The contagion bias describes how we are incapable of ignoring the connection we feel to certain items – be they from long ago or only indirectly related (as with the photos).
When we have faced some events in life and if anything related to those events comes Infront of us then we cannot ignore it and cannot stop reacting. Connection in our minds comes alive and we start getting disturbed.
One person has cheated on me a long back but when I met a family member the person, I cannot ignore the connection between both the person and I became rude in conversation.
If we have made an investment in any stock and have incurred a loss, then that sector, management, valuation, or anything will stay in our mind. When we meet up in a similar situation then our mind again lives that connection that impacts our thinking and decision making.
We heard that companies that originated from particular cities have a higher probability of wealth destruction. When any investment opportunity comes in front of us from similar cities then we used to ignore that opportunity without doing proper research on it.
So that we need to prepare a checklist for every stock, every time. If a stock is passing that checklist, then we must invest in it rather than getting biased from any past events.
When we are getting bombarded with a lot of many options, information and have to decide for those then our mind will get disturbed. This state of mind is known as decision fatigue.
Lots of work and efforts going to test our Willpower. When our willpower stops responding (battery discharge), either we make a faulty decision or we stay on support from luck.
Willpower is like a battery. After a while, it runs out and needs to be recharged. How do you do this? By taking a break, relaxing, and eating something sweet. Willpower plummets to zero if your blood sugar falls too low.
Investment – When we are making an investment decision, we also getting bombarded with lots of options, lots of information. Also, have to be answerable if managing other people’s money.
This will bring out a state of decision fatigue. So that we have to take a timely break, have to do a fun, long drive, drinking or eating sugar food (I am always opposed to taking processed sugar regularly, natural sugar can be helpful also.), etc. which can help us to bring back our focus to use willpower and we can make wise and effective decisions. If we do not recharge our willpower then we might be put our wealth at great risk.
Also, we can use a checklist that helps us to filter out unnecessary information, options, etc. to save our willpower to waste on unnecessary things and reduce needs to refill it very quickly.
Authority bias comes when we put an extreme trust on authority, expert of a particular field. We just follow what they say and do not doubt on their opinions.
Whenever you are about to make a decision, think about which authority figures might be exerting an influence on your reasoning. And when you encounter one in the flesh, do your best to challenge him or her.
Business – Corporate has authority bias as founder, CEOs, directors pass an order and everyone follows it. If someone has viewed with proper data, facts and logic then also cannot challenge their order.
Successful business houses have the practice to invite better ideas from different employees group or department so that they get better insights for improving efficiency and operation.
Investment – Comeback to the stock market, we follow many of the celebrated investors, fund managers and we consider them as an authority. We do not argue on their opinion, investments thesis. We also tend to follow what they are doing. This behaviour is very rapidly affecting the majority of the participants. If Mr XYZ has bought ABC stock then the majority of us do not think anything and just run to buy ABC.
We should work on the preparation of process & checklist from listening, reading each guru, books etc. The process should be on what suits our temperament. It may be possible that few aspects may not be accepted by our process what authority says then we should not to do. Evolve from this bias can help us with becoming an independent investor rather than being depending on the authority.
The company is an operating into the business of insurance which has a presence in 22 states, decent underwriting record with Don Towle as a manager. They made a deal to acquire a company at $75 million.
The company is the world’s leader in the training of pilots. The company operates in 41 locations, outfitted with 175 simulators of planes ranging from the very small, such as Cessna 210s, to Boeing 747s. About half of the company’s revenues are derived from the training of corporate pilots, with most of the balance coming from airlines and the military. They made an acquisition at $1.5 billion.
We need to prepare a list of the errors which can be dangerous for the health of our investment and work to avoid those errors. If we work on the avoiding mistakes then we can win 50% of the battle.
List of mistakes which I have experienced during my investment journey –
Never ignore the true value of the company—Every business has some value and that we should not have to ignore. If we commit such a mistake then the market will defiantly punish us. Be careful with the true worth of the company and only buy it when it falls below its true worth. And if business not available below its true worth then ready to missed that opportunity. Loss of opportunity is better than the loss of capital.
Don’t buy HOT —-If we buy the hot business such as recent trend, new IPOs, business on which everyone is bullish etc., then we must have to exit it at the proper time. So if we aren’t able to exit at the proper time then it’s better to let it go such opportunities. If we buy HOT then that HOT will BURN our portfolio.
