n the first move, white and black have the possibility to choose between 20 possible moves. Thus, after each player has made his first move, there are no fewer than 400 potential different piece positions. After the second move of each player, there are 72,084 potential positions. After three moves, this number explodes to nine million. After four moves, we reach 288 billion potential positions!
You may have heard that a chess master can calculate several moves ahead during a game. So, how is it possible to calculate ten moves ahead when the game becomes exponentially more complex after each move?
Candidate List
To navigate through this complexity, a technique commonly used by chess players is to create a candidate list. By making this list, experienced players exclude moves that add no value. This allows them to focus their energies on the moves that offer the best potential without wasting time exploring situations that are likely to lead nowhere.
In investing, I believe a similar approach should be used to optimize time in researching securities. At COTE 100, we have a habit of immediately excluding companies that are too indebted, have not shown good historical financial performance, or whose stock seems far too expensive. This first filter, which is largely carried out by our COTE 100 System, allows us to focus on ideas that meet our basic selection criteria.
Then, like the chess player, we draw up a candidate list and begin our in-depth analysis work. Many stocks on our candidate list will be eliminated along the way, some more quickly than others. Low barriers to entry, poor capital allocation by management, undistinctive products, low long-term growth potential, and unreasonable competition are some examples of situations that will lead us to reject a stock.
In many cases, the stock market price may be too high to justify a purchase. If we consider the stock to be of high quality, we will add it to our long-term watch list and hope to buy it at a more attractive price in the future.
Simplicity versus Complexity
The ability of a chess player to calculate several moves ahead usually depends on the level of complexity of the position. In a complex situation, where many attacks and counterattacks must be analyzed, it becomes difficult to see more than three or four moves ahead. Conversely, some relatively simple positions can be analyzed 15 or more moves ahead.
In investing, the same principle applies. It is difficult to assess risks and long-term growth potential when the situation is highly complex. To illustrate this point, let’s take the case of NVIDIA. What new processors will the company and its competitors develop in the coming years? How will the market evolve in the long term? Even if NVIDIA’s stock market price became reasonable, we would struggle to buy it because the complexity of the situation reduces long-term visibility.
Now, let’s take the case of Netflix, a stock we hold in our portfolios. In our opinion, Netflix’s situation is much less complex than that of NVIDIA. In this case, our better ability to see long-term allows us to reduce risk in our decision-making. As Warren Buffett so aptly puts it, the first rule in investing is not to lose your money. In our view, investing in a situation with greater long-term visibility significantly reduces the risk of loss.
The beauty of the investment world is that what is complex for one investor may be simple for another. Some chess players are better at analyzing potential mid-game tactics, while others excel in the endgame. The goal is to steer your game toward your comfort zone.
Achieving attractive returns in the stock market generally depends on the price paid for a stock. Greater long-term visibility allows for a better understanding of the stakes and facilitates our ability to determine if the returns from the purchase are attractive.
In conclusion, the time of a chess player and a stock market investor is limited. For each, it is impossible to analyze all moves or stocks in depth. By drawing up a candidate list and focusing on the most promising situations with good long-term visibility, the stock market investor can maximize his efforts and improve his chances of discovering attractive investment opportunities.
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Jean-Philippe Legault is Portfolio Manager at COTE 100.
His blog is published in
