Book Value Incentives People

Life in the weird zone continues. It’s 2020. There’s also a full moon, but full moons don’t last 365 days (unless you get into some tricky lunar orbital mechanics, but I digress.) Understanding people is so difficult that religious leaders, trained psychologists, and anthropologists have work, never-ending work. The rest of us just get to shake our heads (and sometimes fists.) A recent example is playing out in one of my investments. That may be the safest environment to comment on, currently. You can draw parallels (or squiggly lines, if you prefer.)

(The following is a heavily paraphrased discussion.)

“But, it is obvious. Take the value of these assets, and even if you ignore income and expenses, the company is worth x and the stock is worth x/(number of shares). Right?” 

“Yes. No. But reality is different.”

Finance and investing seem like they should be logical, based on data, constrained by legalities, and independent of luck and chance. Yes. No. But.

There are many ways to estimate a value for a company. Some investors invest that way. That’s a separate discussion.

Investors are people. Even the institutions that allow algorithms to dictate actions, people are still involved in choosing the algorithm and deciding whether to implement or countermand its suggestions. Investors and institutions do not have infinite resources. They may have far more than enough, but they can’t do everything. They can’t chase every opportunity.

Individual investors have more freedom but fewer resources. Active investors must decide which stocks to own. Individuals have different values, capabilities, and opportunities. It is understandable that it can be difficult to understand an individual’s actions. We’re all just people, humans, silly creatures that are trying to figure our way through the world.

Institutions seem like they can be more logical because they aren’t as affected by the seemingly trivial disruptions that happen in every life. They should be able to analyze all of the public corporation data, rank the results, and distribute funds accordingly. Find companies with cheap stocks relative to a variety of criteria, track those criteria, and adjust accordingly. Logical. Methodical. Probably true, sometimes.

An analyst published an article, probably more than a decade ago, that described the reality of their job. Sure; the computer produced a stack of stocks to consider. Supporting documentation, error bands, competitive analyses, etc. gave the analyst more than enough information to make a decision. But that’s not what really made the decision.

The analyst had to decide which of the prospective stocks met the computer’s criteria, the firm’s criteria, the analyst’s criteria, and their boss’ criteria. It was those last two that made the process human, and sometimes seemingly illogical.

The analyst was part of a team that competed against outside and inside competitors. Once a week the analyst had to attend a meeting to present their recommendations. It wasn’t just about the numbers. It was also about the people in the room. What was best for their job? Recommending something someone else recommended wouldn’t get them more attention, or a raise. Recommending something too obscure was too bad, too. If there’s no demand for the stock, maybe there never would be and the investment would never become profitable. In that environment, quicker profits were preferred over long term profits. It was necessary to find that balance between too little and too much risk. Anything proposed also had to meet the criteria of whoever was making the decision. Do they have a preference? Do they avoid certain industries? Is there a grudge or a fan reaction? The best investments could be ignored because of the wrong image, timing, or because they’re too complex to describe in a short intense meeting where dozens of simpler stocks were being mentioned.

My friend’s analysis was logically and mathematically valid, but it was for a stock for a company with an un-trusted management culture, a technology that is too innovative and risky for some, and a history of poor finances. It might be valued at less than its assets, and may eventually become a phenomenal success, but for now it might be too much trouble for an analyst to recommend.

The analyst’s job is supposedly to find good investments, but their incentives are to keep their job, advance their career, and get paid along the way. That doesn’t mean finding the most profitable long-term stock, but finding a series of stocks that are profitable enough and appealing enough to prove the analyst’s worth soon enough.

The analyst’s meeting was more important than the computer’s results.

I saw something similar happen when I was struggling to avoid foreclosure (which was successful thanks to some excellent help. See My Mortgage Modification.) I heard many people talking about the bank hoping to benefit from taking ownership of my house, or that the mortgage servicer would appreciate any money I could send them. The calls I received from the mortgage servicer were traumatizing. I’d shake for days after some of them.

A friend who worked in the field for a short while pointed out that the banks and the foreclosure had little to do with the people I talked with. The people I talked with were paid to be part of the foreclosure process. If there were no foreclosures, they would lose their jobs. Their incentive was be part of the process. The longer the process, the longer they had a job. Whether the banks wanted the properties or not was secondary. There were no obvious incentives for them to make the process more efficient or fair or compassionate. My friend also pointed out that one incentive for some of the employees was the opportunity to be nasty over the phone in ways they never could in person.

As a real estate broker (with Coldwell Banker 360 Team on Whidbey Island – a state-required disclosure that interrupts this narrative), as a broker I’ve watched a similar dissonance. As someone said; “It’s obvious that everyone’s goal is to make as much money as possible.” Yes. No. But reality is different.

Aside from money, there’s also time. “Get me out of this place! Now!” or its corollary “Get me into the place! Now!”. There’s complexity. Sometimes great deals get too complex, or simple deals fall apart because the property’s details are too complex. Too much of a good thing is too common. And then there are human elements like neighbors, the distance to family and friends, and what the other generations in the household might think.

And then there’s the rest of the world. As I watch advocates and deniers, marchers and enforcers, and the general voting public I also know that logic isn’t as fashionable as feelings. Wearing a mask or not is rarely a choice made after analyzing infection rates; many trust the authority figures, others trust conspiracy theories. By the way, people who believe conspiracy theories don’t see them as conspiracy theories. They trust and believe a different set of authority figures. I ask, what is everyone’s incentive? Fitting in with a particular crowd? Being on the “right” side?

This post is being published later than usual because I spent too much time trying to track down a specific quote. It might be from a sci-fi author. It basically said, everyone does what they think is right, even if they don’t like it. Even if someone does something purposely wrong, there may be a fundamental value in doing that is effectively “right” to them. There’s that human need to belong to a community, or maybe try to prove to a community that they should be included. And, of course, one person’s “right” is another person’s “wrong”.

We humans have only had a global civilization for a few decades. Our psyches and bodies take longer to evolve. It was easier to understand each other when villages were small, and everyone knew your name. We’re clashing as we’re mixing. But I keep in mind that “we” and “they” are stereotypes and labels. Crowds and causes are a mix of individuals and their individual incentives. As I watch the news I wonder about each person in each crowd and wonder if we’re getting closer to similar incentives or further from them.

As for my friend’s analysis of the stock we both own, yes, the analysis looks valid; but I suspect the analysts won’t look at the stock until the company proves there’s sufficient incentive for other investors to invest there, too. We and they are only human.

About Tom Trimbath

real estate broker / consultant / entrepreneur / writer / photographer / speaker / aerospace engineer / semi-semi-retired More info at: and at my amazon author page:
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