close
OCKHAM’S RAZOR:
A NEW APPROACH TO INVESTMENT ANALYSIS
The research and financial insights at Ockham are guided by a principle which was first espoused in the fourteenth century. The Franciscan Friar, William of Ockham (sometimes spelled “Occam”), is credited with the origination of the following principle:
Entia non sunt multiplicanda praeter necessitatem
…“Entities are not to be multiplied beyond necessity”
In basics terms, what Ockham was driving at is that when choosing between competing theories which arrive at the same conclusion, it is best to study the theory which answers the question without any unnecessary or extraneous elements.
Often times, this principle is boiled down to “keep it simple”, but in actuality, the Razor has a more valuable purpose. Further, it is termed the “Razor” because it is meant to cut through the extraneous, the irrelevant, the uncorrelated, and the unnecessary.
While the principle finds its most common use in the study of logic, physics, reason and other sciences, we have found that financial analysis is a perfect place for Ockham’s Razor to be applied as well. Here is how it works…
Suppose you have two research methods for examining securities. Further assume that both methodologies rate a particular stock as a “Buy” at the same time. Additionally, let’s assume that from the time the positive rating was placed upon the specific stock, the price of that stock rose steadily for a strong gain. In other words, both theories came to the proper conclusion, and both have value.
Now let’s compare the two research methods. The first report analyzes 400 factors in a multivariate construct which emphasizes the interactivity of sector and industry specific price action verse the underlying fundamentals, technicals, and earnings projections from a consensus of 15 Wall Street firms. It is 42 pages in length, has 4 authors and interviews 15 industry experts, tying all elements into its ultimate decision to issue a “Buy” rating.
The second report analyzes only several key factors about the stock in question. It provides a concise outlook and “Buy” rating in a several page format.
Which report is better?
Which theory is the more appropriate one to pursue?
Ockham’s Razor dictates that the second theory is the better one of the two. By focusing upon the simplest correct solution (but no simpler), each investor can achieve a better use of their time and analytical effort. This is not to say that the analysis of many factors isn’t a valuable study, but when factors do not yield any better conclusions and the goal achieved is identical, Ockham’s Razor dictates that the more appropriate theory is the more simple one. And with financial analysis, the application of the Razor has been sorely needed for decades now.
Now we understand that in the world of Wall Street experts and television stock evangelists, simple explanations and direct conclusions are rarely the modus operandi. However, Ockham has worked diligently over the last two decades to combine a proven fundamental analysis approach with the performance analysis of hundreds of independent research products and services to identify the most effective research methodology possible. We scoured all the available methodologies and investing frameworks and began cutting away. First by analyzing the recommendation effectiveness of each theory of analysis, and then by digging into the remaining methodologies which had consistent positive performance across multiple performance measures.
The result has been the identification and implementation of the Ockham research methodology. Once established, we at Ockham then set out to apply Ockham’s Razor to all aspects of our service offerings to cut through to the most salient and necessary points for investors and clients.
In summation, when choosing between two competing theories (or more), Ockham’s Razor is a useful principle to cut through to the best theory. Financial analysis and equity research has never subscribed to Ockham’s Razor (until now), as the level of complexity in analysis of companies and stocks has been rewarded the more convoluted it has become. Ockham is dedicated to cutting through the extraneous and unnecessary to bring our clients direct, efficient, and effective information and equity research.