SENSITIVITY ANALYSIS: LUCK

8 months ago, I drafted an article explaining why you should do a sensitivity analysis of your strategy to luck.

I was planning to publish it in March of this year, because of St Patrick’s.

That draft started with “Now is the time to be bold.”. I pointed out that the largest Canadian banks were trading at 1.3x their book value – suggesting that investors believed that they were better off if banks kept their money as capital, rather than returning it (US banks were not as uniformly good but were doing just fine).

Then COVID happened and I abandoned my draft and now Canadian banks and the largest US banks are trading close to book value.

That is how Lady Luck works. She is a whimsical diva and she does not take sides.

When times are good

When times are good and Fortune bestows her favours upon you and your household, she is also giving lucky breaks to your adversaries.

Think of fintechs for example: innovation is a messy process. To succeed, fintechs need to deliver great value propositions and overcome many execution barriers.

But a little luck cannot hurt.

In fact, lucky breaks are often translated into the additional time and resources they need to fix their value proposition and acquire that first Everest client. Lucky breaks often mitigate the impact of execution mistakes and provide them the respite to overcome what otherwise would have been life-threatening flops.

Think of this question backward:

Next time you are holding your strategy discussion and the presenter shows up a SWOT analysis, consider which of the threats in this list become more threatening in a scenario in which “luck is on their side”?

Of course, you should also think which of the opportunities you identified becomes more attractive if YOU are the recipient of said favours.

When times are bad

By the same token, when you feel overwhelmed by your misfortunes, it is easy to lose sight of what is happening to thy neighbours.

The reversal of tides will catch many at very inconvenient times: they will have started that hard-to-reverse, large technology investment, they will have just built teams to enter a new market which is now vanishing or they will need to divert resources to deal with a security breach.

Your strategy could be improved by asking: what opportunities open up to me if I am someone else’s lucky break? And how would my decisions change if the stars re-align?

But isn’t this Risk Management?

Yes. Yes, it is.

However, I took some poetic license with the idea because I often see Risk Management very diligent about measurable day-to-day risks like credit and financial risk but a little dry when it comes to creating strategic options.

Financial service companies need sound, mathematically-rigorous risk management. It allows them to survive at the edge of their business and earn superior risk-adjusted returns.

However, they also need inspiration and the ability to see and articulate strategies where others only see noise.

Disclaimer

This applies to everything I write but I wanted to repeat just in case since I mentioned both the stock market and luck:

First, nothing I write is investment advice. I mentioned trading multiples as illustrative evidence that there is reason to be pessimistic or optimistic but the value of a stock is influenced by a multitude of factors and uncertainties and analyzing them is not business.

Second – in case it is not obvious – I used words like “luck” and “Fortune” figuratively to make a point. I do this a lot. As far as I know, there is no such thing as actual “luck”.