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Bias in Valuation

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By andrewychan
November 21, 2002

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Hi guys,

If you don't mind, I'd like to contribute my 2 Canadian cents about bias in valuation.

As Sean and the D man pointed out, there are many reasons why we can be biased about valuation. I believe that this side of the question has been dealt with. The question that arises then is: "How can we reduce the bias?"

The only thing I can come up with is to be challenged by somebody.

As a buy-side analyst, all my investment proposals have to be approved by my Portfolio Manager. I have to convince him and as he puts it, he will always be against me. It's not to be mean or to slow the investment process, it's simply a method to remove the bias that I may have had and make sure I have covered all aspects of a company. He will question all my assumptions and I better come up with a non-anecdotal and solid business justification to all my assumptions. My PM isn't always right, he will try to contradict me even if I am right, and it's just that I have to come up with a strong argument to support my thesis.

So personally, the best mechanism for me to remove any personal bias is to be challenged. It's a hard process because it can knock your confidence a bit, but in the end, you're the winner.

Obviously, not every Fool works with a PM, but I think that the Motley Fool message board can be a great place to find someone trusty and knowledgeable to be challenged and to challenge others.

The best that we can do is to recognize our own personal bias. This is easier said than done, after all presuppositions are located in one's subconscious and, as such, cannot be known.

Recognizing our own personal bias is a hard thing to do. What is even harder is being told that we are biased. Even harder is to admit that we are biased and change our model accordingly. It's hard on the ego sometimes and I've had those kinds of episodes. But in the end, your partner, friend and fellow Fool is there to help.

It may be just as hard to fight bias than it is to fight denial. We are all human after all. It's inevitable and as Sean puts it, incorporating a margin of safety in a buy decision is the best thing to do.

In the end, recognizing that our own bias will only hurt ourselves might help us remove personal bias. After all, it is our money that we are "playing with".

Cheers,

Andrew


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