Buying a high leverage business — We need to avoid a business which has a huge borrowings, such borrowings can kill the business and also kill our investment journey.
Using the wrong valuation method — Every business will not get valued with a similar valuation matrix. We need to identify the nature of the business and then value a particular business. Such as we should not use the valuation matrix of growing non-cyclical business for cyclical business, should not use the valuation matrix of assets light business for assets heavy business and vice-versa. If we made such a mistake then whether we might miss a decent investment opportunity or we might lose our capital.
A mistake of buying a story, not a fundamental — I have never ever made such a mistake because I am a hard-core lover of numbers. But I have seen many of the people who always focus on the story and also which is very trending to the market. I believe that without the support of numbers, no story can survive for long. In the year 2014-15, Logistics stocks due to GST gets a trending story but due to lack of good numbers, the story gets failed. People generally avoid numbers due to lack of understanding of it. I firmly believe that “Stories are for kids, not for investors.”
Investing without a process and philosophy — I can overcome this mistake at the initial period of my investment journey and that is only because of my guru – Neeraj Marathe Sir (who always believe on having a process and philosophy for making an investment). I have seen many people who spent lots of time into the market but they do not have any process or philosophy. They change their philosophy as they meet various people. If we do not have our own process and philosophy for making an investment then we will not able to create a successful investment journey. I also learn from my guru that we must have our philosophy in a written format so that we can refer it over a period of time and stop ourselves from occurring a mistake.
Not using a checklist — We should have a checklist for a business, industry, financial, management etc. so that we can focus on the points to study and also not forget any point to study. I am using a checklist for the last 3 years and I can say that having a checklist helps me a lot. My checklist keeps on improving as my experience grows.
Making an investment decision with disturb mind — We should avoid making an investment decision while our mind is disturbed. Disturbance in mind will end up with the faulty investment decision and which can be harmful to our wealth.
Cloning a well-known investors/fund managers — Again I can overcome this mistake at the initial period of my investment journey and again credit goes to my guru. If we have our process and philosophy then we will not try to clone others. I have seen many people who have spent 10-15-20 years to the stock market then also not having any process and philosophy & they clone others. Many of the people have cloning as their investment philosophy because they love to use shortcuts. I always remember the quote of my guru –
When Company does not have an opportunity to reinvest earnings at a higher rate than the company should distribute those earnings to the shareholders so that they can use it somewhere for getting a higher return. If the company does not have a good opportunity to reinvest earnings and then also company does not distribute earnings as a dividend then we need to be careful with a company (Question on the capital allocation decision of a management or earnings can be manipulated or business always needs a huge capital to sustain only).
Examples – No/Low growth high dividend payout
Examples – No/Low growth low dividend payout
We need to check the above-mentioned factors in the company where we have made an investment and where we want to make an investment. Most important is to gain a market share. The company cannot able to gain market share, though the company has a competitive advantage then that competitive advantage not useful for us. We should not focus on the leadership position of the company rather need to focus on the companies which focus on the manufacturing, distribution, packaging and product innovation. Market leadership can be changed if the company does not focus on the mentioned points.
According to Mr.Buffett, paying a higher price does not risk for the good companies compared to paying higher prices for the bad companies.
Let me take an example of one the biggest wealth creator company of the Indian stock market—
If someone has bought this company during the March-2000, at the high price of around Rs.431 then after the 16 years of the period, he gets returned at 7% CAGR. And if enter to the similar company at the low price of around Rs.275 during the March-2000 then after the 16 years of the period, he gets a returned of 10% CAGR (*Considering all-time high price for calculating returns). Though revenue has grown at 30% CAGR, Operating profit grown at 27% CAGR and Net profit also grown at 27% CAGR during the same period with supported by a good management team. During March-2000, the company was traded at 64x P/E at the low price of Rs.275 and this multiple is common nowadays.
When management of a good business diverts their focus into the business which is not performing well then such decision of the management affect the performance of the business.
Example – We have seen examples such as liquor manufacturer enter into the airlines business, airport contraction business has diversified into the power business.
Mr.Buffett has also mentioned the Circle of Competence concept –
Control on our temptation, control on our emotion towards our investment is essential to survive and create wealth from our investment.