CategoryLearning

Thinking Through Risk and Uncertainty: Contemplating the Coronavirus

“Without a structured approach to ordering the world, the world will impose its views on us. The fact is some things are more important than others, some things are easily verifiable…Simple processes help us sort the mess and prioritize.”

from “Managing Risk by Screening Out Trouble”

The coronavirus presents two specific risks to most of us. One, we transmit the virus to someone vulnerable (older, ill, or immunocompromised). Two, we or someone we love gets sick or injured in some other way and can’t access the health care system because it’s overwhelmed. These risks highlight the interconnected nature of the situation. Our individual choices affect others.

Given the risks, how do we contemplate a path forward?

We know what we don’t know.

This is a numbers game. And the numbers will get worse before they get better. In forestry, for example, trees planted years ago give us the forests we have today. Waves of trees can grow in massive booms. Foresters call this “a wall of wood” or “the pig in the python”.

With the coronavirus, the spreading that occurred silently weeks ago gives us the infections we have today. We don’t know the infection rate, which makes it difficult to know the pervasiveness, speed and, ultimately, decline of the coronavirus. What tells us we can return to normal? When we have smog alerts or forest fires or car crashes or hurricanes or food poisoning, we have metrics and indicators that signal “all clear!” Why? Because we have data.

We don’t know what’s knowable.

It does not matter if this situation is better or worse than people think, thought or said; it just is. And currently, we don’t know what “is” is. We can’t yet touch the bottom of the pool because we don’t know how deep the water is. We need data, and data requires testing. Each and every failure to deliver, offer, conduct, collect and communicate the results of a test reflects a small crime and failing in this battle.

Anything short of complete, ruthless transparency obscures our ability to know what is knowable, develop plans and support each other. From here, we can chart a path for our teams and help people make decisions for their local situations.

We know what to do.

In forestry, we have systematic approaches that apply generally to situations requiring clarity for making decisions. First, work to understand the local situation, as it varies by region and market. Second, question the data to understand its quality (e.g. seek trustworthy sources such as Johns Hopkins Coronavirus Resource Center). And third, make (phone) calls to know what’s knowable and confirm that people have what they need to follow the simple practices we know work well.

With a clear sense of where we are and how things work, it’s easier to organize our teams and get moving. This gives purpose to our work and confidence in the process with an eye towards the future.

For those interested in a further discussion of strategic thinking (and how the coronavirus affects the forest industry), click here to read a five-page white paper.

Managing Risk by Screening Out Trouble

My work as a researcher in forestry sometimes highlights ideas relevant to developing plans or managing risk in other industries. For example, it helps to have a simple screening and ranking process. Without a structured approach to ordering the world, the world will impose its views on us. 

The fact is some things are more important than others, some things are easily verifiable, and some things depend on others. We have “nice to have” and “need to have.” There are “necessary” conditions and “sufficient” conditions. Simple processes help us sort the mess and prioritize.

At Forisk, my research team applies simple screens each quarter to the wood bioenergy sector to sift out speculative projects. Typically, our analysis suggests one-third of these projects will fail. We’ve fielded disgruntled calls over the years on this, but back-testing has found that our screening, applied consistently and systematically for over a decade now, has been helpful. 

Our screen poses two answerable and generalizable questions. First, does the project rely on a proven technology? In other words, does this thing work? Second, has this project secured at least two of the necessary resources or agreements such as financing; air quality permits; engineering contracts; or supply agreements? In other words, is this thing moving forward and on schedule?

While we can always ask other questions, this approach has proved useful in systematically distinguishing probable from speculative projects, investments, and technologies. Simple screens don’t tell us everything, but they do tell us something that focuses the mind and reorders follow-up questions.

We all apply screens in our lives. Does he tell the truth? Does this house have three bathrooms? Does this car have a big enough trunk for my flux capacitor? The key is to apply these screens consistently, systematically and then revise based on back-testing performance over time. That’s how we learn and improve.

For those interested in a further discussion of screening risk or the wood bioenergy sector, click here to read a seven-page white paper.

How to Read an Annual Report (if you only have 20 minutes)

Quarterly financial statements and annual company reports are the language of investors and executives. At the end of the day, the results of managerial business and capital allocation decisions get translated through audited financial statements, which, like haikus and box scores, require interpretation and translation. While investors and analysts claim to like transparency, the reality is the reading and interpreting of financial statements requires practice and patience (and interest).

Warren Buffett, for example, has interest. He reads 500 pages per day. He says that, while others may enjoy Playboy, he prefers annual reports and financial statements. (No comment).

