Pulak Prasad’s book, “What I Learned About Investing from Darwin,” offers a unique and insightful perspective on the world of investing by drawing parallels with the principles of evolutionary biology. As the founder of Nalanda Capital, Prasad brings a wealth of experience in long-term investments in Indian companies to this fascinating interdisciplinary exploration. This book isn’t about forcing a scientific connection, but rather using the elegant logic of natural selection, adaptation, and survival of the fittest as analogies to illuminate key investment strategies. For those seeking to understand the enduring principles that underpin successful investing, exploring What I Learned About Investing From Darwin Pdf Free might be the first step to uncovering these valuable lessons.
Prasad’s background at Warburg Pincus and his deep dive into evolutionary biology, despite not being formally trained in the field, showcases his intellectual curiosity. He masterfully translates complex biological concepts into relatable investment principles. The book emphasizes the crucial role of adaptability, long-term perspective, and understanding human behavior – elements vital for navigating the ever-evolving market landscape. Even for readers unfamiliar with biology, Prasad’s engaging writing style makes these intricate ideas accessible and immediately relevant to the world of finance.
While the book provides a rich framework for thinking about investing, it’s important to note that it’s not a scientific treatise. Instead, it uses Darwinian analogies to reinforce sound investment philosophies. The core takeaway is powerful: the natural world offers profound lessons in adaptation, survival, and long-term growth that are directly applicable to building a robust investment strategy.
Let’s delve into some key insights from the book, organized by core investment themes:
Minimizing Errors: Learning to Avoid Type 1 and Type 2 Mistakes
Prasad begins by framing investment decision-making through the lens of error management, categorizing mistakes into Type 1 (errors of commission) and Type 2 (errors of omission).
Almost everyone—and I say “almost” because this statement does not apply to my wife—makes mistakes. These errors fall into two broad categories: We do things we are not supposed to, and we don’t do things we are supposed to. For me, buying a hot fudge sundae at McDonald’s falls into the first category, and not keeping in regular touch with my school and college friends falls into the second.
As any statistician will tell you, the risk of these two errors is inversely related. Minimizing the risk of a type I error typically increases the risk of a type II error, and minimizing the risk of a type II error increases the risk of a type I error. Intuitively, this seems logical. Imagine an overly optimistic investor who sees an upside in almost every investment. This individual will make several type I errors by committing to bad investments but also will not miss out on the few good investments. On the other hand, an overly cautious investor who keeps finding reasons to reject every investment is likely to make very few bad investments but will lose out on some good investments.
Just as humans can make errors in judgment, so can predators and plants in nature.
Let’s now turn our attention to the predator. The predator, too, can make two types of error: It can commit itself to killing prey that turns out to be too dangerous or too large or too fast (type I error), or it can refrain from attacking prey that it could easily have killed (type II error).
Plants can choose to commit resources broadly to two areas: defending against attacks or growing. As with deer and cheetahs, any error that significantly compromises life or fitness for a plant can be categorized as a type I error. Since the lack of a proper defense may prove fatal to a plant, a type I error, or an error of commission, occurs when the plant does not devote resources to protecting itself. A type II error occurs when a plant directs energy toward preservation when it should have invested in growth. This error of omission may not kill the plant but may compromise its ability to grow and reproduce relative to its competitors. Ample evidence from nature suggests that plants avoid type I errors at the cost of committing more type II errors.
Plants, like animals, have found a way to their spectacular evolutionary success by focusing on reducing their errors of commission. In other words, like their animal counterparts, they avoid taking risks to their life and well-being at the cost of giving up some potentially juicy opportunities.
This translates directly to investing. A Type 1 error in investing is investing in a poor company, while a Type 2 error is missing out on a great investment opportunity. Prasad, echoing Warren Buffett’s philosophy, advocates for minimizing Type 1 errors – avoiding significant losses – even if it means occasionally missing out on potential gains. Focus on downside protection and invest in quality businesses where the risk of permanent capital loss is minimized.
