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In the 5 May issue of finweek, I wrote about some of the many cognitive biases that affect investors’ decision-making processes. This week I would like to delve into recency bias – whereby investors are heavily influenced by recent results or experience.
Last week I was going to be a guest on a local TV show to discuss global investing. So, before I went on air, I asked people via Twitter what they considered to be their favourite offshore share. The overwhelming answer was Tesla, followed by Amazon.
There's nothing wrong with that on the surface, but here’s the thing: almost exactly a year ago I was on the same show and asked the same question, yet last year the answer was overwhelmingly Apple.
This time around, nobody mentioned Apple. And last year nobody mentioned Tesla or Amazon. So what has happened in the last year?
In truth, we have seen recent news on all three of the stocks. Apple just reported its first quarterly decline in iPhone sales. [This article was written before it was announced that Berkshire Hathaway bought a $1bn stake in Apple in the first quarter of 2016.]
Tesla just sold almost 400 000 of its new Model S cars, which require a deposit of $1 000, with delivery only starting in late 2017 (if everything goes well for the company). Meanwhile, Amazon just hit a new all-time high, clearing the $700 level for the share.
So in all cases there is news on the stocks, but is this just short-term news or real, big-picture, long-term and game-changing?
In other words, this serves as a classic example of potential recency bias. We’re not looking at the big picture; we’re focusing on what we’ve just heard in the media or read on Twitter and the like.
Simply put, the focus is on the hot new fad. Now fads are just that – something that’s hot now, but might not even exist in the next week or three.
But investing is long-term, so we’re mixing our timeframes.
As an investor you only ever really need a long-term view, and an understanding of the stocks you invest in and the areas they operate in.
But, as importantly, you need to ignore the short-term fads. The biggest example of a short-term fad was the dot-com boom of the late 1990s and we all know how that ended – in tears.
Let’s consider Tesla, Amazon and Apple.
Tesla is an amazing company and it now promises to deliver 500 000 cars in 2018 – two years ahead of schedule and up tenfold from the 50 000 it delivered this year.
In other words, it wants to be the greatest engineering company ever; a great ambition, but a massive risk.
Thus far, Tesla has done a lot right, but manufacturing this number of cars is something it hasn’t yet attempted. The risks here are very real. But this isn’t really new news; sure, the response to the Model S was unexpected, but that adds more risk than reward for now.
Amazon reaching a new, all-time high is great. But for an investor, this is totally meaningless. Yes, it is nice to see your stocks at highs, but that’s never a reason to be a buyer.
As for Apple: sure, iPhone sales slipped and the company hasn’t had a massive hit since the iPad. But it made over half a billion US dollars in revenue every day of the quarter. Apple has massive brand quality and very loyal users, who are locked into its ecosystem.
So I am not saying we must ignore new news, but we must add it into the investment case for each stock and give it the weight worthy of its importance, rather than giving it more weight simply because it is most recent.
This article originally appeared in the 26 May 2016 edition of finweek. Buy and download the magazine here.
