Beware of our Biases

[CeezTheDay]

The recent UPST saga got me thinking about how I let myself unexpectedly get caught up in the board’s stream of positivity about the company prior to earnings. When things like this happen, I like to take a step back and examine my thought process and what I can try to do differently moving forward. I thought I’d share my reflections about the traps I fell into with the group in case anyone had (or has had in the past) a similar experience. I think we should always keep the following investing biases in mind as a board so that we can collectively remain disciplined and impartial when discussing our investments.

Anchoring Bias

Relying on a reference point in the past when making decisions about the future.

Sometimes our positive first impressions of companies cloud (no pun intended) our judgment about them moving forward, causing us to view them only through rose-colored glasses. For instance, from the get go, UPST was branded by the board as a high quality growth company with cutting edge AI technology and, especially after their Q2 results, it seemed that they could do no wrong. So I think many of us were somewhat blindsided by the Q3 results (even though they were still relatively strong and didn’t necessarily break the positive long-term investment thesis). I think we often anchor onto our initial positive assessment of a company and it makes it difficult to shake our collective conviction.

Lesson: First impressions don’t need to be the only impression. You should stay flexible, continually challenge your conviction, and understand that Mr. Market is EXTREMELY UNPREDICTABLE, even when it comes to seemingly high quality “can’t-miss” growth companies.

Herding (Groupthink)

Following the crowd. This is a natural human tendency because it’s a comfortable and safe strategy, increasing our odds of survival. This herd/mob mentality doesn’t work well in investing because it discourages independent thought.

As investors on this board, many of us are likely guilty of herd mentality if we indiscriminately follow what others like Saul, Bear, Gaucho, etc. are doing without performing our own due diligence. I’ll admit this happened to me with UPST during this past month. Members of the board posted such excellent and thorough research and analysis on an almost daily basis that I thought there was no way the Saul collective could be wrong. I didn’t bother to do any additional research for myself or question the proposed assumptions and I uncharacteristically bought a short-term call option before earnings. I was convinced that our herd was right (just like in Q2) and that we had found a “sure winner” for this latest earnings season.

Lesson: Think for yourself, do your own research, and don’t be afraid to go down the “road less traveled” and stray away from the herd. I would also add (based on my impulsive decision to buy a call option) don’t get swept up in the hype and let emotions drive investing decisions.

Superiority Trap

Being overly confident and believing that you know more than everyone else.

I think we have amazing members on this board who provide extremely insightful analyses on quality growth companies. I honestly think this might be the best investor community on the internet! That being said, we should always keep in mind that WE MIGHT BE WRONG sometimes. Despite our collective best efforts, we could be way off in our expectations for companies. I think Saul is keenly aware of this fact and is quick to cut his losses when he realizes that he was wrong about a company.

Lesson: Make sure you don’t get too cocky and overconfident. Stay humble, respect the markets, and recognize that you will probably be wrong sometimes.

Confirmation Bias

Confirmation bias happens when investors seek out information that validates their opinions and ignores any theories that refute it, leading to a false sense that nothing is likely to go wrong.

I’ve noticed that once our group falls in love with a stock (e.g., UPST), members tend to flood the board with mostly positive comments and developments about the company, but rarely look for or share potentially damaging information about them (and if it is shared, ardent supporters quickly shoot down the negative narrative and the discussion ends). Companies are complex and multifaceted, so there’s no way that there will ONLY be positive news throughout the course of their growth process.

Lesson: You should challenge the status quo by actively looking for red flags and thoughtfully questioning popular assumptions/conclusions about companies. To quote Charlie Munger, “Rapid destruction of your ideas when the time is right is one of the most valuable qualities you can acquire. You must force yourself to consider arguments on the other side.”

I hope you all find this post helpful and that it encourages you to consider the blindspots and biases that might inadvertently impact your investing process. We’re all human and are bound to make mistakes. What’s important is that we reflect on them and hold ourselves accountable to learn from them.

As always, thank you to Saul for creating this incredible community that has inspired and educated so many of us. You’ve established a tremendous investing legacy and, even though I may never meet you, I sincerely appreciate you! And thank you to all of you “Saulites” (haha!) for teaching me so much and helping me to become a more thoughtful and thorough fundamental investor.

