Wednesday, July 29, 2015

Developing The 5 Whys Technique In Investing

I came across this technique when I was studying for my MBA last year and has found them to be very useful when it comes to investing. 

Many times, we as investors, have failed to ask relevant pertinent questions causing the underlying reasons for the companies we are interested or vested in. Even though it appears that most investors have done the first level of due diligence by screening check the financial numbers, many failed to consider the underlying root cause that explains why the share price of the company may be languishing where they are at the moment. 

This is where the 5 Whys Technique might prove to be useful in investing. Mathematicians called this the power of second derivative thinking. In simple terms, it means going beyond the first level screening where everyone is able to see or figure out. This makes sense because in investing, you need to be able to think and prospect ahead of the pack (mostly retail investors or research brokerage analysts) and take action before they do in order to earn higher than average returns. Otherwise, you’ll be better off investing in an ETF index fund for longer sustainable returns. 




The 5 Whys technique was formally developed by Sakichi Toyoda and first used within the Toyota Motor Corporation during the manufacturing evolution decades ago. They are an iterative question-asking technique used to explore the cause and effect relationship, each depth going deep and deeper to uncover and determine the underlying root cause of the problem. They are important in investing because for most of the times, the underlying root cause to the problems are not so formally evident at an investor’s eyeball level. They require the tenacity of the investor’s persistence in asking the right questions and the ability to see what is ahead in order to make a calculated risk return assessment on whether the investor should buy the share at present

Let’s take a look at an example: 


1st Why - Q: Why do you write a blog? 
                A: Because I want to document my journey towards financial independence. 

2nd Why – Q: Why are you seeking financial independence? 
                   A: Because I want the freedom to do things that I love. 

3rd Why – Q: Why do you want the freedom to do things that you love? 
                  A: Because my current job does not satisfy me, but money is an issue. 

4th Why - Q: Why is money an issue? 
                 A: Because my current expenses are exceeding my current income. 

5th Why - Q: Why are your expenses higher than your income? 
                 A: Because I have a family of 6 to feed and I am the sole breadwinner of the family. 


This is just a very simple example but you can see how each questioning uncovers the underlying root cause of the problem as the question moves along. We can also apply the same to investing. 


1st Why – Q: Why are you interested in Keppel Corp? 
                 A: Because they are trading at an "attractive" low P/E valuation. 

2nd Why – Q: Why are they trading at such valuation? 
                  A: Because the share price has gone down more than the drop in earnings. 

3rd Why – Q: Why did earnings (and share price) goes down? 
                  A: Because their O&G segments are dependent upon the oil price. 

4th Why – Q: Why did oil price drop? 
                  A: Because there is an oversupply and alternative replacement of shale gas. 

5th Why - Q: What is the tolerance level of sensitivity of oil price the business can take the hit? Can oil goes back to pre-crisis level?, etc etc...


I think by now you should get the idea of how you can use the 5 Whys technique. You can modify or customize it to your liking, but the idea is to get a deeper understanding of the underlying root cause before you decide to action.

What do you think? Is this useful to you? Do you conduct second derivative thinking when analysing companies?



14 comments:

  1. Hi B,

    I do this, but 3 whys when asking pupils to do reflection ?

    Lol.

    ReplyDelete
    Replies
    1. Hi SI

      Ahh, you inflicted the 3 Whys on your students for reflections?? I usually stone when my teacher asked me to do so -.- hahaha

      Delete
  2. B : I learnt about this "Whys" technique a couple of years ago, during one of the management course. Maybe it is for different context but when we keep drilling into the next whys, we would be able to identify the root cause(s) ultimately.

    Kee "Why-ing"... ;-)

    ReplyDelete
    Replies
    1. Hi Richard

      Like you, I also first heard about it and apparently they are prevalently used in management courses. The theory and idea behind it is great. Whether or not they are relevant, it needs to depend on the right questions too :)

      Keep Why-ing ;)

      Delete
  3. 3 whys or 5 whys, it's always wise to question or play devil advocate.

    However, I've read somewhere that successful entrepreneurs are often take big risks, I'm wondering if they've done their "whys" or they'd just do it and ask question later? :) Then again, most of the selfmade millionaires, they're often grow up poor so they don't have much to lose.

    ReplyDelete
    Replies
    1. Hi Vivianne

      You bring an interesting point there about entrepreneurs.

      I think entrepreneurs ask a lot of why, it's just their execution are more direct, which explains a lot of successful and failures amongst them. I'm not so sure if I can be like them, finger crossed -.-

      Delete
  4. Hi B

    Asking whys are good sanity check, but there is another situation whereby people analyse until paralyse. The best way to strike a balance is to keep learning so that we are always prepared for what could be coming.

    Be courageous when doing, be mindful when planning.

    ReplyDelete
    Replies
    1. Hi Frugal Daddy

      You are right. Analyze until paralyse without action is equivalent to a waste. Everything needs to be balanced. The ying and yang :)

      Delete
  5. The Wise (Why) folks! Being Wise (Why).

    The Last Wise (Why) Man in the stock market - Why you didn't take action after answering all 5 Whys?

    The E ...

    Yalor. Still unable to overcome the E..

    :-( :-( :-(


    ReplyDelete
  6. Hi B,

    The method is very helpful in overcoming many of the biases that do fog our decision making so often.
    Biases trick us because we are generally lazy to think. Asking the '5 Whys' forces us to think.
    However we should be in agreement with ourselves that once the '5 Why-answers' are in line with our objectives and values, we do proceed and act without further procrastination.

    ReplyDelete
    Replies
    1. Hi Tacomob

      Thank you for your feedback.

      Our human mind is really lazy, we always think of short cuts and are generally sleeping if they are not properly utilized.

      You are right, the questions need to be combined with a sustainable action to do, otherwise, it'll only be a leg up and nothing is accomplished.

      Delete
  7. Hi B,

    Asking why is important, like my children keep asking why until u feel like saying "Stop it!" But it's a process of learning and growing up. :-)

    But one thing I am quite sure is most of us today, focus too much on the questions and external happenings, that we often fail to re-examine our inner self, which many cases is the root problem!

    For investments, careers, life, I believe that the inside-out approach is key. Frankly I may be a bit extreme here, but I think in the long term, the success of investments, career/business, life are somehow related, if u eventually piece them up together. Just like Singapore as a country...

    I reckon therefore once our inner self and inner mind is tuned correctly, the rest will be in place with ease, be it ur investments, ur career, ur family, ur life etc.. Maybe that is why so many great investors are great philosophers!

    ReplyDelete
  8. I am a big believer in placing comments on blogs and forums to inform the blog writers know that they have added something useful to the world wide web! Holborn Assets

    ReplyDelete

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