originally published at https://www.investingideas.ca on March 22, 2021.