• Ceez

[CMFSoloFool]

Ceez, I hit recommend above because I get swept away too at times from reading all the hype that typically envelops an ideal issue like UPST.

FOMO often leads to rushed decisions where the hype gives me anxiety, making me believe I must be missing something if everyone else is so excited, so I tend to look for the bright and shiny parts, while missing or discounting the tarnished and opaque parts.

Conversely, I personally find myself oftentimes getting caught in analysis paralysis, especially when looking at the fast-moving, high flying growth issues this board tends to follow. As you and most participants in this club know very well, traditional valuation metrics don’t typically apply to these early-stage growth monsters that seemingly defy gravity. And most here, me included, shun market timing and other typical (value-based) investing wisdom (doctrine?). So wait and see often means watching the stock run away in parabolic fashion while I dwell on why I hesitated.

One of the key characteristics I think the successful investors in this club have is their ability to act swiftly and decisively when they smell something rotten, and never look back. We are all trying to predict the future, and let’s face it, we’re not likely to guess right every time, either on the buy or the sell side. Being able to manage my emotions and anchoring tendencies is difficult, but the most accomplished members seem to do it with ease. I need to work on this.

[stocknovice]

One of the key characteristics I think the successful investors in this club have is their ability to act swiftly and decisively when they smell something rotten, and never look back. We are all trying to predict the future, and let’s face it, we’re not likely to guess right every time, either on the buy or the sell side. Being able to manage my emotions and anchoring tendencies is difficult, but the most accomplished members seem to do it with ease. I need to work on this.

This thread has the potential to drift quickly off topic (so let’s please not unnecessarily extend it), but I’d recommend this paragraph 1,000 times if I could. One of the key lessons I’ve learned here is it’s never about being right on any one company. It’s about doing right for my family’s portfolio AT ALL TIMES. And that includes being willing to quickly recognize and admit when I’m wrong.

Keeping that perspective in mind makes individual decisions a heck of a lot easier.

[kwealth]

“The only people who have been decimated in UPST have been the momentum chasers that got in this thing above $300.”

“You don’t understand why people on this board have 50%+ returns with concentrated holdings in UPST, DDOG, SNOW, NET, CRWD, ZS, SE, etc.? The returns are that high because this board has found these names BEFORE the momentum chasers have come in.”

Perhaps, but that’s not really how this is supposed to work, is it? I’ve seen this sentiment posted a lot and it rubs me wrong every time.

If Upstart was a dangerous hold above $300, everyone should have been selling it above $300 instead of so many of us holding 20+% positions. From what I understand, Saul investors are price agnostic. What’s important are the business prospects/growth. Many of us analyzed Upstart’s financials when the stock was at $300+ and found reason to believe it would have another massive beat in Q3 and see continued stock price appreciation. “Momentum chasers” definitely affect upside and downside moves, but that’s not what triggered the initial enthusiasm or the selloff. The selloff was triggered by the market pricing in a much bigger Q3 and not getting it. Like it or not, we called it wrong and have been “decimated” in that UPST is down nearly 50% from its high. Now we need to re-analyze UPST’s business/financials as it stands right now in this moment.

Simply put, given no new information, holding UPST at $300 -should- be the same investing decision as buying at $300 for the first time.

[FallingWallenda]

I think the psychology of the board is really interesting. Two people I really respect, Bear and Saul, have responded the opposite to UPST’s earnings. If they’re using the same methodology, shouldn’t their actions be the same or, at least, similar?

Let’s take CRWD: people started lightening up on their positions because Crowdstrike’s revenue growth is decelerating, although it is still north of 50%.

UPST’s deceleration is more extreme, albeit from a higher, less sustainable peak. Seems like Bear’s actions are adhering more to what we’ve learned here.

Is UPST a special case? It’s not SAAS. It’s showing signs of unpredictability. Is it just because so many of us have sunk so much of our portfolios into it that we can’t think objectively? Or are we seeing the kinks in the hypergrowth approach that may not apply to every situation?

