Fooling yourself -Investing Tragedy

In August 2007, Mary Meeker, Morgan Stanley’s famous internet analyst published a bullish report on Google. Google had just announced that its video website, You Tube, would soon begin displaying video ads. In her report, Mary initially projected that You-Tube’s video ads would result in incremental revenues of $720 million next year. But, while doing the number-crunching for her report, Mary made a serious mistake. She took the price of the ads as ‘$20 CPM’ to mean price per ad impression, and not per thousand ad impressions, which is what ‘CPM’ means. In other words, she overstated projected revenues by a factor of 1,000. The actual projected incremental revenues, based on Mary’s corrected model were only $720,000, an insignificant number when compared with Google’s total revenues.

What’s interesting for us, however, is to observe what happened next. When Henry Blodget, another famous internet stock analyst, pointed out Mary’s mistake on a public forum, she acknowledged her error.

However, instead of revising her overoptimistic conclusions, Mary left them intact! She rationalized them by revising yet another assumption in her model which resulted in much higher projected revenues for Google than would have been the case, had she not made this second revision. In her report update, Mary wrote: “In fixing the error, we also took the opportunity to dig deeper into our assumptions and.... we provide an updated scenario analysis of the opportunity.” Mary Meeker’s response was not quite contrary to what most of us do, when we are presented with evidence which proves that our previous conclusions may be wrong. When we face such situations, our first reaction, almost always, is to discredit the new piece of evidence which proves us wrong. If we can’t do that, for example when the evidence is solid, we tend to invent other, new reasons which would keep our prior conclusions intact.

The above example shows that we are capable of going to extremes in order to fool ourselves into believing that we’re right about things about which we are really wrong. Contrary to the belief of most economic theorists, we’re really not rational animals. Rather, we are rationalizing ones. There are obvious lessons here for the readers.

Take the idea behind what is called as the ‘sunk-cost fallacy’. We’re obsessed with what it cost us to buy an investment. The cost of our investment is not just a financial commitment made by us - it’s also an emotional decision about ourselves. We like to think we were right. If the price of a stock moves up after we buy it, we take it as evidence of our intelligence and investing skills.

However, if it falls well below our cost, we tend to overlook negative developments about the company which we learn subsequent to our purchase, information, for example, by deluding ourselves into believing that the adversity our company is facing is only of a short-term nature, and that its only a matter of time when our stock will soar.
We consciously ignore other alternative investment opportunities that become available to us, because we don’t want to buy them from cash realised from the sale of a dud investment. We fear that if we sell, we will suffer a loss, not realising that the loss happened the day we made the wrong decision. We forget a fundamentally sound economic principle that, with a few exceptions, sunk costs i.e. what it cost us to buy a stock, are irrelevant in the sell decision

Question is when to sell I feel you have follow one principle for sell decision which is

Mentally liquidating your portfolio into cash and then re-creating it is the best way to judge if you have made a bad decision