Buffett has never explicitly explained this (at least I have never found an explanation), but this is what I think he means: Avoid big risks. Don’t make type I errors. Don’t commit to an investment in which the probability of losing money is higher than the probability of making money. Think about risk first, not return.
Natural Selection: Identifying Businesses with Enduring Traits
Natural selection, the cornerstone of Darwin’s theory, highlights the survival and propagation of organisms with advantageous traits. Prasad cleverly applies this to business, suggesting that investors should seek companies with inherent “fitness” to thrive in competitive markets.
The famous experiment with silver foxes demonstrating the rapid evolution of tameness through selective breeding illustrates this principle powerfully.
Dmitri Belyaev and Lyudmila Trut’s1 long-term experiment in Siberia has shown that selecting for tameness in wild silver foxes transforms them into a creature not unlike a pet dog over very few generations.
When the pups were about seven months old, the experimenters assigned them to one of three categories based on their tameness. Class III foxes were unfriendly toward the handlers and either ran away from them or were aggressive. Class II foxes behaved neutrally and displayed no emotional response toward the handlers. Class I foxes were the friendliest and seemed to want to engage with the handlers. Lyudmila and her team selected a few of the calmest Class I foxes for mating and repeated the experiment with the next generation of pups. By the third generation in 1962, Lyudmila noticed that some of the tamer foxes had started mating a few days earlier than usual and were producing slightly larger litters than wild foxes. Otherwise, there was no indication of any significant change. In April 1963, as Lyudmila approached the cages of the fourth generation of pups, she saw a male pup called Ember vigorously wagging his tail. This was precisely what a puppy would do. But no one had ever witnessed a silver fox—whether in a cage or the wild—wag its tail at a human. Ember wagged his tail at other humans, too.
In investing, identifying a single, measurable trait that correlates with overall business quality can be incredibly valuable. Prasad suggests historical Return on Capital Employed (ROCE) as such a metric.
As an investor, would you not want to be in the position of selecting just one trait of a business but getting many high-quality attributes for “free”? As discussed earlier, this single trait should satisfy three criteria: it should be measurable, reject most businesses of poor quality, and select most high-quality businesses. Most, not necessarily all. We have seen that some factors like high-quality management, revenue growth, and margins do not serve the purpose well enough. At Nalanda, here is what we begin with while short-listing businesses: historical return on capital employed (ROCE). The first word first. Historical. I devote an entire chapter to this important and oft-ignored word, but for now I wanted to clarify that the ROCE number is what a business has delivered in the past.
Many investors prefer return on equity (ROE). I don’t. ROE is calculated after taxes and interest payments, and hence mixes operating performance with financing strategy and tax structure. As a business owner, I am much more concerned with the superior operating performance of a business. While taking on leverage (which will improve ROE but not ROCE) and “planning” for taxes may benefit a firm in the short to medium term, in my experience, success over the long term comes only by running great operations.
A company delivering high ROCE with modest revenue growth will generate excess cash. This is not an opinion—just a mathematical fact. For example, Company X growing its sales at 10 percent with ROCE of 25 percent can grow from zero cash to a cash balance of almost 18 percent of sales in five years (other assumptions: margin 15 percent, tax 30 percent). With an increasing cash cushion, X’s management team can choose to launch new products or target new geography. Even if the new business fails, X can recover given its ability to generate cash from its core business. Now let’s look at its competitor, Y, which is growing at the same rate (10 percent) with the same margin (15 percent) but with a lower ROCE of 12 percent. In five years, Y would have a negative cash balance of 3 percent of revenue. In other words, Y would have to borrow to grow at the same rate as X.
High historical ROCE signals a business that is inherently efficient and generates excess cash, providing resilience and optionality for future growth. This “fitness” allows these companies to adapt and thrive across economic cycles.
The Irrelevance of Macroeconomic Forecasting in Long-Term Investing
Prasad challenges the conventional wisdom of relying heavily on macroeconomic forecasts for investment decisions. He argues that macro events are often unpredictable and have limited correlation with long-term stock performance.
