Richard Feynman, Yellow Paint, and Opinion on Consensus
“If people weren’t so often wrong, we wouldn’t be so rich.” - Charlie Munger
In his memoir “Surely You’re Joking, Mr. Feynman!” Nobel Prize-winning theoretical physicist, Richard Feynman, recounts a story of his interaction with a painter during his time at Princeton. After striking up a conversation (as how many of the tales in his book start), the painter tells Feynman how a painter must learn a lot to be a professional. Not only do you have to know how and what to paint, but you also have to learn how to mix colors. Feynman’s text is illuminating:
The guy seemed to know what he was doing, and I was sitting there, hanging on his words, when he said, "And you also have to know about colors how to get different colors when you mix the paint. For example, what colors would you mix to get yellow?"
I didn't know how to get yellow by mixing paints. If it's light, you mix green and red, but I knew he was talking paints. So I said, "I don't know how you get yellow without using yellow."
"Well," he said, "if you mix red and white, you'll get yellow."
"Are you sure you don't mean pink?"
"No," he said, "you'll get yellow" and I believed that he got yellow, because he was a professional painter, and I always admired guys like that. But I still wondered how he did it.
I got an idea. "It must be some kind of chemical change. Were you using some special kind of pigments that make a chemical change?"
"No," he said, "any old pigments will work. You go down to the fiveandten and get some paint just a regular can of red paint and a regular can of white paint and I'll mix 'em, and I'll show how you get yellow."
At this juncture I was thinking, "Something is crazy. I know enough about paints to know you won't get yellow, but he must know that you do get yellow, and therefore something interesting happens. I've got to see what it is!" So I said, "OK, I'll get the paints." The painter went back upstairs to finish his painting job, and the restaurant owner came over and said to me, "What's the idea of arguing with that man? The man is a painter; he's been a painter all his life, and he says he gets yellow. So why argue with him?"
I felt embarrassed. I didn't know what to say. Finally I said, "All my life, I've been studying light. And I think that with red and white you can't get yellow you can only get pink."
So I went to the fiveandten and got the paint, and brought it back to the restaurant. The painter came down from upstairs, and the restaurant owner was there too. I put the cans of paint on an old chair, and the painter began to mix the paint. He put a little more red, he put a little more white it still looked pink to me and he mixed some more. Then he mumbled something like, "I used to have a little tube of yellow here to sharpen it up a bit then this'll be yellow."
"Oh!" I said. "Of course! You add yellow, and you can get yellow, but you couldn't do it without the yellow."
The painter went back upstairs to paint.
The restaurant owner said, "That guy has his nerve, arguing with a guy who's studied light all his life!"
But that shows you how much I trusted these "real guys." The painter had told me so much stuff that was reasonable that I was ready to give a certain chance that there was an odd phenomenon I didn't know. I was expecting pink, but my set of thoughts were, "The only way to get yellow will be something new and interesting, and I've got to see this."
Feynman encounters an expert that presents information contrary to what he considers to be accurate. Still, he is open to the idea of being wrong and is willing to go along with the experiment. An expert, the painter, mixes red and white to get yellow and can only get yellow after adding yellow paint (proving Feynman right). The restaurant owner is initially on the side of the professional painter – after all, why shouldn’t the pro know what he is talking about? He later switches to Feynman’s side after the experiment is over.
Consider this story through the lens of North Beach Holdings. We are Feynman, the painter is the conventional financial system, and the restaurant owner is the market.
There are a few applications to this analogy:
Feynman had a belief based on his factset and his breadth of knowledge that was contrary to the statement of an expert. Similarly, at North Beach, we reach independent conclusions about investments that are sometimes contrary to the beliefs of so-called experts.
An expert (the painter) was proven wrong through experimentation, similarly to how some public companies outperform the broader stock market due to initial conclusions by the so-called experts about the underlying business being wrong.
The restaurant owner is initially on the painter's side, but later switches to Feynman’s side after the experiment. This switch demonstrates the short-term, irrational, behavioral nature of the market and the madness of crowds (hopefully more on this in a future blog!).
Let’s press this analogy with the recent story of Criteo S.A. ($CRTO).
We began research on Criteo last year when the stock was trading around its 52-week low. The valuation was depressed due to consensus around the business’s reliance on third-party cookies and Google’s announcement that it would phase out third-party cookies on its platform. Management acknowledged this in conference calls and presented the story of a business transformation and new service offerings that would reduce dependence on cookies and increase the top and bottom line. Investors were also ignoring the competitive advantages and market positioning of Criteo in the advertising technology space – a situation that poises them to protect (and increase) their 10-year median return on invested capital of over 40%.
This business transformation is now in full swing as Criteo has rolled out numerous new service offerings to clients and has other services still in development. These new solutions are expected to be approximately 30% of the business for 2021 and grew 60% in Q1. The market has rewarded Criteo shareholders for belief in the business transition as the share price has appreciated more than 170% over the past year. This was driven by an improvement in the fundamentals and then put on rocket fuel recently with Google’s announcement it would be delaying the third-party cookie elimination. This delay provides even more time for new business lines to make up a greater percentage of revenue.
We reached an independent conclusion on Criteo that went against consensus. The market initially disagreed with us. An experiment (the beginning of the business transformation) took place, experts were proven wrong, and the market now seems to agree with us.
Surely we’re joking(!)?
At North Beach, we operate in the financial system but are not a part of it. We have a healthy disrespect for convention. We practice a bygone investment approach that is intellectually honest, unconventional, conservative, disciplined, and entirely free from conflicts of interest.
If you are an investor or business owner who shares our opinion on consensus and are interested in what we are doing here at North Beach, please reach out. We’d love to have a conversation with you.