At heart, I’m more of a Foolish investor. Buy and hold great companies. But I started buying into the strategy of this board and sold off core holdings (like AMZN) to increase my position in UPST. From what I’d read here and everywhere else, there seemed to be a good chance that this quarter would be a blowout like the last. And maybe we deluded ourselves into thinking the 3D look at UPST which the board was gathering was giving us an insight no one else had. It turned out to be illusory, but at the time, it seemed that people like JonWayne were digging up gold, not pyrite (no offense, Jon, because I think you were doing some really creative analysis and thinking outside the box, it just may not have been as revelatory as we thought)

SOOOOO, when the stock dumped from 400 to 320 on two upgrades that were purely valuation based, I felt that there was a cushion that made buying at this price relatively safe. If it had been near its highs at the time of earnings, I would not have added to my position because the risk/reward would have been higher. But since the only thing that changed was the price, I felt we had a bargain on our hands. And I added. And added. And added until I turned 180% gain into 30% loss.

So what am I going to do? I sold 20% on the day of and I’m staying put with the rest. I don’t feel great about it, but if I just try to clear my head of all the static and widen my time horizon, I still own stock in a company growing a couple hundred per cent, much faster than DDOG, CRWD and NET at half the PS, that has yet to ally itself with a major financial institution, that has great technology and leadership, and should be a winning stock over the next 5 years. I hope the price turns around sooner rather than later because the opportunity costs of tying up all this money is painful, and watching a stock go down every day is not my idea of a good time. But as I said, I’m sitting tight. And buying stock in Pepto Bismol.

FW

[chang88]

FallingWallenda, excellent post. I have some thoughts I’ve been brewing for a while since UPST earnings and seeing all the board discussion.

Consumer-facing vs SaaS

We are not going for the largest market cap on this board. But the fact is that most of the largest companies by market cap do not have a SaaS-like recurring revenue. They are consumer facing.

• AAPL has a mix of hardware and software revenue to consumers and businesses.
  -GOOG/FB are advertising companies and there’s no recurring revenue. (GOOG’s GCP is a very small part compared to their search revenue)
• NFLX, the best performing stock in the 2000s, has no SaaS recurring revenue. They have consumer facing subscription that you can cancel any time (as I have done so to subscribe and unsubscribe many times a year.)
• NVDA makes hardware. There’s no recurring revenue whatsoever.

One company that has a large chunk of recurring revenue is AMZN, and maybe you can argue MSFT.

For those consumer-facing companies, the best you can say is that they have such great products so people come back over and over again. (Microsoft Office?) I believe this is the most important criteria when evaluating consumer facing companies.

Consumer facing revenues can be lumpy, but they tend to have a much longer runway in their TAM than B2B SaaS companies. I simply can’t see DDOG becoming a 500B company with their products, even 200B feels like a stretch. This fits into the Fool philosophy of buy and hold forever because the Gardners wants to minimize your headaches - or maximize the quality of sleep - when you pick stocks.

(PS. I really liked the Fireside Chat With Morgan Housel & Tom Gardner from Sep 10 this year if you have Stock Advisor subscription. Tom explained the idea behind why Fool decided to use buy and hold forever in great detail. I am not sure if I am allowed to post Fool subscriber only links or not.)

Recurring revenue is awesome until it’s not - the stickiness of revenue also means when a company is displaced it’s almost impossible to win it back. Alteryx, for example, was an early winner in the data analytics space but got quickly displaced by better technologies, both by open sourced ones and other SaaS companies. This fits into the one of the board’s core principles - cut the stock when you see material change in the company’s thesis. This lesson is very expensive for SaaS companies stocks.

Two principles

So you have two principles that are mutually exclusive:

• Buy and hold forever
• Cut when the company’s thesis changed

Both are wildly successful. What gives?

It reminds me of a quote from Scott Fitzgerald:

“The test of a first-rate intelligence is the ability to hold two opposing ideas in mind at the same time and still retain the ability to function.