We have seen two problems with treating macroeconomic factors as critical proximate variables. First, we noticed that even big macro events (like the Asian financial crisis) are uncorrelated with longer-term stock price performance. Second, taking the example of the Indian tire industry, we concluded that using proximate economic data to assess industry and company performance is very hard, if not impossible. The third problem with using economic data is the most obvious of all. No one knows anything. Okay, that is exaggerating a bit. But only a bit. Since even expert economists are abysmal at forecasting the economy, why should we investors squander our time giving it any importance?
Focusing on predicting macro trends is often a futile exercise. Instead, investors should concentrate on understanding individual businesses and their long-term prospects, irrespective of short-term macroeconomic fluctuations.
Common Ancestry and the Futility of DCF Analysis
Darwin’s theory of common ancestry posits that all life on Earth is connected through a shared evolutionary history. Prasad draws a parallel to business analysis, emphasizing the importance of understanding a company’s historical performance rather than relying on speculative future projections, particularly through Discounted Cash Flow (DCF) analysis.
Darwin proposed not one, not two, but three revolutionary theories in Origin: natural selection, sexual selection, and common ancestry. Let’s briefly see what these theories are and how he used history in all of them to arrive at his radical explanation of all organic life.
Natural selection requires three key ingredients.9 First, there needs to be random variation among the progeny of an organism. Note the word “random.” Variation does not seek any goal. Second, there needs to be differential fitness among these variants such that injurious variations get rejected and favorable ones are preserved. Last, the favorable traits must be heritable so that they are passed on to the next generation. Then, these three elements repeat ad infinitum over millions, even billions, of years. Resulting in a pangolin from a protozoan. In Darwin’s own words, “This preservation of favorable individual differences and variations, and the destruction of those which are injurious, I have called natural selection.”
Back to the lessons from Darwin. Like Darwin: • We interpret the present only in the context of history. • We see the same set of historical facts as everyone else. • We have no interest in forecasting the future. We study the history of a business to understand its financials, assess its strategies, gauge its competitive position, and finally assign value to it. So let’s take them one by one.
DCF analysis, while theoretically sound, relies heavily on predicting future cash flows and choosing an appropriate discount rate – both highly uncertain endeavors.
As per corporate finance theory, the value of a business is simply the sum of all its future cash flows discounted to the present time. This makes academic sense. It’s true mathematically. But as a practical way to invest, it borders on being nonsensical. Let’s understand why. There are two main requirements for building a DCF spreadsheet: the discount rate and the cash flow projection.
We have never done a DCF analysis and never will. However, I know many—if not most—investors and analysts do. Maybe they have figured out a method to look far into the future that eludes me.
Prasad advocates for a more historical approach, understanding a business’s past performance and current strengths to assess its intrinsic value, rather than relying on potentially flawed future projections.
Convergence: Recognizing Patterns of Success
Evolutionary convergence describes the independent evolution of similar traits in unrelated species facing similar environmental pressures. Prasad applies this concept to business, arguing that patterns of success and failure emerge across different industries and companies.
When presented with a specific problem, the Caribbean anoles on different islands have evolved the same solutions, such as tail length, body length, and color. Amazingly, they have done it independently of one another. The anoles are a textbook example of evolutionary “convergence” wherein unrelated organisms in similar environments develop the same body form and adaptations independently.
I could go on and on to fill this book with examples of convergent evolution in the natural world. But scientists now agree that convergence is the rule, not an exception, in nature. This sentiment is best expressed by the most famous advocate of convergence, the Cambridge paleontologist Simon Conway Morris, who has written two books on the subject. He has explained convergence by saying, “Certainly it’s not the case that every Earth-like planet will have life let alone humanoids. But if you want a sophisticated plant, it will look awfully like a flower. If you want a fly, there are only a few ways you can do that. If you want to swim, like a shark, there are only a few ways you can do that. If you want to invent warm-bloodedness, like birds and mammals, there are only a few ways to do that.” Convergence in nature symbolizes a profound fact: There is a pattern to success and failure. What can the Caribbean anole, the crest-tailed marsupial mouse, and caffeine teach us about investing? Convergence in business symbolizes a profound fact: There is a pattern to success and failure.
