A letter a day!
Letter#14 June’2011
Mental shortcuts
1.It is so easy to screen out a good idea because of a bad association. As Charlie Munger quipped at a speech given at the same course a few years earlier “the human mind is a lot like the human egg”: once one sperm has entered then all the other sperm are locked out.
“A market research company we visited recently told us that most car advertising is read after the purchase decision for the car has already been made! And it was read only then to gather information to convince other people the purchase decision was rational (“no, no it wasn’t the car’s sexy shape – this car has twelve airbags and emits 170g of carbon per mile!”) We have all done it. The human mind has these learnt biases, short cuts, fears, habits, and associations and, in the case of the panelist above, they can stop us from making rational decisions.”
2.When investors think about the future of a business, they often have in mind the assumption that growth rates slow with time, as competition ekes away advantages and marketplaces become saturated. Predicted revenue growth rates (used in \valuation models) therefore start high and end low. This is especially true for firms that are quite large already.
“However, if the rate of growth in internet retailing is a product of attitude, rather than assets, then, the fact that a firm is quite large already does not necessarily tell you that its growth rate is set to slow. The widely held presumption that regression to the mean begins the moment the analyst picks up their pen, risks being wrong footed as a result. Two years of forty percent revenue growth, for example, will result in revenues doubling in twenty-four months and regression to the mean-based estimates would be out by almost a factor of two! That did not take long. In other words, although some online retailing firms may be quite large, they may also be quite young. In our opinion, it is this realization that has partially driven the revaluation of internet retailers these last few years.”
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