I hope the board’s wisdom will help me dissect the difference and become a better investor. Here’s my take

On some occasions we see companies that fits into both profiles: SHOP, TTD, early NVDA, that kept growing into and expanding their massive TAM beyond the initial S-curve. Those are the companies that challenges our thinking and both principles apply.

Does UPST fit into this profile? I am not sure, but my own current research says yes. Because of my own investment philosophy, I am willing to hold through the volatility in its stock price. I personally have a large chunk of SQ (15%) which is a rarity on the board.

Back to your example, I also cut all of my CRWD after seeing a deceleration for several quarters and moved the money to DDOG as soon as the last ER came out. Am I acting irrationally for treating USPT and CRWD differently? In my opinion it’s only natural to treat them differently given their source of income and nature of business.

Saul has repeated said that you shouldn’t copy what he does. He has been living on investment income for a long time. He explained that he cap his holdings in percentage because he has no other source of income. I am in my 30s with income and my holdings reflect that. Everyone on the board is on a different part of their life and with different financial goals. The different is the source of different opinions and why we have a MARKET. I try to read all the posts and learn all the wisdom here with said acknowledgement in mind.

[WillO2028]

I agree that sometimes, as when in the face of seeming contradiction, we must be able to hold at least two opposing ideas in mind and act, at least until we’re able to reconcile them. The following is my attempt to reconcile some of the principles taught here which have been addressed so well on this thread.

We are seeking predictability when we are asking ourselves what will be the rate of hyper-growth going forward for a business. A lot has been said on this Board about how to determine predictability, from reading the tea leaves of management commentary to the numerical variances from quarter to quarter within a company to differing business models between companies. ARR May afford a powerful level of predictability in a companies quarterly growth for example. If a company sells seats vs being usage based depends on the macro environment a bit. The level of growth available into a particular TAM size is often talked about as enabling or limiting growth as is the ‘Law of Large numbers’. The sustainability of technological advantage is another predictor of future growth albeit eschewed by many here (this is we’re getting into the weeds too much can be a problem per Saul, see Fastly as one example).
One thing that I believe is particularly relevant to the predictability in the continuation of a certain amount of growth for a company like Upstart is the fact that what they are good at is AI, which is itself a way of predicting outcomes. I believe that Upstart is applying this increasing ability to predict to determine what the growth will be for their business. The whole idea of AI|ML as a technological advantage is that where a human is unable to synthesis the enormous amount of meaningful data available, much less do so quickly, AI technology is able to do this. I’m not saying we shouldn’t try. And I believe that the acts of our attempts to reconcile the various principles laid out here, on this Board, is what is producing our, on average, superior returns.

With Upstart specifically, I believe a greater level of trust in the Management team is necessary for long term buy and hold (Thanks again to all the amazing analysis here on this front). This when added to 250% revenue growth (narrative+numbers) affords me my conviction/comfort level. Because of the fact that I averaged into Upstart around $100, where by my position grew to where some might say I’m only comfortable taking this risk based on that, I assure you everyday I ask myself if the money in one company might grow more in the next 1-3 years than it would in another.
My favorite from all the posts about UPST after earnings:
Jweist-
“SaaS is great for revenue consistency, but it says nothing about growth.”

I see my limitation here being: how well I might synthesis/learn how to better be able to listen to a company like Upstart and understand what level of growth I can expect. Writing this down is helpful for me. For now I’m keeping Upstart at a 10% position.

Best,

Jason

[jwiest]

So you have two principles that are mutually exclusive:

- Buy and hold forever
- Cut when the company’s thesis changed

This is a false choice.

I’ve been on the Fool since the days of 3dfx, and they have never been “buy and hold forever”. Sure, they have held some things for a very long time, sometimes through some serious contractions, but as far as I can tell, they have always been “cut when the company’s thesis changed”…it’s just that people are not often in agreement about whether or not a thesis has, in fact, changed; or in agreement about whether a change can be recovered from, etc. There’s a lot more nuance going on.

