TDM: ‘What we need to believe’ for an investment thesis

 

As growth investors, a necessary part of our jobs is to make inferences about the future.

While this is part and parcel of our role, it is certainly no easy feat. Predicting the future is close to impossible, as by definition it implies making guaranteed statements about something that has not yet happened. Like Howard Marks often says, rather than making predictions, we believe it is more important to make inferences — conclusions based on facts, observations, and probabilities. The distinction is subtle, yet critical to how we think as investors.

For example, it doesn’t matter if they are seen as the best team in the competition- no one can definitively predict whether the Golden State Warriors will win the NBA championship…but we can infer a probability of them doing so, by triangulating indicators such as team form, home court advantage and historical winning percentages. Put another way, rather than saying they will win, we would prefer to say, ‘based on X,Y,Z, there is a 4 in 5 chance of Golden State Warriors winning’ (but also a 20% chance that they lose).

One method we can use to think in inferences, especially to test investment theses, is to ask ‘what we need to believe?’. This mindset involves breaking down forecasts into objective implications, relative to things we know today. Effectively, we frame the future around concrete facts that we can verify — which makes it easier for the human brain to assess probability.

This mindset becomes even more important when we look at fast-growing, generational category leaders. At TDM we have been proud to compound our client’s capital in excess of 25% per annum for over 16 years. Because we have such a high investment hurdle rate, in instances where a business may be priced richly relative to its near-term sales / earnings, we need to believe that the company will grow at very high rates for long periods of time to meet our return profile.

 

To provide more colour, TDM have applied '‘what we need to believe’ thinking to a potential investment opportunity in Peloton — a company they view as the category leader of Connected Fitness - read the case study here.