Nick, Peter and Fraser discuss why it is so hard to spot future potential in ideas.

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Hello and welcome to the Cognitive Engineering Podcast produced by Telme Studios for Aleph Insights. In this series of podcasts we take a look at interesting topics and discuss what we think they tell us about analysis and decision-making. I'm Fraser McGruer and I'm here with Nick Hare and Peter Coghill of Aleph Insights and this week we're taking a look at the recent purchase of Yahoo by US telecoms giant Verizon for 4.8 billion US dollars. Peter, lead us in, give us your analysis of this deal please. So I think it's easy

buyouts. Okay and just being completely explicit here I mean one of the reason why this is raised eyebrows let's say is because this was the purchase was just for 4.8 billion dollars is that right and at one time Yahoo was valued at 125 billion dollars as you said it could have bought Google a certain price and Google now makes lots of money and it basically I think the subtext here is hey Yahoo's gone really down in value right that that's kind of the point yeah but something you said there which I think is really interesting which I know this is a big thing Aleph Insights which is that the decision not to buy Google we look at it now and go oh god that's a disaster look how brilliant Google has done but actually you can look back and go with all the information that was available at the time it was actually a good decision it was a very defendable decision and I guess that begs the question is if Google has become such a huge success and I guess the question we really want to ask here is this is about spotting potential how can we spot

just not very good who knows well okay so they're not very good at doing stuff still 4.8 billion dollars I mean if anyone out there would like to come and make an offer for my company I will accept half that you know so I think this is you

know the the holy grail isn't it for you know venture capitalists and people who are thinking about startups and people who go on Dragon's Den is how do we know whether this idea is going to succeed so how do we know that we have obviously you know a lot of the a lot of the valuation you look at you know the ludicrous valuations or superficially ludicrous valuations for some of these companies which you know don't do anything you know like like Twitter or Facebook or even even Amazon which I think may may have moved into profit but has never made a profit which Amazon yeah yeah and and the the enormous valuations are obviously driven by the promise of future revenue so the value you know that the theory of valuation is that it's a combination of both expected revenue you know now what it's a sort of net present value of future revenue so you know you buy a share you will one day get some profits from that share because the profits will be shared among the shareholders you know you get a dividend out of it that's the idea and you know but when when you have companies which are loss-making but still have enormous valuations that has to be because there is an expectation that at some point they will find a way to monetize their their brand value and their reach and their user base and so on anyway so so basically that the the Holy Grail is you know can we find a company which is valued something smaller than it's actually worth than it ought to be valued at that's what you want as an investor is to find that and that's how stock markets work as well right well yeah I mean and so this is I suppose you know where I'm going is is that they're so far no one's found it because I mean if if they had done we would we would you know everyone would be a millionaire there is no one has successfully found there were rules of thumb that people use there are lots of you know things that VCs will look for so for venture capitalists when they're looking at a startup often won't won't really look at the idea so much as look at the team because actually most startups don't end up doing what they were set up to do and actually what you really want is good people who will be adaptable and will you know pivot whatever they're doing in the direction that the market wants them to do for example and you know there are you could use quite easy to spot obviously bad ideas but it's in the realm of the of the things that are you know all potentially winners that's that's where this this question becomes most important you know so which should I buy this company should it should I invest in this share and and the evidence is that you know unless you're a wizard you are not going to be able to outguess the market right so so there's no there is no evidence that anyone any investors so I'm thinking here of sort of stock market investors rather than this sort of early-stage venture capitalist type investment but there's no evidence that any investors can consistently beat the market a lot of commentary about the way the stock market works kinds of depend kind of depends on the idea that there is you know oh I the shoeshine boy told me he was selling oil so you know I made a made a fortune on it sort of stories but but actually you know there's no there's no evidence that's not that that some investment strategies are going to be others you know which leads us to conclude that probably the market is pricing these things well and that you know it doesn't matter if you've got something which you know which is promising a thousand percent reward that is going to be much less likely to succeed than something which promises you a 10% reward okay

we're gonna come to Peter but first isn't but isn't there a strategy which maybe does work which is actually what you're saying which is researching

fundamentals isn't isn't no because the point is that unless you're the point that somebody else will have researched those fundamentals for you and me I'm not let's assume we're not we're not venture capital okay so what I'm saying

so this is classic what Warren Buffett does he sort of you know he he refers searches stuff himself or there's another investor who he will use sort of you know stuff that's going on in actual life around him and sort of draw

conclusions yeah the there is a that that is not universally agreed that people like Warren Buffett are making money because they're so that's a because they have such a big influence on the market anyway that that there may well be just a sort of circularity to that okay they're able to make profits because people see them sure as you know and follow their lead so there's not so so what all I'm all I'm saying is that you at home are not gonna be able to sit down and be better on average at spotting winners and that actually it doesn't matter whether you're investing in something early on or whether you're investing in it once it's a raging success the probability of it succeeding

is going to be priced in okay yeah Peter yeah just pick that up the mark the market already has all the information available kind of in the price of any given stock so we just invest in an index then yeah yeah I said but the the where the shoe shine boy providing is giving you information that other people are not party to so therefore you can adjust your your you can adjust the market value to what to factor in that new to factor in that new information

that you receive so but I should point out why I've been talking about sort of you and me non venture capitalists is that there is a market right so so where you have a market you can assume for all intents and purposes that the market has priced in whatever information you think you're going to turn up through a Google search however the situation is different for you know well particularly early-stage venture capitalists who are looking at something for which there's no market you know there it did and and you know there's when you when you've got a company that doesn't really exist yet you can't you can't put it up for sale you know we're talking about these things before they hit the market and there it does become an issue you know you're looking at fundamentals looking at all the usual things them doing the market research but there are still you know inherent technological constraints particularly when it comes to new innovative technologies you know something like Facebook no one knew the world wanted Facebook until it became a huge success there's no reason to think well I'll invest in this because you know social networking is the future