Just as nature reveals patterns of successful adaptation, so too does the business world. Industries with inherent economic advantages, where companies can consistently generate profits, are more attractive investment landscapes.
Investing in companies is no different. Buying into a business means also buying into the industry of that business. For example, while I may think I am investing in a company that makes and sells sanitaryware, I am inheriting all the good and the bad of the sanitaryware industry. No company is an island. We can never ignore the kinds of businesses that surround it. One of our principles of convergence investing is that if the industry allows its companies to make money consistently, we love it; if not, we better have a perfect reason for spending even one minute analyzing a business like an airline. Life is too short.
Focusing on industries with favorable structures and dynamics increases the odds of investing in companies that exhibit convergent patterns of success.
Evolving Companies and Long-Term Investing
Darwin’s finches, famously studied on the Galapagos Islands, demonstrated how species adapt to changing environmental conditions over time. Prasad uses this to illustrate the importance of long-term investing in high-quality businesses that can evolve and adapt.
But in 1977, after a brief spell of rain in January, Daphne Major suffered a severe drought. Almost all the greenery disappeared from the island, and the only plants that survived the drought were cactus bushes. The finches fed on seeds of all sizes. The small and medium-sized seeds disappeared very soon, and the finches were then left with only large and hard seeds. But only the finches with larger beaks could break open these larger seeds; finches with small and medium-sized beaks could not open these seeds and so starved and perished.
In 1983, there was a very heavy rainfall because of El Niño, and the island became lush and green. Green vines covered even the cactus bushes. This changed vegetation had a significant impact two years later when drought struck again. This time, tiny seeds were abundant (produced by the vines of 1983), and large seeds became rare. As a result, the finches with large beaks found it hard to pick up the seeds, and a large proportion of the survivors of this drought were the small- beaked finches. Their offspring, as a result, also had smaller beaks. Natural selection and evolution were evident again, except that, unlike in 1977, the beaks had evolved to become smaller.
Just as finches adapted to changing food sources, successful companies must adapt to shifting market dynamics and competitive landscapes.
This realization has helped me formulate an investing principle that I call the Grant–Kurtén principle of investing (GKPI). It goes as follows:
When we find high-quality businesses that do not fundamentally alter their character over the long term, we should exploit the inevitable short-term fluctuations in their businesses for buying and not selling.
All investing models have downsides. In my opinion, no investment strategy is foolproof. If you know of one that is, please write a book on it (or better still, email me the magic formula). Our application of GKPI will have Kodak-like downsides, but in my experience, it works well most of the time. And that’s the best we can expect of any model.
High-quality businesses, too, seem to undergo many changes when measured over days or weeks or months but are much more stable when the period of measurement is years or decades. 3. Empirical data from the longevity of Fortune 500 businesses demonstrate the long- term resilience of exceptional businesses. About 40 to 45 percent of the Fortune 500 businesses of 1955 continued to be successful for the next sixty years.
This leads to the “Grant–Kurtén principle of investing” (GKPI): focus on investing in enduring, high-quality businesses and capitalize on short-term market volatility to buy more, rather than sell. Long-term resilience and adaptability are key traits of businesses that thrive over decades.
Conclusion: Embracing Darwinian Wisdom for Investment Success
“What I Learned About Investing from Darwin” is more than just a book review; it’s an invitation to rethink your investment approach through the lens of evolutionary biology. Pulak Prasad provides a compelling framework for understanding risk management, business selection, and long-term investing by drawing insightful analogies from the natural world. While the allure of finding a what i learned about investing from darwin pdf free version is understandable, the true value lies in engaging with the book’s ideas and allowing them to shape your investment philosophy. By embracing the timeless principles of adaptation, survival, and long-term thinking, investors can cultivate a more resilient and ultimately more successful portfolio.
If these insights resonate with you, picking up a copy of “What I Learned About Investing from Darwin” is highly recommended. It’s an enjoyable and enlightening read that can profoundly impact your investment journey. Happy investing!
1Conducted out of Novosibirisk
