I am constantly amazed how individuals react to articles written about stocks they maintain in their portfolio. Recently, much discussion has occurred on this website and across the internet on the purchase of Skype by Microsoft (MSFT, Financial). Those that hold Microsoft are certain that it is a great buy and a great product that will allow the company to expand. Those of us that don’t, feel that it was too expensive of a price to pay and that it will have no great long-term effect on the company’s growth prospects. Both sides are both passionate and certain of their position and have little tolerance for the opposing viewpoint as evidenced by the responses below each article. Who's right and how do you decide?
James Montier’s “The Little Book of Behavioral Investing” has an interesting experiment in the chapter entitled “See No Evil, Hear No Evil,” which will perhaps help us. It goes like this:
Let’s imagine that you have four playing cards laid out in front of you. Each one has a letter on one side and a number on the other. The four face-up symbols are E, 4, K, and 7. I’m going to tell you that if a card has an E then it should have a 4 on the reverse. Which cards would you like to turn over to see if I am telling the truth … If you are like an incredible 95 percent of the fund managers who answered, you will get it wrong …
The most common answer is E and 4. The correct answer is that you do need to turn two cards over, and they are E and the 7… Most people get the E; if you turn it over and it doesn’t have a 4 on the back, you would have proven that I lied. If you turn the 7 over and it has an E on the back, you would have also proven that I lied. However; turning the 4 over can’t help you. I said that E had to have a 4, not that 4 had to have an E. The habit of going for the 4 is known as confirmatory evidence that agrees with us.
Confirmatory bias is something we are all guilty of at one time or another, but it is a mistake that can have investors seeing red. The study goes on to conclude that we are twice as likely to search for evidence that we are correct over evidence that says we are incorrect. So what does this mean? It means that we should take the articles for what they are … someone else’s opinion. Don’t get mad when your stock is trashed by me or any other author. Montier goes on to conclude that we seek out the people that agree with us and hold in disdain those that disagree with our position:
Why? Because it makes us feel warm and fuzzy as human beings to have our own ideas repeated back to us … we can all leave agreeing that we are all very smart.
This is a lousy way of testing a view. Instead, we should sit down with the people who disagree with us most. Not so that we will change our minds, because the odds of changing one’s mind through a simple conversation are about a million to one against, but rather so that we can hear the opposite side of the argument. If we can’t find the logical flaw in the argument, we have no business holding our view as strongly as we probably do.
We value investors like to consider ourselves independent thinkers and we know that the noise from Wall Street is exactly that, noise. We know not to listen and follow the herd. The herd mentality is for others that are destined to fail. Yet, in a real sense, we value investors have our own herds. We follow some gurus to a fault. We all need to understand that they make mistakes too. Lots of them. They freely admit it and state that fact over and over again and yet, somehow, we believe if enough gurus concur with the stock we chose that it somehow validates our thought process.
The truth is, we don’t need validation. If we have our margin of safety and have done a thorough analysis that we are happy with, we may be fortunate enough to see the stock price rise. If it doesn’t rise and we tire of waiting or find an alternate or better investment, it doesn’t prove we were wrong either. Listen to what others are saying about your stock even if you don’t agree. Learn from them also and learn not to take it personally.
James Montier’s “The Little Book of Behavioral Investing” has an interesting experiment in the chapter entitled “See No Evil, Hear No Evil,” which will perhaps help us. It goes like this:
Let’s imagine that you have four playing cards laid out in front of you. Each one has a letter on one side and a number on the other. The four face-up symbols are E, 4, K, and 7. I’m going to tell you that if a card has an E then it should have a 4 on the reverse. Which cards would you like to turn over to see if I am telling the truth … If you are like an incredible 95 percent of the fund managers who answered, you will get it wrong …
The most common answer is E and 4. The correct answer is that you do need to turn two cards over, and they are E and the 7… Most people get the E; if you turn it over and it doesn’t have a 4 on the back, you would have proven that I lied. If you turn the 7 over and it has an E on the back, you would have also proven that I lied. However; turning the 4 over can’t help you. I said that E had to have a 4, not that 4 had to have an E. The habit of going for the 4 is known as confirmatory evidence that agrees with us.
Confirmatory bias is something we are all guilty of at one time or another, but it is a mistake that can have investors seeing red. The study goes on to conclude that we are twice as likely to search for evidence that we are correct over evidence that says we are incorrect. So what does this mean? It means that we should take the articles for what they are … someone else’s opinion. Don’t get mad when your stock is trashed by me or any other author. Montier goes on to conclude that we seek out the people that agree with us and hold in disdain those that disagree with our position:
Why? Because it makes us feel warm and fuzzy as human beings to have our own ideas repeated back to us … we can all leave agreeing that we are all very smart.
This is a lousy way of testing a view. Instead, we should sit down with the people who disagree with us most. Not so that we will change our minds, because the odds of changing one’s mind through a simple conversation are about a million to one against, but rather so that we can hear the opposite side of the argument. If we can’t find the logical flaw in the argument, we have no business holding our view as strongly as we probably do.
We value investors like to consider ourselves independent thinkers and we know that the noise from Wall Street is exactly that, noise. We know not to listen and follow the herd. The herd mentality is for others that are destined to fail. Yet, in a real sense, we value investors have our own herds. We follow some gurus to a fault. We all need to understand that they make mistakes too. Lots of them. They freely admit it and state that fact over and over again and yet, somehow, we believe if enough gurus concur with the stock we chose that it somehow validates our thought process.
The truth is, we don’t need validation. If we have our margin of safety and have done a thorough analysis that we are happy with, we may be fortunate enough to see the stock price rise. If it doesn’t rise and we tire of waiting or find an alternate or better investment, it doesn’t prove we were wrong either. Listen to what others are saying about your stock even if you don’t agree. Learn from them also and learn not to take it personally.
