I was recently reading a blog about predictions and how often people are wrong in their predictions, whether it be about a particular stock, sports team or political event. Every baseball analyst on ESPN predicted that the Cleveland Indians would beat the New York Yankees in the ALDS this year and we all know how that played out. As a behavioral economics "junkie" and an avid reader, learning and participating in both the financial markets and sports, I often find myself trying to figure out ways in which I can increase my odds of being right about a particular event or stock. Notice that I am staying away from the word “prediction” because often people make predictions and don’t admit when they are wrong, or they are right but because they were lucky. Too often, we judge based on outcomes and not on process.
How does one create and improve a process for better decision making? For one, it is essential to think in the mindset of probabilities and not absolutes. Watch CNBC or ESPN; you will see experts and pundits who are paid a lot more money than me who are always making predictions, probably because it makes for a good headline. What is more important is to have a clear, defined process of how one comes to their decision by using a combination of logic, statistical data and reason. Another way to improve decision making is to think in terms of probabilities. For example, by using the available inputs for a particular company, one can make a better decision whether to buy, hold or sell a stock. Often, the best CEOs make optimal decisions based upon a set of probabilities. Whether it be a decision on buying back company stock, raising the dividend or making an acquisition, CEOs who focus on what decision is likely to yield the best results for shareholders will probably generate superior returns. I have learned that when examining a particular company, I am never going to know everything about it. By studying as many of the critical inputs that make a stock price move (price action, the stock chart, expected earnings growth rates, valuation, and management to name a few), I can increase my odds of making the correct decision.
It is important to realize that there can be unforeseen or random events that lead to a bad result. Even when making your decision, it would’ve been impossible to forecast something you don’t know would happen. Lastly, keeping your ego in check and being flexible in your thinking will help you avoid being biased when it comes time to make a decision. Recently, a perma-bear (always negative) market forecaster (who for many years was featured in Barron’s and other financial publications) made some very racist and ignorant comments in an investor newsletter. While his comments were inappropriate and had little to do with investing, they should not come as a shock as he was someone who had been saying whacky and stupid things for many years. No matter what data points you presented him, he was always going to have negative views on the markets. He constantly sold fear and was not (and probably won’t ever be) flexible in his thinking. He let his ego get in the way because at one point he was right in his bearish views on the markets. On the complete opposite side of the spectrum, famed investor Warren Buffet, known for shunning technology stocks, and airlines, has recently been buying shares of companies within those two industries. Does this mean Buffett has lost his mind? Probably not, I think it means he is being open-minded and flexible in his views on the world and economy.
I like to end my blogs with quotes so I will leave you with this: “Fear is loud. Evidence is quiet.” — Phil Huber