The Human Misjudgment (1)

Firstly, I like to thank many readers that have written to me in support of the blog. Not being a natural writer, it is so easy to succumb to lethargy and ill-discipline and stop the blogging altogether. In fact, I observed that of late, I have been updating the blog rather infrequently.

But your recent support has made a difference. And I re-commit and promise to keep the blog updated. Not daily but certainly weekly. Thank you again.

This week, I gave a presentation on the "Psychology behind Investment and Trading Decisions". This is essentially a repeat of the same presentation I did a year ago. Again, time constraints did not allow me to elaborate on cetain issues. Hence, I've decided to put them on the blog.

I will start with the 24 Standard Causes of Human Misjudgment, cited by Charlie Munger in a 1995 speech. But to ensure "bite-size" blog entries, I shall at each time, tackle 3-5 Human Misjudgment.

Firstly, the under-recognition of "reinforcement" and incentives. In particular, businesses can benefit substantially - more than expected but simply changing commision structures paid to salesman. Or to pay the night shift more in order to motivate the night shift workers. Basically, the human mind works for its own interest!

Secondly, there is psychological denial. For example, parents of criminals often think their children are innocent, even if proven guilty. Similarly, investors seldom admit that the stocks they picked were lemons, and end up holding them for long periods without any return.

Thirdly, incentive-cause bias in both our minds and that of the advisors. For example, sale presentations of real estate businesses are never close to truth. Would agents deny themselves the fee by discouraging sales? Similarly, it is common practise for lawyers to try and drag out the legal process as their charges are based on time usage.

In short, Charlie Munger showed that the human psychology often resulted in biasness and misjudgment. And his advice is simple: Avoid them.

Know Your Vowels, Please...

I kind of feel stupid right now. After 40 years, I still got my vowels mixed up. Surely, I meant to keep the "o" and not the "e". What am i talking about? Read on....

In 2007, I had this grand investment idea that surely China will be water scarce given the pollution in the country. Hence i went about investing in companies, engaging in waste treatment, pollution control etc. The two companies I picked was Sino-Environment (SINE) and Sinomem (SINO). The former was into desulphurisation while the latter was into water treatment. Both had good balance sheet (and so i thought).

In mid 2008, SINO announced that there were accounting irregularities at its subsidiaries which would impact its profitability adversely. Given this, i felt it was better to sell the investment away as it was tainted.

In end 2008, SINE announced that its Chairman had lost its entire stake in the company to a Hedge Fund as the Chairman had pledged all his shares to them. This resulted in a management change of control that triggered loan convenants etc. Also the company's ability to remain as a going concern was threatened as the Chairman was the key man to the business. The stock unravelled. Interestingly, there were no breaches of rules, even when the Chairman failed to disclose its share pledges.

In the meantime, there were no further bad news on SINO. Today, as I write, SINO has recovered 8X from the lows, while SINE languished at the bottom. As it turned out, the "O" was Outstanding while the "E" got Executed. And I kept the E. Sigh, that's investment.

So what is the moral of the story? When investing in Waste, make sure it is referring to the product and not the company. I invested in toxic waste...little did I realise that it was the management that was toxic.