Last week I wrote about mass versus gas when it comes to value investing. Someone suggested that this week I should talk about value investing in terms of quantum mechanics.
Challenge accepted!
If you’ve ever spent time reading about quantum physics, you’ll have come across one of my all-time favourite experiments — the double slit . I read up on it at least once a year, just to refresh my memory, and it always gives me a thrill (not unlike when I play through the Donald Byrne vs Bobby Fischer ”The Game of the Century” from 1956, something I also do once a year).
It was first performed by the British polymath Thomas Young in 1801. At the time, he wasn’t trying to prove quantum weirdness, he was trying to settle a debate about whether light was a particle (as Isaac Newton had believed) or a wave. By shining light through two thin slits and seeing the “interference pattern” on the wall, he proved light behaved like a wave.
A century-and-a-half later, in 1959, the first “true” double-slit experiment using electrons was performed by German applied physicist Claus Jönsson (who, I just found out, only passed away in 2024… I feel like that should have been bigger news). He confirmed that matter (not just photons) has a “wave-particle duality” and that observing it changes its behaviour.
Jönsson fired particles (like electrons) at a barrier with two slits. When no one was watching, the particles acted like waves, passing through both slits simultaneously and creating an “interference pattern” on the back wall, which means they existed in a state of multiple possibilities at once. However, the moment a sensor was placed at the slits to “observe” which path the particle takes, the behaviour instantly changed. The particles stopped acting like waves and started acting like little solid marbles, hitting the wall in two straight lines. As it turns out, the act of measurement collapses the wave of possibility into a single, fixed reality.
By observing something, you change its reality. Think about that for a minute and I guarantee it’ll blow your mind.
Why is it so?
It’s because in every bar of Cadbury dairy milk chocolate… no, wait, wrong experiment.
We don’t know why waves become particles. We don’t even know what “observing” really means in this context. Read five books on quantum physics and you’ll get five different interpretations.
BUT WHAT (I hear you ask) does this have to do with investing?
In investing we also have “the observer effect”. How often have I heard TK say that he likes it when we don’t have any analyst forecasts for a stock on our buy list because it means it isn’t getting any attention yet and we might be picking it up first?
Think of a hot AI stock, gold or crypto. Millions of eyes are on it. This “observation energy” creates a massive Hype Cycle, pumping the stock full of “Gas.” The trajectory is no longer based just on the business fundamentals, but on the heat of the crowd, the heat of expectations. It seems like everyone is talking about it, everyone thinks it’s a great idea, and you’d be an idiot not to invest in it.
Strangely enough, I also see this all the time on the value investing sub-reddit, where I post my weekly American pulled pork. Have a look through that and see how many people are posting about tech stocks. It’s unbelievable.
When a stock is “unobserved”, ie no analysts, no AFR / CNBC coverage, no Reddit coverage, no TikToks, it exists in a state of undiscovered potential. But the moment the “Observers” (the herd or a potential acquirer) turn their flashlights on it, the value “collapses” because the price adjusts to reflect all that new attention.
We might say that QAV lives in the Low-Observation Zone (LOZ). And doesn’t it feel that way at times? We are often talking about companies and stocks that seem completely incognito. Select Harvests? Almonds?? Really? How sexy. Servcorp? Office rentals? Not going to be great conversation at a dinner party.
“So, Barry, what are you investing in these days? Bitcoin? Gold”
“Let me tell you about almond harvesting.…”
Yawn.
Eventually, after the Observers find out about it, a QAV stock might hit The Measurement Zone (TMZ), not the celebrity rumour site, but that time when a major analyst or influencer “observes” the stock, which causes the wavefunction to collapse, making the price jump, or “revert to the mean”, as Tony says. It stops being undervalued and starts to become fairly valued, or, sometimes, overvalued. The TMZ itself becomes the thing driving the price. This is where the Mass (Value) can be replaced by Gas (Sentiment). That’s fine with us, as long as we bought it when it was still in the LOZ.
Eventually it will enter the Decay Zone: once there are no new observers left to join, the energy dissipates. The “Gas” evaporates, and the stock crashes back to its original “Mass.” This might take months or even years, and we hold on to it as long as our rules allow us to.
Eventually, as it decays, our sell triggers activate and we get out at a profit (.… most of the time). No tree grows to the sky, as TK says.
So stay in the LOZ, friends. It’s going to make for boring dinner party conversation… UNLESS YOU START COMPARING INVESTING TO QUANTUM MECHANICS.
Nope, Chrissy says. STILL boring. Ah well.
QAV Myth Killers is a weekly column in the QAV newsletter, taking apart a piece of
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