Or… why we need NUMBERS, not just words to manage risks

Lone Star Analysis uses probabilistic methods for nearly all our analytics work. We think about what is probable and improbable. We’ve also thought about rare events… a lot.

So, when Morgan Housel wrote an excellent blog on the risks of rare and unforeseen events, it caught our attention. The heart of the article was inspired by a 2006 Warren Buffett quote on avoiding risks; “A single, big mistake could wipe out a long string of successes.”

Housel makes several otherwise observations about avoiding business risks, too. One of them is the notion that something rare is going to happen. You can count on it.

We recently did some “rare event” analysis involving a catastrophic accident for one of our clients. It turned out a set of conditions occurred at one of their operating locations. This affected about 2%- or 20- of their fleet of nearly 1,000 assets. We determined that the “rare” event had about a 5% chance of occurring, but only at that one location.

So, there is almost a 100% chance the customer’s rare events will happen from time to time, and it has. The first time this catastrophe struck, it seemed unprecedented. After some analysis, however, it now seems entirely understandable.

For Lone Star clients reading this, as Carly Simon said, “you probably think this song is about you.” But we’ve had this experience with more than one customer’s “unprecedented catastrophe.” This is the point Housel is trying to make.

“It’s always something,” as Gilda Radner used to say.

Housel asserted the New York Times used the word “unprecedented” about once for every ten times the word “common” appeared in the paper. He thought that was “a lot” of unprecedented things, and we felt so too. In fact, we wondered if Housel had his facts right- but he did. The ratio of “common” to “rare” in the New York Times is about 10.8 to 1. But, there’s more to the story than words.

It seems words don’t reliably convey what the odds are. This same ratio Housel quotes in the Wall Street Journal is 4.3 to 1. So, are unprecedented things happing more often downtown on Wall Street? Does it take only 4 common things to trigger an unprecedented thing there, while it takes more than 10 of them in Midtown?

Looking at The Wall Street Journal, The New York Times, and The Washington Post, we found interesting differences in preference for describing rare and common occurrences.

All three papers dislike the word “atypical,” and all seem to prefer the term “rare” when describing the unusual. But things diverge from there. The NY Times is about eight times more likely to use the word “improbable” than the Journal. And the Post is around four times more likely to use the word “unprecedented” than the Journal.

For common occurrences, the Journal tends to call them “normal” while the Times prefers “common,” and the Post says “probable.”

We tested eight words that convey some degree of uncertainty and rarity:

  • atypical
  • unprecedented
  • rare
  • improbable
  • typical
  • common
  • normal
  • probable

Here’s how the word frequency occurs in each of the three papers:

It may be hard to see the disparity in usage. It is 210 times more likely the Post will call something “probable” than the Journal. Meanwhile, the Journal is 6 times more likely to call something “normal.” Overall, the Journal uses words that convey ideas of rarity about once for every 20 words related to uncertainty. The ratio for the other papers is about 1 in 5. Are rare things more common at the Post?

What does all this mean? Narrative descriptions about uncertainty are dangerous. Whether you are doing a risk analysis or reading an annual report, the words don’t mean much unless you have numbers.

More important, as Housel and Gilda point out – it’s always something (rare) that’s going to surprise you, whether risk or an opportunity.