Beware Overconfidence

by: Roger Nusbaum

Yesterday the comments on my post about yield on cost really blew up. I noticed a recurring theme in a few of the comments that has popped on past posts related to overconfidence and hindsight bias.

One commenter was particularly dismissive of getting caught in a stock that ends up going the way of Eastman Kodak (EKDKQ.PK), noting that stocks give a couple of years of warning for investors to get out. Many stocks do indeed provide warnings and some others are indeed obvious.

It does not take a forensic accountant to realize that typewriter company Smith Corona was doomed when Hanson PLC spun it off more than 20 years ago and likewise, digital photography seemed like a pretty easy-to-spot threat for Kodak but there are plenty that have not been obvious that caught very smart people unaware and this will happen again in the future.

Fair to say that the financial crisis caught some very well regarded investors off guard. Perhaps Bill Miller and Chris Davis simply had the tide go out on them or not, but think about how many people said that housing can't have a national decline, the yield curve inversion won't matter this time (here I mean 2007) and so on. Think about the iconic names that are now gone or just a shell; Bank of America (NYSE:BAC), WaMu, Wachovia. Bear Stearns, Lehman Brothers, Fannie Mae (OTCQB:FNMA) and Freddy Mac (OTCQB:FMCC). Freddie Mac had serious accounting issues raised in 2003 which was a legit warning but it was not heeded by many.

As we have covered here many times before, stock market history is full of companies that could never fail but did and the confidence of some anonymous commenters notwithstanding, thinking this is easy is very hubristic.

Anyone, I mean anyone, can get caught on the wrong side of one of these. This is why we generally have 2 and 3% target weights for individual stocks -- if we get caught in one it will not cause any client to have to rewrite their financial plan.

Here's one that probably never gets talked about anymore; Boston Scientific (NYSE:BSX). If you were involved with markets and individual stocks ten years ago, you know how important the stock and its products were. I mention this because we used to own the name, we sold it in April 2005 at $28 and change. It is now below $6. You may or may not recall the buzz around this stock but the outcome up to now would have been unfathomable ten years ago.

I'm sure there are plenty of people who can hindsight bias their way around BSX and every other stock that has failed one way or another but this is a behavior that will do people in.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.