Recognising personal biases vital for smarter investing

Investors failing to recognise personal biases risk making poor investment decisions, says Ben Brownette, a behavioural consultant for ASX-listed businesses.

Investors who fail to recognise personal biases rick making poor investment decisions, says Ben Brownette.

Investors failing to recognise personal biases risk making poor investment decisions this reporting season as broader economic and inflationary pressures force a greater number of companies to spin results.

Investment analyst and behavioural consultant for ASX-listed businesses, Ben Brownette, said companies are set to cherry pick data such as highlighting adjusted earnings before interest, taxes, depreciation, and amortisation to cast the company in favourable light.

He added investors use mental shortcuts that simplify decision-making but can lead to biases and therefore impact the ability for investors to make informed decisions.

“The way information is framed can significantly impact preferences and decisions. Earnings presentations often leverage default options and status quo bias by highlighting metrics like Adjusted EBITDA, pro-forma EBITDA, and cash EBITDA, designed to cast the company in a favourable light,” he said.

“A strong “cash conversion” number may appear positive but requires further investigation. Kahneman’s dual-system theory emphasises encouraging System 2 (analytical) thinking in high-stakes decisions while acknowledging the influence of System 1 (intuitive) thinking.”

Company results for the 2024 financial year are expected to show further signs of household stress, particularly in a soft fourth quarter, with at-home consumption outperforming out-of-home.

Market forecasts are for an average profit fall of 4 per cent among ASX companies over the 12 months to June 30, compared to the previous period. Analysis from stockbroker Morgans shows forecast earnings per share (EPS) growth for the financial year has slid to 6 per cent from previous expectations of 7 per cent, while it expects the S&P/ASX 200 will return to steady earnings growth of 5.8 per cent in FY25, and 7.8 per cent for EPS.

Mr Brownette said investors must be aware of ‘choice architecture’ in earnings presentations this earnings season, which is how companies use different methods to present choices to shareholders, and the impact of that presentation on decision-making.

“A presentation can serve as a ‘default option’, anchoring views on favourable metrics before thoroughly analysing more objective financial statements. Understanding why a company might disclose certain numbers and nudge in specific directions can provide deeper insights into their true direction,” he said.

Mr Brownette said heuristic misjudgements, such as earnings and valuation forecasts anchored on unrealistic past performance, illustrate the complex interplay of biases in investment strategies.

As earnings deteriorate under greater economic clout, more investors are expected to probe the pay for executives to ensure that salaries and bonuses are comparable to performance. Businesses have come under greater investor scrutiny over executive pay packages in the past year, with a record 41 remuneration ‘‘strikes’’ across the ASX 300 – including Qantas, with a more than 80 per cent vote against its executive pay report following controversy surrounding former CEO Alan Joyce.

Mr Brownette said understanding behaviour led to better investing and corporate decision-making because executive bonuses and public recognition (extrinsic motivation) often overshadow intrinsic motivations.

“If executives are rewarded for maximising statutory profit over cash flow or capital, they will likely act accordingly,” he said.

“Behavioural Game Theory predicts how people behave by considering psychological factors. Understanding these factors helps explain why a rational person might use a mutually assured destruction strategy or respond to conflicts between self-interest and fairness. Personal satisfaction is a strong determinant of behaviour,” he said.

Understanding human behaviour could be used as a powerful tool for investors looking to navigate and find new opportunities within the sharemarket following a reversal in fortune triggered by concerns that the US could face a recession.

Mr Brownette said that many investors jump into consumer-facing stocks that are fads instead of leveraging behavioural biases that generate good returns in sectors exposed to credit cards (present bias), food & beverage companies (psychological triggers for repeat purchases), luxury goods (social proof), and insurance (Prospect

Theory, overweighting low probabilities).

“Understanding the psychological drivers behind products and services, alongside financials, can yield better outcomes. Berkshire Hathaway’s core investments over time (Coca-Cola, Apple, American Express, GEICO, Dairy Queen) consistently leverage key behavioural biases to sustain long-term customer loyalty and profitability,” he said.

Mr Brownette said the buy now pay later sector appealed to present bias, mental accounting and the pain of paying hypothesis, which exemplified how understanding these biases can drive consumer behaviour.

“Human behaviour often defies rationality, with preferences being incomplete, inconsistent, and shaped by numerous factors that traditional economic models fail to capture. This underscores the intricate nature of human decision-making,” he said.

Mr Brownette has examined how decision-making biases applicable to finance and gambling, such as the tendency to overweight low-probability events, which he said was used in the insurance industry to highlight the potential for rare but catastrophic events can encourage consumers to purchase policies to mitigate perceived risks.

Mr Brownette recently completed a Master of Behavioural Economics at the University of Technology Sydney. His major research project, titled “Unfair Odds and Cognitive Illusions: The Role of the Conjunction Fallacy in Same Game Multi Betting Strategies”, focused on the dynamics of sports betting.