Earnings season is hunting time for the Shleifer Effect and provides the most concrete "new news" updates to track the progress of targets already on the Watchlist.
Shleifer Effect Concept Summed Up
The Shleifer Effect is rooted in the social psychology concepts of representativeness, conservativeness, and overreaction as highlighted in Andrei Shleifer's book Inefficient Markets: An Introduction to Behavioral Finance. (I introduced the construct here in the context of evaluating Aeropostale (ARO) as an investment opportunity.)
In a nutshell, Professor Shleifer describes how investors have a tendency to interpret a series of events as a pattern that will continue in the future (representativeness); once they believe a pattern is in effect, they stick to their view until multiple instances of "new news" suggest a new pattern has taken hold (conservativeness); at which time they tend to pull an about face, believing the new pattern will persist into the future, and make their investment bets in dramatic fashion according to the new news (overreaction).
Together, these behaviors create the Shleifer Effect whereby investors overreact to news sending the price of some stocks soaring above and some stocks plummeting below any reasonable assessment of their intrinsic long-term value. These tendencies create opportunities for investors who pay attention and are ready to take advantage of the thinking "glitch." We're most interested in overreaction on the down side creating buying opportunities in high quality businesses.
Tweaking the Concept - Introducing Salience
Walmart and Intuit both reversed previous announcements of bad news with an instance of good news. This creates an interesting question for how we manage the Shleifer Effect Watchlist. If the company manages to sidestep multiple instances of bad news (multiple being the theoretical requirement needed to produce investor belief in a new trend and thereby force an overreaction), does that mean they fall off the list altogether?
My gut reaction is "no." I'll suggest that existing owners are taking a wait and see approach. For Walmart in particular, the older bad news came from the NY Times story about bribery scandal allegations in its Mexico operations (featured here). The stock took a five percent hit the day after the story broke. The repercussions of that story are still unfolding and will likely take years before the full affect is known. I think it's fair to consider it to be on its own overreaction track. A separate track, I suspect, from a larger earnings representativeness bias that was in process and taking a higher priority in the minds of investors...namely, the challenge with same store sales in the US and its depressing impact on overall corporate earnings.
The latest earnings news (the press release is here) arrested the down trend by showing growing earnings, beating analyst expectations, and (most importantly, I think) the growth coming on the back of 2.6 percent growth in US stores.
In terms of tweaking the concept, I'll hypothesize that there's an element of salience to be considered here. In other words, the Mexico bribery scandal grabbed a lot of headlines. Some investors reacted by selling their shares. But its salience to the base of most existing investors was not very high. They didn't consider as an event significant enough to affect the earnings power of the business. And that - the earnings power of Walmart - is the most important issue to investors. The story with the most influence on earnings (therefore most salient) is the sales performance of US stores.
So, when the latest report shows an improvement in US store performance, the Mexico story loses its punch as it applies to the Shleifer Effect. The Walmart Shleifer Effect is temporarily suspended. Since putting Walmart on the list, it's up over six percent. If the report had been negative, I believe there would have been a compounding result. The belief in a trend of US stores being in overall decline would become stronger. The conservativeness bias as Walmart being a "has-been" retailer would strengthen. And this would have built on the Mexico scandal, sending investors into a selling overreaction.
I'll keep Walmart on the Watchlist for now with zero occurences of bad news. The next potential for Shleifer Effect news seems to be the annual meeting, scheduled for Friday, June 1, 2012 (information here).
That's my current thinking anyway. The whole Shleifer Effect is a construct-in-progress, so give me the freedom to shoot a bit from the hip while I figure out how it works in this live fire Watchlist environment.
Shleifer Effect Concept Summed Up
The Shleifer Effect is rooted in the social psychology concepts of representativeness, conservativeness, and overreaction as highlighted in Andrei Shleifer's book Inefficient Markets: An Introduction to Behavioral Finance. (I introduced the construct here in the context of evaluating Aeropostale (ARO) as an investment opportunity.)
