"People
make estimates by starting from an initial value that is adjusted to yield the
final answer," explained Amos Tversky and Daniel Kahneman in a 1974 paper.
"The initial value, or starting point, may be suggested by the formulation
of the problem, or it may be the result of a partial computation. In either
case, adjustments are typically insufficient. That is, different starting
points yield different estimates, which are biased toward the initial
values."
This, in short,
is Anchoring bias. Investors look at the current market price of a stock and
immediately think of the past price that is anchored in their brain and then
make an investment decision. This anchoring bias is probably the biggest killer
of portfolio returns.
As per limited
shareholding data available for the month June, 2019,retail
investors added to their positions in 54 penny stocks. These
include over-leveraged loss-making companies like MTNL, Sintex and Adlabs where
retail shareholding has increased to as much as fifty percent of the total
shareholding. Almost all of these penny stock companies are in deep trouble.
Their core business is non-competitive, balance sheet is in deep distress, most
of them are in the process of being dragged to the Bankruptcy Court by lenders
and institutional equity investors have long abandoned them. So, other than daredevilry,
what is it that attracts retail investors to these capital destroyers?
Answer can be
found by comparing the current market price of these stocks with their peak
price. Here are some,
Company
|
CMP
(Rs.)
|
All
time high price (Rs.)
|
MTNL
|
6.35
|
390
|
Adlabs
|
4.2
|
199
|
Sintex
|
2.6
|
302
|
Suzlon
|
4.6
|
460
|
RCOM
|
1.6
|
844
|
RPower
|
3.65
|
565
|
GTL Infra
|
0.65
|
106
|
Ballarpur Ind.
|
0.9
|
43
|
In the face of
deathly odds, retail investors hope to make money by anchoring their mind to
the all-time high price of these stocks and believing that one day they will
get back to glory days. A recent study by ICICI Securities shows that only
eight of the 228 stocks, which fell more than 75 per cent over a two-year
period since 2010, have been able to reach their previous high. That is a
success rate of about 3.5%. How can a retail investor win against a loss
probability of 96.5% other than by being extremely lucky? Even then, how do you
replicate that luck in the next penny stock investment?
Warren Buffet
recently explained how anchoring bias damages returns in another way. Talking
to CNBC he said, “It is a little hard when you look at something at x, and it
sells at 10x to buy it. It shouldn’t be but I can just tell you psychologically
it’s harder when you looked at it in the first place and passed at x, and then
buy at 10x, It cost a lot of people money at Berkshire. They saw it at a lower
price then and just said – “If it ever gets back there, I’ll buy it.” That’s a
terrible way to think!”
This is the
reason that retail investors miss out on investing in good quality stocks like
Titan, Asian Paints, Interglobe Aviation, Infoedge, HDFC Life, ICICI Lombard
etc. because they only recently saw these stocks at much lower prices and
believe they would buy them at the same low price.
Once you combine
the impact of both these biases, the retail investor is left with a portfolio
that is long on penny stocks and short on high-quality
stocks. You can easily imagine the impact of this on the portfolio returns. The
only hope left for these retail investors is to hand over their portfolio to
professional portfolio managers who can restructure the portfolio in a
non-biased manner. Retail investors are often unable to restructure their
portfolio themselves because of another bias called endowment bias where
investors tend to overvalue the stocks that they already own. This leads to
severe aversion to booking a loss. I will cover this in a later blog post.
Very good article.
ReplyDeleteA brilliant read! I wish more people would write as incisively and lucidly about the impact of our own biases on investment returns. Looking forward to more in this series!
ReplyDeleteAbsolutely true. It is the bias with which all the investment fraternity starts. Investment in penny stocks start with the seed of speculation in the mind and ends in huge losses.
ReplyDeleteA definite point to bear in mind before investing. Control/awareness of bias is by far the way to success in investing. Very well captured article.
ReplyDeleteVery well articulated. Looking forward to the rest of the series.
ReplyDeleteAlso most retail investors end up committing Herding bias and Confirmation bias which makes it very difficult to get out of bad investment decisions.
During a down cycle, It might well be worth checking with one’s investment advisor, if their investment analysis has these biases before making further investment decisions (doubling down or averaging down) on investments which are not working in favour.