The Systemic Mistakes Of Bias and How It Infuses A Process (Disposition Bias)

As a value oriented analyst I find that 'disposition bias' infusing my whole process.

Whether it is using a higher discount rate than appropriate, or discounting growth and margins more than is likely.

I have found myself over the years moving from a 12% discount rate (or expected rate of return) to a 10% discount rate to recently using an 8% discount rate.

I have found myself moving from a normalized PE of 18x down to 15x and contemplating moving it up to 18x. I use the normalized PE to base relative PE's off for each stock. 

As a value investor with the implicit cautious nature of that disposition, I tend to use growth rates and margins less than what is embedded by the current consensus.

I am sure the reverse goes for a growth oriented analyst. They are likely to use lower discount rates and higher growth rates and margins than what the current consensus has embedded into the price.

What does this all mean? It means (1) You need to know the bias of your analyst, and (2) You've got to compare your assumptions with the consensus.

Note: In a world where the current WACC or discount rate is probably somewhere around 5%, growth is king. If you use a normalized discount rate of 8%-10%, then current stock prices are not going to look so bueno. But if the game is played using a 5% discount rate, rightly or wrongly, shouldn't you get with the system and play the game the way it is currently being played? Ans. No. Because when the discount rate normalizes, then stock prices will be re-rated to a normalized discount rate.

A Phenomena

There is a phenomena I have seen over and over again. It usually manifests itself as follows:

Company appears to be doing well via the numbers. Sales are growing, margins are expanding and the multiple is huge (too expensive for me). BUT...

I can't work out why the company is doing as well as it is. THEN...

It disappoints the street and the multiple shrinks enormously even as profits are substantial and it seems to the company is doing a lot more things right.

Case in point today is Coach (COH) which reported another disappointing quarter and is in Wall Street's doghouse.

The same could also be said for Apple.