• Hannah Boundy

Hindsight is 20/20

I recently read Richard Thaler’s Misbehaving (some of you may have picked up a copy of it at our recent investor conference) and these days I seem to find examples of misbehaving, or irrational behavior, in everyday life constantly. Earlier this week I came across an article titled Domino’s stock has outperformed Google, Facebook, Apple, and Amazon this decade. I instantly thought, “there’s bound to be some misbehaving here” and from the very first sentence, I knew I was right.

There’s a common saying that hindsight is 20/20, meaning it’s much easier to see what has happened than it is to predict what will happen. In behavioral economics, this is referred to as the hindsight bias. Also known as the knew-it-all-along bias, this bias is the belief that what has happened was entirely predictable despite there having been no objective basis for predicting it. I clicked on the headline and was treated to a short article on how the low-cost pizza chain had updated its recipe and generated incredible returns on its stock since that point. The article opens with the following:

It’s 2010. You’re an eager investor presented a choice between two stocks: Google or Domino’s Pizza. Where do you put your money?

You should have gone with your gut.

You should have gone with your gut. But here’s the thing: your gut had no idea Domino’s would outperform. Not to mention, when are we ever presented with just two choices? In 2010 there were thousands of investment opportunities available to the average retail investor. Even if you felt really good about pizza for whatever reason, should you have invested in Papa John’s or California Pizza Kitchen? Maybe you should have invested in Yum Brands who owns Pizza Hut. You would have had no idea who was going to change their pizza recipe, nor would you have been able to predict how consumers would have responded. What if Domino’s had gotten the recipe wrong and made their pizza worse? The future is not 20/20, only the past is and this is where misbehaving really starts to take hold.

What’s scary about these types of articles is that like the opening sentence suggests, eager investors exist and they read these articles and say “of course Domino’s pizza was a great call!” and then they try to predict the next big thing with the same 20/20 accuracy. If only you had gone with your gut seven years ago you would have made it big!

Every now and then we get calls from people wanting to invest in the next big thing. Sometimes the next big thing is 3-D printing. Sometimes it’s e-commerce. Every time we have the same response: the future isn’t 20/20. Even if we know something is popular and up-and-coming like 3-D printing, we have no idea which company is going to be "the Domino’s." We have no way of predicting which company will concoct that perfect recipe and make it big. That’s why this behavior is dangerous and can often get investors into trouble. We don’t know what we don’t know. We only know what has happened and it’s impossible to invest in the past. We can only invest looking forward. If you’d like to learn more about how we at Cedarstone approach investing, feel free to shoot us an email from our contact page or give us a call.

Purdy, Chase. "Domino's stock has outperformed Google, Facebook, Apple, and Amazon this decade." Quartz. March 22, 2017. https://qz.com/938620/dominos-dpz-stock-has-outperformed-google-goog-facebook-fb-apple-aapl-and-amazon-amzn-this-decade/.

#hindsightbias #predictingthefuture #thenextbigthing

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