In a nutshell, Professor Shleifer describes how investors have a tendency to interpret a series of events as a pattern that will continue in the future (representativeness); once they believe a pattern is in effect, they stick to their view until multiple instances of "new news" suggest a new pattern has taken hold (conservativeness); at which time they tend to pull an about face, believing the new pattern will persist into the future, and make their investment bets in dramatic fashion according to the new news (overreaction).
Together, these behaviors create the Shleifer Effect whereby investors overreact to news sending the price of some stocks soaring above and some stocks plummeting below any reasonable assessment of their intrinsic long-term value. These tendencies create opportunities for investors who pay attention and are ready to take advantage of the thinking "glitch." We're most interested in overreaction on the down side creating buying opportunities in high quality businesses.
Tweaking the Concept - Introducing Salience
Walmart and Intuit both reversed previous announcements of bad news with an instance of good news. This creates an interesting question for how we manage the Shleifer Effect Watchlist. If the company manages to sidestep multiple instances of bad news (multiple being the theoretical requirement needed to produce investor belief in a new trend and thereby force an overreaction), does that mean they fall off the list altogether?
My gut reaction is "no." I'll suggest that existing owners are taking a wait and see approach. For Walmart in particular, the older bad news came from the NY Times story about bribery scandal allegations in its Mexico operations (featured here). The stock took a five percent hit the day after the story broke. The repercussions of that story are still unfolding and will likely take years before the full affect is known. I think it's fair to consider it to be on its own overreaction track. A separate track, I suspect, from a larger earnings representativeness bias that was in process and taking a higher priority in the minds of investors...namely, the challenge with same store sales in the US and its depressing impact on overall corporate earnings.
The latest earnings news (the press release is here) arrested the down trend by showing growing earnings, beating analyst expectations, and (most importantly, I think) the growth coming on the back of 2.6 percent growth in US stores.
In terms of tweaking the concept, I'll hypothesize that there's an element of salience to be considered here. In other words, the Mexico bribery scandal grabbed a lot of headlines. Some investors reacted by selling their shares. But its salience to the base of most existing investors was not very high. They didn't consider as an event significant enough to affect the earnings power of the business. And that - the earnings power of Walmart - is the most important issue to investors. The story with the most influence on earnings (therefore most salient) is the sales performance of US stores.
So, when the latest report shows an improvement in US store performance, the Mexico story loses its punch as it applies to the Shleifer Effect. The Walmart Shleifer Effect is temporarily suspended. Since putting Walmart on the list, it's up over six percent. If the report had been negative, I believe there would have been a compounding result. The belief in a trend of US stores being in overall decline would become stronger. The conservativeness bias as Walmart being a "has-been" retailer would strengthen. And this would have built on the Mexico scandal, sending investors into a selling overreaction.
I'll keep Walmart on the Watchlist for now with zero occurences of bad news. The next potential for Shleifer Effect news seems to be the annual meeting, scheduled for Friday, June 1, 2012 (information here).
That's my current thinking anyway. The whole Shleifer Effect is a construct-in-progress, so give me the freedom to shoot a bit from the hip while I figure out how it works in this live fire Watchlist environment.
On to Intuit (the initial post was located here). On April 20, 2012 Intuit made an announcement suggesting that third quarter earnings might fall below Wall Street expectations because of the digital tax prep category under-performing slightly. That's caused the stock to fall about six percent.
Last week it changed the course, reporting that - despite the impact of digital tax prep - Q3 was quite good and management is optimistic enough to increase its guidance for earnings performance for the full fiscal year 2012. (That release is here.) The stock has recovered somewhat, but still sits just below its price at the initial write-up.
Last week it changed the course, reporting that - despite the impact of digital tax prep - Q3 was quite good and management is optimistic enough to increase its guidance for earnings performance for the full fiscal year 2012. (That release is here.) The stock has recovered somewhat, but still sits just below its price at the initial write-up.
With that, I'm suspending Intuit from the Shleifer Effect Watchlist. The two stories off-set each other, and I don't see any momentum right now toward investors believing a new negative trend is developing. It falls back into its previous mode, in which investors expect it to continue growing at a nice clip and are content with it sporting a 20+ P/E ratio.
I'll keep tracking it on the list, but we're putting it back to square one with ZERO occurrences of bad news.
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