Annual reports can yield valuable information, even if you are short on time. Reviewing annual reports can better prepare you for working with customers, suppliers, and your markets. They can yield insights, benchmarking and market intelligence. If you had 20 minutes, where should you focus? I think “L-L-C” to prioritize three things with the goal of understanding how a business makes money, how the managers/leaders think (and who they are), and the overall performance of the firm.

  1. Letter: read the Chairman/CEO letter. While some write this off as “fluff”, it always included business highlights (and lowlights, reasons, and excuses; make sure to know the difference). The letter will include noteworthy investments and efforts, and usually discusses the strategy and the business model.
  2. Leadership: understand who runs the company, including the Board of Directors. Look at the makeup, backgrounds, and skills of those who control the company. This can be especially relevant in smaller firms, and recent changes to the Board can highlight firm priorities.
  3. Cash: confirm how cash is generated and used, including financing. Are the core operations generating cash? How is the company using that cash? How are they financing investments into growing the firm? The ability to review the Statement of Cash Flows can benefit from a brief tutorial, but it is straightforward once your eye knows where to go. At the end of the day, numbers need to match.

If you have more time, read the Business Description to confirm the business model, business segments, key customers and exposures.

Learning: Tips for Conducting Informational Interviews

Informational interviews provide one avenue for learning about a business, developing professional relationships and sharing ideas.  We initiate informational interviews as job seekers, entrepreneurs and researchers to tap the experience and knowledge of others. As with job interviews, successful informational interviews rely on preparation and practice. How?

  1. Write an interview guide. This is the single most valuable way to prepare. Whether 30 minutes in person or 15 minutes by phone, know what you are going to ask to make the most of the time available. When developing your guide, ask yourself “What do I hope to learn in this interview from this person?” Defining the purpose of the interview helps you order and phrase the questions correctly.
  2. Start with general questions and move to specifics. Begin with general questions about the industry, for example, before getting specific about the person’s responsibilities or research.
  3. Learn about the interviewee prior to the interview. Know the person’s background and education. The interviewee is doing you a favor by setting aside time to meet with you; it is your job to be prepared.
  4. Do not exceed your requested time. However, be prepared to stay longer if the person is willing.
  5. Dress as if it were a job interview. First impressions always matter. Get to your appointment a few minutes early and be courteous to everyone.
  6. Ask open-ended questions which promote a discussion. Listen and guide.  And don’t interrupt; you will gather more information and stories.  Like I learned while counseling students in college, the greatest gift is often a sympathetic ear.  Work through the history, and the issues will come out.
  7. Avoid body language that indicates a lack of interest. This includes folding or crossing arms, slouching, or looking around the room. Turn off that cell phone and don’t check it. Take notes, and keep the pen moving.
  8. Share. Productive informational interviews often include active two-way exchanges and dialogues.
  9. Say “thank you.”Write a brief note which restates your appreciation for this person’s time.  State how the interview helped you move forward in your research or career development.

Finally, when planning informational interviews, consider talking to a range of individuals. Interesting and insightful information often comes from salesmen, administrative staff and customer service technicians. They have direct customer and product contact and may know where businesses struggle. And direct communication with those on the inside gives us insight and a feel for the real issues in a business or industry.

Analyst’s Creed

You are an Analyst, a warrior shrouded in mystery and feared for your ruthlessness with Excel. Your actions can throw Board meetings into chaos, and your existence will shape the company during this pivotal moment in history.

[Inspired by the Assassin’s Creed]

Finance is the language of managing resources as investments.  It addresses three questions.  First, the investment decision considers, “How do we screen, value and rank our investment alternatives?”  Second, the financing decision asks, “How do we pay for this investment?”  Third, the exit or sale decision asks, “How and when is the appropriate time – during good markets or bad – to reduce our position or sell the asset to maximize profits?”

Investment objectives matter.  Analysts use finance to compare projects and identify those that satisfy the predetermined criteria of clients or managers.  This facilitates the investment decision by screening out those that we can set aside, and those that we should consider further.  For example, for timberland investors, a preliminary screen may include geography, deal size, information quality, and basic financial metrics. If the potential investment satisfies the initial screen, then managers can allocate the human and financial resources required to investigate further.

When serving as analysts, we make investment recommendations.  It is our responsibility to be transparent and truthful in our assumptions and analysis, and practical and clear in communicating recommendations and ideas.  For me, this mean analytical and research professionals should also be able to differentiate and explain the pros and cons of alternate approaches to their work.

As analysts and researchers, how can we better support our firms and clients?  Over time, I have found few methods as effective for increasing analytic rigor and reducing errors as repeated application of financial tools in a range of cases to highlight the variety of unique questions and attributes associated with different assets. Through these trials, we develop the context and intuition to provide valued guidance.