Lately I’ve seen a lot of people tout these two ideas as if they are in opposition, but I think that’s dangerous and misses the point. Because the first isn’t a “principle” at all, it’s a religion. The second is simply practical advice anyone should follow, within the parameters of the kind of investor you want to be. I think it’s safe to say everyone should always do the second. That doesn’t imply you have to be constantly trading, far from it. You can still pick things you think have legs for the long haul, but it does mean you have to be realistic about changes that do happen, whether you think bad turns can be recovered from, whether turns are due to market madness or real systemic problems at the company, and how long your patience is for recovery.

If you really want to buy and hold forever, it would be best to simply invest in an index fund. Then, if historical trends hold true, you’ll grow by 7-10% per year, and never have to think about it. But if you hold any individual stocks at all, you really have to be prepared to reassess, at least every quarter.

[FallingWallenda]

Obviously buy and hold isn’t an ultimatum. But MF rarely sells. I recently looked at their stock screener and they have some stocks that have been on their list for many many years and have dismal returns. It really takes some extreme circumstances for them to bail on a company.

hyper growth is a very specific strategy. It’s Buy and Hold…for as long as certain criteria are met. That’s not really buy and hold any more than someone holding a match is going to hold it for very long. I’m sure you’d agree MF operates much differently. Trust me, they are not hemming and hawing about UPST like many here on the board. And would Saul have stuck through the vicissitudes of Netflix to gain 30,000%?

As for saying buy and hold is akin to buying a mutual fund, MF returns far outpace the markets. Are they right all the time? No. But if u choose their recommendations wisely, you can do fairly well. And maintain your sanity. They are OK missing on a stock because they believe 80% of your gains will come from 20% of your picks. So they’re playing baseball whereas this board is practicing archery.

I’m in the middle of these two strategies right now and thats hard to reconcile. I haven’t been on this board long so I’m not sitting on large gains. I don’t have the temperament to have 25% of my portfolio on any one stock but I committed to UPST far more than I have ever done before. On the heels of LSPD, I’m doing some soul searching on what kind of investor I want to be and what matches my mental make up. I’m still working through it.

[SaulR80683]

Hi Conifer, glad for your success and many forms of investing work for many people. However, this board is for a particular kind of investing, so I’ll have to delete your post.
Saul

[SaulR80683]

NO MORE POSTs on the Beware Biases thread. This is not the board to discuss LTBH strategies.

Thanks for your cooperation.

Saul

[SaulR80683]

I think the psychology of the board is really interesting. Two people I really respect, Bear and Saul, have responded the opposite to UPST’s earnings. If they’re using the same methodology, shouldn’t their actions be the same or, at least, similar?

Hi Wallenda,
Think about it. That’s a bit silly isn’t it? Of course different people respond differently. We are all different. It would really be worrisome if we all reacted exactly the same. We each have some different stocks in our portfolios although with lots of overlap. We have different weightings, as we decide them for ourselves. We think for ourselves and have to take into account family responsibilities, kids in school, assets, planned purchases, and a myriad of other considerations.

However people like Me and Bear and Gaucho all use the same METHOD of investing, which is the essence of this board. That is, concentrated portfolios of high growth stocks which we buy to hold, but watch very carefully, and exit if necessary. And we all get approximately the same results at the end of the year.

Bear and Saul have responded the opposite to UPST’s earnings.

We didn’t respond the opposite, we responded the SAME, but TO DIFFERENT DEGREES. Bear cut his position by 100%, I cut mine by 50%. Responding opposite would be if one of us exited and the other added and doubled his position at the lower price.

Best,

Saul

[stryker82]

Initially you stated to hold position and mentioned good numbers and company at beginning of s shape curve. So that indicates that original thesis is intact.

I did see later you mentioned about trimming after first bounce. Can you please explain your reasoning of this trim?

I think the main takeaway is to not feed losers which is what I did after determining that thesis is intact. That has hurt me a bit. However if thesis is intact and we are looking for 1.4 to 1.7b 2022 rev then I feel it’s something I can hold on to. None of other stocks I have can match that growth.

This is 4th correction in upst.
First was 59.5% decline
Second at 51.2%
Third at 44.1% (this one was painfully longest)
Current one is 48.9% so far

It has always been able to recover well in past. This correction however has earning disappointment baked into it.