Many retail investors are usually not trained or equipped with the right skills to do analysis of a company. Because of this, they don’t usually draw an analysis of companies more in-depth than those analysts working in the sell-side. There may be an exception of one or two who does provide a balance view in their analysis but they are mostly rare.
Analysts’ reports provide retail investors with an easy access to understand about the background and facts of the company they research in as well as their financial information in a summarized table. Interestingly, what is being focused in the reports by readers are always the analyst' recommendations and their 12 months projections outlook and target. I'd say most of the information and thesis regarding what the analysts put in their financial model and outlook remain valid, so I will not dismiss them straight away.
There are many investors who lack on their own ability to analyse the companies, tend to rely on these analysts’ reports for their investment decision. This is where the stem of the issues arise. When these people look at the recommendation's buy or sell, they’d think they must be right because they are after all professionals who had more educational background than most of us did.
These were the problems we had when analysts were calling a consensus buy call on Keppel and everyone believed their story. The problem with these consensus call is none of these reports consider the potential risk the company may be undertaking. In other words, we are talking about projections that may create an illusion of apparent precision, bullishness and when these gets extrapolated 3 to 5 years into the future, we get an intrinsic value or target price that are discerningly “attractive” to the naked retail investors’ eyes. The same problem occurs similarly to banks when everyone was dead sure that rising interest rate environment would benefits the banks without any doubt. Buy DBS. Buy OCBC. Buy UOB.
The duo strength of Berkshire founders, Warren Buffett and Charlie Munger, sums it best when they explain how these analysis could be miskewed when it comes to assumptions and projections.
“We never look at projections. Projections are put together by people who have an interest in a particular outcome, have a subconscious bias and its apparent precision on the assumptions makes its fallacious. Projections in America are often a lie, although not intentional, but the worst kind because the forecaster often believes them himself.”
While the above statement may resonates with some of us, it is important to note a proper due diligence of the company and an analysis is still important, as a closer look on hindsight often suggests that the decision process to come up with a certain assumption is the more important aspect of investing, than the result itself.
For instance, when we consider the growth in earnings when a company launches a new product, have we considered the impact of how a competitor might react to the changes or whether there are cannibalization to the existing product. Have we considered the unexpected in both aspect of systematic and unsystematic risks involved in a particular decision? Often, it is too easy to suggest a biasness in upside because we are an optimistic creature in nature, hence creating an intrinsic target price which points to the upside, not downside.
I am guilty of this myself, as shown from my first Kingsmen analysis on hindsight and am paying a dear price for it. Obviously, I failed to consider the risks back then which can happen to anyone or to any companies.
The need to understand our own fallacy and weaknesses will resonate with the way we interpret the goodwill of the analysts’ report. They are as fragile as we are and we need to admit that no one in this world are able to predict the movement of a share price accurately most of the time, not a CFA graduate, not even a Nobel Prize winner. We need to be able to identify the main villains that disrupt our decision making and improve on it, for if not we will always be grounded in similar situations despite paying a heavy tuition fees to the market.
- Confirmation Bias – People likes assurance and they tend to look for positive things or news that may resonate with the individual. Think about the last time you do a research or analysis on a company you are very interested in (or vested). Were you looking more for positive news on contract wins and management key optimistic outlook or do you consider the risk that comes with it?
- Narrow Frame of Mind – Do you look at all angles and consider each prospective objectively? Are you open to constructive feedback and criticism from your fellow investors or peers or are you deep in your own world thinking only you and you can be right.
- Emotional Attachment – Are you emotionally too attached in a particular stock and were not able to justify your buy or sell objectively. Some companies may be in your portfolio for 10 years but do you have the ability to cut loss when you need to? These are not easy decisions and if you think they are easy, then it is because you are looking at it on hindsight.
Now that we know why most analysts are just like us, perhaps we can remind ourselves the next time we read these reports. After all, the fallacy of human's perile is something that makes the market more interesting isn't it?