All lies and jestsHearing what you want to hear is one of the most important factors which makes two value investors disagree on a stock pick.
Still a man hears what he wants to hear
And disregards the rest
-- Paul Simon, “The Boxer”
Selective hearing is not a new invention. Following are the lines from the New Testament:
For a time is coming when people will no longer listen to sound and wholesome teaching. They will follow their own desires and will look for teachers who will tell them whatever their itching ears want to hear. - Timothy 4:3This simple observation has some major repercussions, financially and socially.
- We do not like hearing truth which is uncomfortable to us. If an event occurs that does not fit our mental models developed over our lifetime, then we consider the discomforting evidence as an anomaly and only make minor correction or no corrections at all.
- We actively look for evidence which agrees with our world view and succumb to the “confirmation bias.” The sane thing to do would be to look for disconfirming evidence. Disconfirming evidence is going to prove your view incorrect. A confirming evidence increases your confidence in a possibly wrong idea.
- We love to hear flattery. We like people who make us feel good and tell us that we are smart, beautiful/handsome, funny and a great human being. If the flattery is not too obsequious then people believe quite easily, even when there are glaring inconsistencies. This is the case of “disregarding the rest.”
- We like a good story. A good and coherent story makes us feel comfortable. So what if it is untrue? Being untrue is a “small detail” which can be ignored. Succumbing to a narrative sets up for “narrative fallacy,” weaving a story out of a sequence of facts. We look at a set of facts and invent a story which “explains” them better. We think that we have a better understanding of the situation. For example, we now “know” that the intelligence agencies made grave mistakes leading up to the 9/11 attacks. There were many journalists reporting on facts which were clearly pointing towards a major attack, even to a non-expert. There was report of a terrorist who actually gave the entire plot to someone in the agency but was not taken seriously. Under these “facts” (and several others) a narrative of willful ignorance emerges which gives comfort to the 9/11 conspiracy clique. But do you know how many terrorists/people contact the CIA with “major revelations?” How does the agency know of which leads to follow? It is not at all clear and mistakes are bound to happen. It does not mean that there was a detectable common narrative running along these facts when they were happening. It only looks clear in retrospect because we ignore all the other possibilities which did not materialize.
- The problem of “silent evidence.” In hindsight, we find everything much easier to explain. We cherry pick the data and journalists do “investigative work” to “verify” the reasons which explain an event. Pick your favorite event, which was surprising when it happened (e.g. inflation during the Weimar Republic in Germany). A few weeks/months/year later, there are people everywhere saying that they “knew” it all along. The reasons/facts were there for everyone to see. They point out the “reasons” as to why the event occurred and many people congratulate these “geniuses” and feel quite stupid for missing such an obvious cause-and-effect scenario. But think of all the other geniuses who predicted something entirely different. If the whole of Africa disappears in the ocean, I am pretty sure there will be people claiming that they “saw” it. And I am sure that they can back it up too. There are always people who believe in crazy things. It does not mean that we have any way to know which one to listen to.
One of my stocks is killing me, Hewlett Packard (HPQ), so I am going to take it as an example. I strongly urge you to read on, even if you are not interested in HP stock. Because this is not really an article on HP, but on us.
The fact is that HP was trading at $18; then they said that the “turnaround” would take a longer time than expected. The stock crashed to $15 and was trading around that point when the fourth quarter results were out. The results in themselves were not bad at all. If we add back the write-off of $8.8 billion, then HP made $1.20 a share for the quarter. In fairness, HP generally always has a write off of around $800 million and taking that into account, we still have an earning of $0.80 a share. I agree that this is rather simplistic view of the situation and at this point there is so much negativity surrounding the stock that any discussion seems out of place.
The kicker was the claim that it overpaid for the Autonomy acquisition because Autonomy management had knowingly duped HP by keeping false accounts and has committed serious accounting shenanigans. Although it was obvious to anyone that it overpaid for Autonomy, apparently HP management failed to see it until now.
A major problem during a situation like this, i.e. when the market is panicking and HP lost $3.8 billion of market cap in one day (dropped from $13.35 to $11.35), is to distinguish “fact” from “fiction.” Let me explain.
Even if it is obvious to many of you that it is a folly to hold HP, I have in some sense convinced myself that it is not. I was a buyer around $30. I already knew that Autonomy was a waste of money. I also knew that PCs is a no-growth business.
The only new information I have is that some of the enterprise customers are leaving HP, an alarming development, I know. But this has not yet reached alarming levels. There was significant management upheaval at HP, and we need to give it some time to stabilize the operations. It is a good sign that Meg Whitman has lasted a year.
But then again, this might be a rationalization of what “I want to hear.” I want to hear that my investment thesis has not soured. So I rationalize by concentrating on “facts” that support my thesis, and I conveniently ignore the “facts” that do not, i.e. customers leaving, declining sales, serious accounting fraud, etc.
It would be very, very difficult to abandon ship in this case. The facts and the fiction are so muddled up that I am unable to distinguish between them. The only way is to let the investment run its course. Either the company recovers or goes bankrupt. We will know in a few years, I hope. For the opportunity cost, well, I have money lying around to invest, if need arises.