The other day I told a colleague about a little-known company
that I hold in my portfolio. His reaction was: “It’s a dodgy company.” I enquired
what he knew about the company. He knew nothing. But because he hadn’t heard of
the company, that rang alarm bells for him.
On another occasion, somebody asked me what company he could
invest in. I suggested a name that he was not familiar with. He gave me a
confused look and asked for another suggestion. I suggested to him a well-known
large-cap stock, and he was happy because he “knew” this company.
For both experienced investors and amateurs, the familiarity
with a company’s “name” is an important investment criterion, though they won’t
confess it. They would prefer a company whose name they have heard of to a
company that they don’t know.
One can’t blame the investor community for this behavior.
The reason for the inclination towards what’s familiar is psychological in
nature. Familiarity breeds trust. And lack of it engenders caution. Naturally,
investors turn cautious of what they haven’t heard of. But due to this
psychological instinct, many great companies are skipped. These companies later
turn out to be multi-baggers.
How do you overcome this problem? First, “curse” yourself.
You don’t know enough, so you must not trust your own knowledge. Just because you haven’t heard of a company doesn’t
make it a dodgy one. All it indicates is you have limited exposure and you don’t know. It’s plain ignorance—yours.
Second, don’t stop at a company’s name. Study it and then make a judgment.
While studying it, don’t begin with a negative impression of it. If you do, you
will simply pick evidence that confirms your suspicion of it. That’s another
psychological bias, called the confirmation bias.
In investing, psychology plays a more important than
finance. Ignoring it and staying buried in finance books won’t get you
anywhere. To spot multi-baggers, understand psychology more than IRR or CAGR or
whatever. Is the analyst community listening?
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