While I was reading Design of Everyday Things, an example around a pair of scissors – its affordances, constraints and mappings inspired me to write the following.
Affordance refers to what does the environment offer the individual. Holes in the scissors are the affordances, they allow the fingers to be inserted. Number of possible actions is limited. Similarly, the market price of the stock acts as the affordance. It allows the investor to take actions. Only 3 possible actions are possible at any given point in time by the investor:
- Option I: Buy the stock
- Option II: Sell the stock
- Option III: Don’t Buy or Sell the stock. This happens to be the trickiest since most investors believe in action, i.e. Buy or Sell and NOT sit on one’s ass and DO NOTHING.
Constraint refers to Restriction, something that controls what one does by keeping within limit. The Sizes of the holes in the pair of scissors provide Constraints to limit the possible fingers; bigger hole suggests thumb and the smaller hole suggests smaller fingers to be inserted. The size of the hole can be referred to as the Margin of Safety, i.e. how big (far) or small (near) the market price is in relation to the intrinsic value of the stock. If there are no holes in the scissor pair, there is no way a pair of scissors can perform its functionality.
If there is no delta between the intrinsic value of the stock and the market price of the stock, margin of safety cannot be ascribed. After all, an investor makes money (while buying) only when the market price of the stock is lower than the intrinsic value. You may note that priceand value are separate – Price is primarily determined by external perception and can fluctuate (at times, wildly) depending upon greed and fear. Value is however, determined by the fundamentals of the company, viz. Cash flows – its occurrence and timeliness and Cost of capital)
If there are no holes in the scissor, desired functionality cannot be achieved. Similarly, if the difference between the intrinsic value and the market price of the stock is not prevalent, an investor would not be able to achieve its objective of making money.
Mapping refer to the relationship between things – an operation that associates one set of things with the other. Hole and the size of the hole in relation to the blade of the scissors, wherein blade of the scissors refer to the sharpness of the investor’s study, conviction about the stock idea and its cyclicality, i.e. his fundamental knowledge about the company and its industry.
Relationship between the investor’s study about the company in relationship to its market price and the margin of safety enables success in the stock market.
While the shape of scissors has not really altered since almost 4,000 years back when it got first discovered in Mesopotamia; the basics of investing has also not really altered, when an investor just needs to adhere to the following in order to make money:
- Market price (Price is what the market offers) -> Hole (Scissors): Affordance
- Margin of Safety (Delta between the Market price and the intrinsic Value of the stock)-> Size of the Hole (Scissors): Constraints
- Relationship (Relationship between Market price, Margin of Safety and the Investor’s fundamental knowledge) -> Relationship between Hole, Size of the Hole and blade (Scissors): Mappings
Disclaimer: Please note that these are my personal views. While, I am a registered Research Analyst as per SEBI (Research Analyst) Regulations, 2014, all investors are advised to conduct their own independent research into individual stocks or industries before making any decision. In addition, investors are advised that past stock performance is not indicative of future price action.