Weighing up the pros and cons
Posted on July 12, 2007 by Richard Beddard
Filed Under Investing |
There’s a classic point in part 2 of the BBC Radio programme, “The Art of Indecision“, where the presenter is interviewing young women about how they decide whether or not to dump their boyfriends. One of them makes lists. She lists the good things about her boyfriends, and the bad things about them, and then she decides. If the list of bad things is longer than the list of good things, it’s bye bye boyfriend, the hapless victim of female logic.
But, wonders the presenter, what if the bad things are less important than the good things?
“Yeah, like wearing bad shoes isn’t as bad as being a complete bastard.”
She replies.
It has been twenty years or so since I was faced with her conundrum and even then the shoe was usually on the other foot, so to speak. Inexperienced though I am in assessing the pros and cons of potential partners, I assess potential investments exactly the same way.
Thanks to the BBC, I’ve discovered the humble lists I make when deciding to buy or sell a stock are an example of ‘Multi Attribute Utility Decomposition’, which is similar to a decision-making technique called PMI (Plus/Minus/Interesting). Students of decision-making describe MAUD as a two-stage process where you list out the pros and cons and then give each one a weighting, say 3 for very important factors and 1 for the least important. The list with the highest total wins, not the list with the most items.
I don’t usually get that far. Like the woman in the interview I usually come across a ‘complete bastard‘, a hole in the balance sheet, say, in the process of making the list and the decision is made for me. Here’s a recent example copied straight from my notebook.*1
To decode, Goldshield looks like a company with a history of profitability that’s going through a bad spell. The price is down, but it has no debt, it’s maintained its dividend, appointed new management in Keith Hellawell, formerly a senior policeman and ‘Drugs Tsar’ (which lends confidence) and the former finance director (which might not, as the outgoing directors are accused of price-fixing). If profits and the share price collapsed because of the costs and distractions of legal wrangling and ill-advised investments now being divested, Goldshield probably fits my idea of a recovery stock. I’ve deferred the final decision, though, at least until I’ve read recent news items and the annual report.
Can you really pick stocks in the same way as you might a girl or boyfriend? To me, the approach seems more appropriate for the discipline of investing, than affairs of the heart. I’m emboldened by the example of Richard Farleigh, millionaire investor and BBC Dragon, who used the same technique to gauge the market when he ran a hedge fund.
Footnotes:
- By notebook, I mean note-taking program. I use Evernote, in fact I’m writing this blog entry in it now. Apart from making it incredibly easy to organise and find notes, you can flag items ‘to do’, which explains the square check box by the word ‘decision’ in the Goldshield example.
- I wonder how other investors make decisions… It turns out there are many ways…
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4 Responses to “Weighing up the pros and cons”
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You could probably take this analysis a step further and compare it to the emotional involvement that comes along with a relationship.
I guess a simple list could be a useful way to quickly filter out good or bad investments; however it would be interesting to know what items were actually in the list for different decisions.
For example, I was reading an interesting article in the Evening Standard today.
It talked about Goldman Sachs impending purchase of a utility company (Southern Water) at a price tag of almost double its long term worth.
The question was why would Goldman Sacks make such a bad investment? The author seemed to believe that the main thing driving this decision were the fees involved.
Through some reasoning (which I am afraid I did not follow) he basically suggested that Goldman was actually investing other people’s money and ultimately they did not care if the investment turned bad. They would still have their fees and the most likely people to pick up the tab would be the passive pension fund holders at some future date.
I cannot personally comment on the truth of this but I certainly would not put it past savvy financial people to make these kinds of ‘calculated’ decisions.
Hi Robin and Deborah, thanks for your comments. It’s the great mystery isn’t it: What goes on in the minds of lovers, and investment bankers
. Robin, what you’re describing sounds like the sort of criticism levied at private equity. I imagine CVC made more money from fees than it did when, with its partners, it refloated Debenhams, and the price has fallen steadily since. Asked by the select committee currently investigating private equity whether Debenhams had damaged CVC’s reputation the Guardian reported these comments from its managing partner:
“Yes, we have been damaged by Debenhams performance,” admits Donald Mackenzie.
“We’re the largest shareholder. Also, there’s a reputation issue. The London market is very important to us, so it you have a reputation for poor performance after a float it can damage you.”
I don’t know whether that means he wouldn’t do it again!
[...] N/A. I can’t back-test because the criteria I use to select stocks vary, and I would not be able to program a computer to replicate my decisions. [...]