Today I begin by asking the question: when you consider buying a stock, do you use a rigorous approach based on sound evaluation criteria?
If you answered yes, you are considered a "rational" investor. You take into account all available financial information, you perform a detailed analysis of all possible scenarios, and you ultimately choose the best investment strategy based on your management style. However, without wishing to offend you, few people actually behave this way...
According to Daniel Kahneman, the 2002 Nobel Prize winner in Economics, when we make a decision, whether we make a judgment call or we answer a question, we use a two-speed mode of thought he calls "System 1/System 2". System 1 involves fast thinking, automatic and intuitive, while System 2 is slower and more analytical, and requires concentration and effort. To save time and be more efficient every day, we tend to prefer System 1. However, by excluding System 2, for example, when selecting securities for our portfolio, we are exposed to errors of judgment. The purpose of this piece is to familiarize you with one of these errors called "cognitive bias".
I liked the shaver so much I bought the company.
Last April, People magazine named Jennifer Aniston, 47, the most beautiful woman in the world. More recently, in another ranking published by Forbes business magazine, the American celebrity ended up fourth among the highest paid actresses. To me, besides her physical beauty, several factors may explain her popularity, including her charisma, the confidence she exudes, and especially the fact that she seems human, friendly and approachable. Indeed, who doesn't like Jennifer Aniston? Not surprisingly, she is the spokesperson for some renowned companies such as Emirates Airlines and Aveeno, the line of natural products from Johnson & Johnson.
To draw a parallel with the investments, in my opinion, Apple has an enviable reputation similar to that of the popular actress. With its range of innovative and quality products (Mac, iPhone, iPad, iPod, iWatch), Apple is frequently listed among the top three most powerful brands in the world according to the firm Millward Brown.
In light of this, under the influence of "cognitive bias," it is normal that we are inclined to invest in Apple. By referring to our System 1, we quickly conclude that the stock is surely a good investment despite further analysis. Whatever your management philosophy (fundamental, technical or quantitative analysis), it is essential to use System 2 and opt for a systematic and thoughtful approach. Otherwise, you could miss fantastic investment opportunities. In fact, did you know that Apple's stock is currently trading at the same levels as those of November 2014? Moreover, a large number of less publicized stocks (e.g. Ball Corporation, Citrix Systems, Edwards Lifesciences) performed better during the same period. This is proof that you should fall in love with your investment process rather than a company you are fond of...