Psychology of Intelligence Analysis Annotated: Linchpin Assumptions

This is the fourth of a series of posts that I try to lay down the most relevant lessons from the book  Psychology of Intelligence Analysis by Richard Heuer.

In my opinion, the next topic lies at the core of investment cases. And it is not the investment thesis per se, it’s a subset of it. Linchpin assumptions are the core companies value drivers. Those are the KPIs executives and investors should understand and follow closely. For investors, those KPIs are simply lagging indicators. For executives, they work with both leading and lagging indicators. Internally, middle management need to act on leading KPIs that shall yield the desired outcome for investors and global goals for the company executives (lagging indicators).

For instance, take a retailer. Gross margin is the lagging indicator. The leading indicator could be the amount of sales sold with some markdown. And the leading indicator of the leading indicator could be a new COO that would redesign the supply chain or even more basic store processes. Many analysts consider gross margin to be the value driver. To be right before Mr. Market, you have to decipher that the COO is the value driver.

Linchpin Assumptions

  • “Analysts actually use much less of the available information than they think they do.”
  • “People’s mental models are simpler than they think, and the analyst is typically unaware not only of which variables should have the greatest influence, but also which variables actually are having the greatest influence.”
  • “When analysis turns out to be wrong, it is often because of key assumptions that went unchallenged and proved invalid.”

It’s easy to become lost with too many pieces of information. One must be sharp, separating what matters from a fundamental value perspective which will eventually be translated to the stock price from pure data garbage. You must pick one, two, no more than three value drivers for your investment case. If you haven’t identified those yet or just have too many of them, maybe you still don’t have an investment case. From previous posts, remember to make them visible and challenge them. Try to disprove your hypothesis and formulate new ones with their respective value drivers.

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