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Black Swan Farming

paulgraham.com

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Re: Black Swan Farming

#301

Post by nkurz »

nl wrote: post #300
martin_bech wrote: post #228

Earlier quoted context omitted.

That actually makes a lot of sense. Ive been having some of the same thoughts, as almost all the profits from my own portfolio is from Apple stock, even though i also own, Amazon, Tesla, Arm and so on. Perhaps thats why index investing is so succesfull, because you get the benefit of the outliers.. the bad ideas, or long shots, that suddenly skyrocket..

all the profits from my own portfolio is from Apple stock, even though i also own, Amazon, Tesla, Arm and so on. No! That is different. These are public companies, and the fact you are seeing amazing share price growth from Apple is an exception. Usually[1] on the public share market you'll see growth rates of ~8% pa, with some slightly above that and some below that. The continued rapid rise in Apple's share price i…

Do you have more data on this? I just did some quick searching, but couldn't find any firm numbers for what the 99th percentile return for individual public companies actually is. I certainly wouldn't be surprised if it was 1000% per year at some point in the tail, if not at 1% then for the top .01 percent of companies. I'd love if you could point to a graph of the tail so I can recalibrate.

Re: Black Swan Farming

#303

Post by nl »

nkurz wrote: post #301
nl wrote: post #300

Earlier quoted context omitted.

all the profits from my own portfolio is from Apple stock, even though i also own, Amazon, Tesla, Arm and so on. No! That is different. These are public companies, and the fact you are seeing amazing share price growth from Apple is an exception. Usually[1] on the public share market you'll see growth rates of ~8% pa, with some slightly above that and some below that. The continued rapid rise in Apple's share price i…

Do you have more data on this? I just did some quick searching, but couldn't find any firm numbers for what the 99th percentile return for individual public companies actually is. I certainly wouldn't be surprised if it was 1000% per year at some point in the tail, if not at 1% then for the top .01 percent of companies. I'd love if you could point to a graph of the tail so I can recalibrate.

Here's some links on average returns for the Dow Jones (ie, top public companies in the US): [1][2]

I certainly wouldn't be surprised if it was 1000% per year at some point in the tail, if not at 1% then for the top .01 percent of companies.

I'm having trouble parsing that sentence. I think you are saying that you think 1000% per year returns are normal for the top 0.1% of companies.

This is absolutely not the case. Even Apple (by far the best example of rapid share price growth in a large company) might, maybe manage to increase its share price 100% this year (low of ~$374 in Nov last year, currently at ~$662). That's exceptional - companies like Standard Oil, Exxon, etc never managed that.

(Occasionally you may get a smaller resource oriented company that fids oil, gold reserves or something and sees a 1000% increase. Or a small drug company that has a successful trial. These are very unusual too though, and more similar to VC investing that the typical public markets).

[1] http://observationsandnotes.blogspot.com.au/2009/03/average-...

[2] (pdf, sorry) http://www.risadvisory.com/images/uploads/Rydex_Historical_t...

Re: Black Swan Farming

#304

Post by rsheridan6 »

hasenj wrote: post #237
rsheridan6 wrote: post #233

Earlier quoted context omitted.

I have no idea, but isn't that exactly what Facebook and Google did?

Facebook (AFAIK) is not quite profitable yet, but it does have a business model: selling ads. The same business model that Google used, and the same business model that the TV industry has been using (very successfully) for decades. If you build a company with no business model other than hoping for a nice exit (usually as a talent acquisition) there's no chance that you can give your investors 1000x returns. This sh…

I assume that any awesome product that's free can sell ads, since people will be looking at it.

Re: Black Swan Farming

#305

Post by rsheridan6 »

lmm wrote: post #279
rsheridan6 wrote: post #229

I'm not a VC, but I don't see how most successful startups seemed like bad ideas. Google was entering a crowded field, but the field sucked (still does, actually) and Google was obviously superior early on. As for Paypal, do you remember mailing checks after winning Ebay auctions back in the 90s? As for Youtube, do you remember what it was like to share videos in 2004? Enough said. Dropbox was about unbreaking broken…

It wasn't at all obvious that Google could do better than the big four of the day. There were at least thirty upstarts that had good results in some way or other. My money wouldn't have been on google. With paypal it seemed crazy that sellers would hand over control of their bank accounts to this unqualified, unregulated company. Given paypal's history of account freezes, it still does. Video sharing sucked in 2004,…

I agree with almost everything you said, but being leery of a startup because it has stiff competition or regulatory hurdles is not the same as reacting with a "WTF?" to the basic idea like PG did when Facebook was new. It was an odd example for him to use.

Re: Black Swan Farming

#306

Post by rsheridan6 »

sidman wrote: post #298
rsheridan6 wrote: post #234

Earlier quoted context omitted.

I think there is a way to improve your chance of winning big - don't invest in startups that serve niche markets. Look at this list of YC companies from last summer: http://www.quora.com/Who-are-the-Summer-2011-Y-Combinator-co... Don't you think you can you pick out some that had zero chance of becoming massive-scale homeruns, because they served sort of a niche market? There are none that were obviously (to me, or a…

> but if you want the next Facebook, you're not going to get it by investing in, say, Codecademy, which, as laudable as its goals are, only appeals to newbie coders, who are a tiny slice of the population Well you would just never know. Computer science and software engineering could become part of the basic school curriculum in the next few years. In the news you see that "the 14 year old boy developed an X for the…

That's true. Even Ebay started as a pez dispenser trading site.

Re: Black Swan Farming

#307

Post by gersh »

pg wrote: post #280
gersh wrote: post #108

Earlier quoted context omitted.

So, if you randomly decided which startups to invest in, would you be more successful? Can you really predict anything? If you randomly invested in 100 startups, would your returns be better than your screening process? Can you test this?

