Logic arguments can move from these simple ‘if, then, therefore’ formats to more complex three or more interconnected statements. Consider this longer argument:

If interest rates fall below 5% Joe will invest in a portfolio of stocks instead of bonds. If Joe invests in stocks then he will expect a total return over five years of at least 11% to compensate for the excess risk compared to bonds. Therefore if interest rates drop below 5% Joe will expect his portfolio to achieve total returns of 11%.  

 The premises of this argument can be disputed, but if they are accepted then the conclusion must logically be accepted. The form of argument is valid and obvious, and simply uses a longer chain of reasoning than the earlier arguments, and there is no reason why the reason chain cannot be extended indefinitely. Consider this lenghty logic argument by a fundamental investor:

If a disciplined investor only purchases good businesses at times when the market prices them below their intrinsic value then this investor can outperform the market index over time. If a good business generates consistently high cash flow from operations then it may not need to borrow money to fund further growth. If a business has borrowings less than a single year’s net earnings then it is not using debt to finance growth. If a business has consistently increased sales, earnings and cash flow from operations at more than 15% per year over the last decade then it may be safely assumed to continue this trend in future years. If future growth is predictable then a company can invest to establish a dominant brand that commands a premium price. If pricing power is established with a respected brand then profit margins will be high. If high profit margins allow continuous investment in new product development and brand building activities then the company will have a sustainable competitive advantage. If the company has sustainable competitive advantages it is likely to achieve a high return on shareholders’ equity (net assets). High ROE businesses would be expected to command premium prices in the market. Therefore, if high ROE businesses can be purchased at a discount to their intrinsic value the investor will eventually outperform the market.

 Some arguments present an ‘either, or’ dilemma, where two premises appear to be mutually exclusive, such as the following:

Either you invest wisely or you invest foolishly. If you invest wisely then your friends will be jealous of you. If you invest foolishly then your professional peers will lose respect for you. So either your friends will be jealous of you or your peers will disrespect you.

 Of course, there is an alternative view that is also valid, and more optimistic:

Either you invest wisely or you invest foolishly. If you invest wisely your professional peers will respect you. If you invest foolishly your friends will comfort you. So either your peers will respect you or your friends will comfort you.

 The second argument is actually a subtle rebuttal of the first argument. It is a clever restatement, which does not directly invalidate either of the premises, but brings the argument to a conclusion with much more appealing consequences. Such a rebuttal leaves the original dilemma intact. It accepts the conclusion but tries to show that there are other consequences, which must be taken into account: the consequences are less dismal than they seemed.

Another important point for making logical assessments is to understand that what is true for a group may not hold true for each individual within that group. Charles Dow founded the Dow Jones Industrial Index (DOW) in 1986– maing the index 111 years old in 2007. This does not, however, mean that every company in the DOW index today is 111 years old. In fact, the truth is that only one of Dow’s original 12-stock index companies in 1896 has even survived to be a component of the 30-stock indes in 2007– General Electric (GE).

The British philosopher John Stuart Mill proposed a similar argument a century ago that ‘because it is true of each man in a community that he desires his own happiness, therefore it is true of all that they desire the happiness of all.’ Observation, however, shows us that in any group, while individual members typically (selfishly) desire their own happiness– there is seldom universal desire for the happiness of all. A nation may benefit by fighting for precious beliefs and a desired way of life– but the brave soldiers who sacrifice their lives to preserve the rights and lifestyles of the survivors are no longer around to enjoy the furits of their sacrifice. The group, in this case, directly and greatly benefits from the ultimate sacrifice of some of its members. It is obvious, and common, for groups and individuals within the groups to experience different consequences from a single action or decision. Consider an economic policy decision by a country:

Singapore will be made richer by embracing free trade agreements with larger nations, so if some Singaporeans fail to welcome the removal of tariff barriers and protected domestic markets either they fail to realize that they will benefit or they do not want to benefit.

While opening domestic businesses in the tiny city-state of Singapore to fight toe to toe with giant foreign competitors may benefit the nation as a whole in the long run, there is certainly reason to believe that many individuals and small businesses will suffer in the short term, and perhaps not survive to enjoy the longer term benefits of the nation. Inferences from group to individuals and conversely from individuals to group are not valid. Sometimes the individual talents of group members meld together to create a powerful synergistic group experience that exceeds what individual members could accomplish on their own, such as the London Philharmonic Orchestra. Other times talented members suffer under the weight of group dynamics, such as 100,000 talented drivers jammed into a Bangkok highway at rush hour, or Warren Buffett joining an investment club where stock selections are made by democratic majority-win voting.

Often all members of a group are assumed to possess the attributes of the majority of the group, which is also a dangerous and false conclusion. Because America is a rich country does not mean that all Americans are rich. Because George W. Bush won the 2000 national presidential election does not mean that all Americans voted for Bush (indeed, not even a majority did). Because the stock market (index) rose today does not mean all stocks rose today (not even that all index stocks rose today). The attribute attached to a group is never likely to refelct the attributes of all the individuals making up the group, and sometimes only describes the attributes of a particular influential minority of group members. If we say that the residents of the state of California have voted Arnold Schwartzeneggar, the Terminator, to the office of Governor, the truth may be that less than half of the millions of voters in California actually voted for Arnie (and a good many apathetically abstained from voting at all), but with a dozen candidates to choose from he was able to carry the election with a minority number of votes from the group.

 Similarly, when a TV financial journalist states that, “stocks fell today on profit taking”– they may be describing the result of actions by a small minority of investors, but that minority controlled a great deal of institutional money, thus their selling of only a few large company stocks that day forced the overall market index lower. Whether they were selling for a profit or a loss is a blind guess by the journalist– a mindless market cliche. A given individual investor may not have sold any stocks that day– and may well have seen a rise in the value of their portfolio.

There are some important lessons for investors here… to be continued…
This article is extracted from the WallStraits publication, The Philosophical Investor, 2005.