One of Charlie Munger’s favorite pieces of advice is to invert, always invert. He once told a large crowd that he wants to know where he will die, so he will never go there. On a more practical note, inverting is very useful in just about every facet of life, including investing. The following WSJ article illustrates the power of negative thinking well and further proves this point.
As it applies to investing, think about what could go WRONG with a particular investment. Could the product disappear completely 5 years from now? How much stickiness does it have? It is in asking questions like these that you implicitly get at a company’s competitive advantage and figure out the size of a company’s moat.
If you figure out that the worst that could happen to a particular company is only X, and X will not destroy that much value, then your downside is protected. And that is investing with an eye for a margin of safety. If heads you win and tails you don’t lose much, then you have an attractive risk/reward that you should bet on.
On the contrary, if the worst that could happen is bankruptcy with low chances of recovery and the odds are reasonable, then you may want to rethink your investment.