We have a good deal of evidence that our selection process is better than random. We know it's at least internally consistent, in the sense that startups that are ranked higher in the application phase are more likely to make it past the interview phase. And we also in turn have (a necessarily small amount of) evidence that the startups that turn out to be big winners do the best in the interview phase.

Are you willing to share what your evidence is that the big winners do the best during the interview phase? Do you rank all startups that are accepted into YCombinator?

Have later YCombinator classes had a larger percentage of homeruns? If you have more applicants and have gotten better at selecting, this should be the case.

Is it about selecting winners, or weeding out losers? Are there companies that you know will fail? Who would be least likely to succeed as an entrepreneur?

Re: Black Swan Farming

#308

Post by pg »

gersh wrote: post #307
pg wrote: post #280

Earlier quoted context omitted.

We have a good deal of evidence that our selection process is better than random. We know it's at least internally consistent, in the sense that startups that are ranked higher in the application phase are more likely to make it past the interview phase. And we also in turn have (a necessarily small amount of) evidence that the startups that turn out to be big winners do the best in the interview phase.

Are you willing to share what your evidence is that the big winners do the best during the interview phase? Do you rank all startups that are accepted into YCombinator? Have later YCombinator classes had a larger percentage of homeruns? If you have more applicants and have gotten better at selecting, this should be the case. Is it about selecting winners, or weeding out losers? Are there companies that you know will…

Sure; the evidence is pretty low tech. Between us we can remember the interviews of all the most successful startups, and in no case there was any debate about whether we should fund them.

Home runs are so rare that it's not a matter of percentage per batch. A batch will have 1 or 0, and probably 0. It will be a few years before I can tell if the rate is increasing.

Selecting winners and weeding out losers seem the same thing to me. There are companies we think will almost certainly fail, but we can never be sure. An ineffectual person would be least likely to succeed as a startup founder.

Re: Black Swan Farming

#309

Post by its_so_on »

yen223 wrote: post #253
its_so_on wrote: post #252

I wrote the following email to PG some time ago, which I hope have helped inform the present essay. ---------------------------------------------------- 1. You know, I came across: " I think they're not so much dense as bitter. There's a subset of HN readers who regard startups as a whole as a sort of con game, and are angry that the participants get so much attention. There may not be that many of them, but their an…

Wait I don't understand, are we assuming that the lottery ticket has a 100% chance of being worth $20 billion? Are we ignoring the fact that there's a sizeable chance that it is worth $0?

The lottery ticket has $20 billion winner written on it. I gave you a range of probabilities that the ticket can actually be cashed. The point is that this probability is clearly not exactly 0.00000... given others have cashed theirs.

But YC assigns it a probability of exactly 0.00000... that you can cash it, given any amount of "seed" money.

However, if you lie and claim the ticket has "$20million winner" written on it (you are misrepresenting the business plan by a factor of 1000 in this case) their ears will perk up and they will assign a non-zero probability (actually an extremely high one), and give you a seed to go ahead and cash it, in exchange for owing them 7% of the winnings.

Given the size of these seeds this behavior doesn't make any sense at all. It is like refusing to take 7% of big winners, only small winners, when most of the lottery payoff is in big winners.

Re: Black Swan Farming

#310

Post by nkurz »

nl wrote: post #303
nkurz wrote: post #301

Earlier quoted context omitted.

Do you have more data on this? I just did some quick searching, but couldn't find any firm numbers for what the 99th percentile return for individual public companies actually is. I certainly wouldn't be surprised if it was 1000% per year at some point in the tail, if not at 1% then for the top .01 percent of companies. I'd love if you could point to a graph of the tail so I can recalibrate.

Here's some links on average returns for the Dow Jones (ie, top public companies in the US): [1][2] I certainly wouldn't be surprised if it was 1000% per year at some point in the tail, if not at 1% then for the top .01 percent of companies. I'm having trouble parsing that sentence. I think you are saying that you think 1000% per year returns are normal for the top 0.1% of companies. This is absolutely not the case.…

Here's some links on average returns for the Dow Jones (ie, top public companies in the US): [1][2]

I appreciate the links, but didn't find information about the extremes. What I'm looking for would be something more like this paper [1] on Extreme Value Theory but with more pretty pictures.

I got lost in this one soon after the introduction, but was interested in their statements "cross country evidence that the tail behaviour of returns is leptokurtic" and "the tail distribution is of the Fréchet type, hence fat-tailed". I was hoping for a cartoon graph showing just how fat that tail is. 

I think you are saying that you think 1000% per year returns are normal for the top 0.1% of companies.

Essentially, but subtly different. Saying that I "wouldn't be surprised" was more to express the degree of my uncertainty than to state my belief. And I posited .01%, rather than .1%. To put numbers on it, it strikes me as plausible that 3 out of the 2700 listed Nasdaq issues would be up 10x for the year.

Occasionally you may get a smaller resource oriented company that fids oil, gold reserves or something and sees a 1000% increase. Or a small drug company that has a successful trial. These are very unusual too though

How unusual? I'd like to put a number on it. Is a gain of 10x over a year a 1 out of 1000 event, which would make it likely for a couple Nasdaq stocks a year? What about 100x returns over a larger number of years? I'd guess that it's happened at least a few times, but don't know.

My instinct would be that it's a fat tail, but not as fat as the VC market. Rather than hoping for 10x over 10 years (26% year-over-year) with carefully chosen startups, with a broad market index you'd probably lucky to hit 3x (12% compounded).

But what would the long term expected returns be for a broad portfolio of mining companies, pre-trial pharmaceuticals, and internet IPO's? And how would it compare to an average VC firm? I have no idea.

[1] http://www.hec.fr/var/fre/storage/original/application/3b27b... (PDF)

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