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.

The Art of Short Selling - High Multiple Growth Stocks, Part 2: High Returns, Faltering Growth

The very backbone of a bull market is growth - new products, new sales, new technology.

There is almost always a bell ringing on the growth stocks that have one product. Shorts get killed trusting their intuition and common sense. Longs get killed with their belief that the company can always expand to one more market.

Two relevant concepts that define the shorts analytical task are pipeline fill and sustainable growth. Pipeline fill gives the revenue curve its shape. Sustainable growth rate sets the financing needs for that curve.

Cott Corp - going against Coke and Pepsi. Most corporate managers reproduce the errors of the past with remarkably regular frequency and inspire their corporate culture with the same consistence of mismanagement.

Pipeline fill refers to the process of filling the distribution channels' inventories - think drug companies getting out a new product. At some point the pipeline is full - every store has a shelf of product - and the growth rate is purely what the consumer consumes.

Cott paid sr employee salaries with stock and capitalized the expense as goodwill on the balance sheet. Watch when an analyst goes to work for a firm they covered. Top tick.

The Snapple story was a great lesson for growth stock players and short sellers alike. Store checks and valuation be damned, inventories are key in a one product company rolling out in a new era industry. If they build up, it is almost always because the product is not selling as planned.

Media Vision and Creative Technology - operate in an industry/sector that is characterized by short product life cycles and rapid change.

The bigger point on cash appetite in a growth company is a concept called sustainable growth rate. Sustainable growth rate says that a company can grow at the rate of return on equity times the retention rate without going to the capital markets. Growth companies with low ROE have to go to the market early and often and, if the prospects for eager buyers decline due to market conditions or failing financials, they have big trouble.

Growth is a good stock to own and a great stock to short if you can time both sides of the pyramid.