because it might not have been okay so look I mean we're halfway through our podcast have we answered the question that's it how do you spot potential you can't thanks very much you know speak to you next week see you next week is

model then maybe they would have been a success okay let's take this in a let's look at this turn this on ahead a little bit okay you're in the business of analyzing decision-making processes in the in with the with a view to getting better at those decision-making processes okay I'm eventually I'm a venture capitalist with a few million quid to spare I come to you I come to Nick and Peter Aleph insights say listen I want to get better at picking the firms that I invest in I want to I want to find the next Facebook I want to I want to how can I get better at spotting potential that's what they come to you

with what would your advice well I said the thing is that I've you know I've tried to look at this I looked I've been looking for any evidence that connects measurable indicators to success that that you know isn't priced in anywhere and I just it's just I haven't found any plausible stories about you know which are backed up by data which which say that okay here are some things that are easily measured that will enable you to you know correctly value a company and if you ask people who are who are whose job is to value companies they will all tell you it's you know and this is in inverted commas because I don't really know what it means but an art rather than a science that that you know it's somewhat akin to you know political forecasting trying to say whether a particular thing will succeed is just very very hard because the system is complex a startup is going to be subject to a huge amount of forces both you know internal political ones external market ones technological ones that are going to affect whether or not it succeeds and there's just no there is no simple model that you can apply to to sort of consistently to consistently pick the winners and and give up on the losers so it is you know the kinds of the strategy that VCs use is probably a good one which is to you know to invest in lots of things and and and and be interested in your average return okay and not you know the jaw your your job is not to be able to say this company has got it made it's going to succeed in that one isn't but simply to say look that these you know we've got these 25 startups all of them are telling a story which is kind of plausible there's not much we can do really to refine our estimate of how successful they're going to be so we'll

we'll invest a bit in all of them I like this because this is I can feel a new career beckoning for me as a venture capitalist because this is very much the Fraser School of decision-making which is like oh it's just complicated let's just do this I like that and thank you for validating that for me Peter you

wanted to say something yeah the the decisions related to whether or not to invest in something are not really distinct from any other kind of decision so if you if you if you're capable of processing more information do that get get more more and more information perhaps consider not letting the market price anchor you in any way so try and formulate your own market price without considering what the real market price is and then if it's different which it probably will be trying to consider why that is do you know more about the company then perhaps the average marketeer does or do you know less and then that provide may provide you with a with an insight that

that on there I can't bring one to mind I know I know people make up backer names for words like the like some people believe that the word posh comes from port out starboard home I thought that was the case no absolutely does not no but for some reason inventing acronyms is very you know it's very popular among amateur etymologists but they're almost always wrong so we need

further research on this this one is I found it on the internet so I mean did you use Yahoo's search engine have they got one anymore I don't know they must absolutely Yahoo stands for yet another hierarchically organized Oracle what do we think so we could take a vote on that what do we think this is accurate that

yeah that's a very skeptical that's I think but I think they thought Yahoo it's a very sort of 90s new sector you know brightly colored exciting logo coffee shops you know kind of indie music sort of thing isn't it and no doubt they then thought you know what well let's invent an acronym that that fits it okay

so you say backronym what do you say I like this new word backronym so you say

backronym what do you say I think that's apocryphal that it's apocryphal I think

we need to do some research it's a bit too obscure and a bit of a mouthful really it is I do you know what I think might have happened though which is it's a bit like I was listening to a program the other day about wimps wimps yeah okay the in an astronomical sense yeah which is I think that the people who at the time sort of just so somewhere between an acronym and a backronym where they they wanted something snappy they wanted something so they kind of you know manipulated it so so they could stand for wimps so it's something like it's to do with dark matter and it's it's something like weak something matter I don't know but the thing about thing about dark matter is that it's it's got I wasn't quite prepared for this the thing about dark matter is that the one the reasons why it's really difficult to spot is because it's dark is is is because it actually it has a very God I can't I can't remember why

leave it that it's dark it's really dark so it's hard to see yeah but also stuff

goes through it like that we've got dark matter right now going through our bodies and we just don't know about it doesn't interact with the with our matter yeah because it weak it weakly influences stuff weakly influence the beginning of wimps right there we go and there's another weak interaction weekly I think weakly interacting matter part exactly and you can imagine these poor geeky scientists in the basement somewhere going brilliant we've come up with it so that's what I think might have happened here in Yahoo so anyway all right we'll

stop there I did I did want to make one little point gone which I should have made earlier so maybe you can weave it in somehow but when I when I said that Facebook and Google are engineering companies so they were all about innovation they're all about fixing new problems that gave them a certain tool set that Yahoo lacked which is perhaps why they are stronger now than they were at the time and they are the winners as it were in this race but but it's not that's not to say that Google and Facebook were any better at reading the market than Yahoo it's just that they had the right tools to deal with it when opportunities arose because they were innovators good okay I like it's a good

point although I'm always slightly wary that there seems to be a subtext often in your points which is the it's the engineers are always right you know that it's God if only the world would be better place if we listen to the engineers so so we'll draw this to a conclusion there but I think the answer was can we spot potential potential no we can't I think that's our conclusion so we'll wrap up there thank you very much chaps I'm Fraser McGruer I've been here with Nick Hare and Peter Coghill of Aleph Insights this has been the Cognitive Engineering podcast thank you very much until next time goodbye