Uncertainty

Uncertainty, in the investment world, is the fundamental inability to know what the future holds. It's not about calculating the odds; it's about acknowledging that for many events, the odds are simply unknowable. This concept was famously distinguished from risk by economist Frank Knight. Risk involves a future with known potential outcomes and calculable probabilities—think of a roulette wheel. You don't know where the ball will land, but you know all the possible slots and the exact probability for each one. Uncertainty, on the other hand, is like setting sail in uncharted waters. You don't know all the possible destinations, let alone the storms you might encounter. For a value investing practitioner, uncertainty isn't something to be feared or modeled away with complex mathematics. Instead, it's a permanent feature of the market that creates opportunity. When others panic in the face of the unknown, they often sell wonderful businesses at foolish prices, handing the patient investor a gift.

Grasping the difference between risk and uncertainty is a game-changer for any investor. It's the difference between playing a game of chance and navigating real life.

• Risk is Measurable: Imagine a standard six-sided die. The probability of rolling a '4' is exactly 1/6. You can calculate the odds and make statistically informed bets. This is risk. In finance, this might be represented by the historical volatility of a stock, although treating market movements as a simple game of dice is a dangerous oversimplification.
• Uncertainty is Unknowable: Now, imagine you're a venture capitalist considering funding a startup that wants to build the first-ever commercial teleportation device. What are the chances of success? 10%? 0.01%? What are the unforeseen technological hurdles? Will a competitor emerge out of nowhere? Will the government regulate it out of existence? You can't assign neat probabilities to these outcomes. This is uncertainty. It's the realm of “unknown unknowns”—the things you don't even know you don't know. The 2008 financial crisis or the global COVID-19 pandemic were classic examples of uncertainty in action, events that no standard risk model predicted.

Value investors don't waste time trying to predict the unpredictable. Instead, they build a robust strategy designed to withstand and even profit from an uncertain future. Their approach is built on a few core pillars.

This is the bedrock of value investing. Coined by Benjamin Graham, the margin of safety is the difference between a company's estimated intrinsic value and the price you pay for its stock. If you believe a company is worth $100 per share and you buy it for $60, you have a $40 margin of safety. This buffer isn't just for boosting returns; it's your primary defense against uncertainty. If your valuation is a bit off, if the company hits an unexpected rough patch, or if the economy takes a nosedive, that cushion protects your capital. It's the financial equivalent of building a bridge that can hold ten times the expected weight—you don't know what kind of unexpected load it might have to bear, so you over-engineer it for safety.

Popularized by Warren Buffett, the circle of competence principle is deceptively simple: only invest in businesses you can genuinely understand. You don't need to be an expert on everything. If your expertise is in retail banking, stick to that. If you don't understand biotechnology or semiconductor physics, stay away, no matter how exciting the story sounds. By operating within your circle, you reduce the number of unknown unknowns. You have a better chance of identifying the real long-term threats and opportunities for a business you understand intimately. This isn't about limiting your potential; it's about avoiding catastrophic mistakes by wandering into territory where you can't tell the difference between genuine opportunity and a well-told fairy tale.

Forecasting interest rates, currency movements, or the next turn of the stock market is a fool's errand. Uncertainty ensures these things are fundamentally unpredictable. Value investors ignore the noise and focus on what is more knowable: the underlying business. They ask questions like:

• Does this company have a durable competitive advantage, or an economic moat, that protects it from competitors?
• Does it consistently generate strong cash flow?
• Is the management team honest, capable, and shareholder-friendly?

By concentrating on the durable qualities of a business, you ground your investment decision in reality, not in speculation about an unknowable future.

For the disciplined investor, uncertainty is not the enemy; it is the source of opportunity. The market's fear of the unknown is what creates the mispricings that value investors live for. While others are paralyzed by what might happen, the value investor acts based on what a business is worth right now. By demanding a significant margin of safety, staying within your circle of competence, and focusing on business quality, you can turn uncertainty from a source of anxiety into an ally in your quest for long-term wealth creation.