👋👋 Hello Y’all, I know I stated in my last article that the next article will be on Microsoft as they release their earnings tomorrow. But I could not resist printing about Halo Effect as I finished reading this amazing book by Phil Rosenzweig, “The Halo Effect”. Multiple spectrums can be covered by this book, but I would like to focus on investing and Halo in today’s blog.
Although there are no prescriptions or scientific methods to avoid Halo’s, I do list the lessons from my experience that might be beneficial. As you will learn more in the blog, take them with a grain of salt. There is no prescribed science to success in the business world.
Introduction – What is Halo Effect?
The Halo effect is a tendency to make inferences about specific traits based on a general impression. This example will help clarify the definition of the Halo effect.
Note: I am just using this as an example, I am not trying to portray likeness or dislikes towards political parties.
After Sept 11 attacks, George Bush’s overall approval ratings rose sharply. No surprise here, we wanted to stand behind the president in tough times. In the same survey, his approval rating on “handling of the economy” also raised from 47% to 60%.
Similarly, by Oct 2005, with the Iraq war fading and in wake of Hurricane Katrina, Bush’s overall rating when down to 37% from 41%. In the same survey, his economic policy rating went down to 32% from 37%, regarding Iraq his rating went to 32% from 38% and the rating for fighting terrorism went down to 46% from 54%.
Now, whether you like Bush’s economic policies or not. There is no reason to believe his ability to handle the economy was suddenly better after 9/11 and worse in Oct 2005. This is Halo in action, suggesting that our judgment is not independent but based on an overall assessment of what is happening at a given point in time.
Let me take another example, I promise this will be quick. Apple. When Apple started selling iPods in 2001, the sales of its MacBook also started increasing. MacBook was Macbook before or after iPod was launched, there were no significant upgrades before or after the iPod launch in MacBook. So why did this happen? Halo effect. iPod was a revolutionary product. It built confidence in Apple as a company. It brought loyalty to Apple and its product. This is a good example of how the success of one product led to the success of a company in general.
Halo’s Around Us
🚀 Investing decisions
🚀 Great books that talk about building great companies,
🚀 Surveys that ask us to rate our company culture,
🚀 Elections – be it any type, etc.
Investing and Halo
For my readers, I want to focus on Investing as it binds us all closely. More than that, it is comforting to talk about money and show how lucky I have been so far with my investments.
When the Halo effect takes hold of our decision-making, it can hinder our ability to think critically. As a result, we may mistakenly miss out on valuable opportunities or put bets on the wrong companies.
While making investment decisions we get drowned in the past success of a company thinking nothing bad can happen with this investment. We use past success as the measure of the future success of a company. If that were the case Walmart, Intel, ABB, IBM, and Nordstorm would have never gone down.
These companies would have continuously given great results. But they did fail. Now the question that we usually ask is, did they fail because of leadership, did they fail because of bad strategy or did they fail because of lack of execution? Well if you believe in a magazine or great bestselling books that have mastered the art of creating successful business strategies you will find answers like, management failed to execute the plan, leaders lost their vision, they divested their resources in too many places, they lost their focus, etc.
Success Is NOT Forever
But did they lose focus or divested too many resources?. Here is the lesson for investors. No company is bound to succeed forever. Failures will come and it is not easy to identify when these failures will hit. Companies make decisions every day. Decisions are probabilistic. They may work or fail. There is no way anyone can predict the outcome of a decision taken. It can go north or south. Only the outcome at the end will tell. All stock pundits who shout on TV or print media about company strategies that they know would work or fail, want it both ways. They use their research as an excuse to make us trust their judgments.
Lesson 1 – Companies will fail, Let’s accept it
Do not mistake past success or failure for future growth or failure.
Absolute vs Relative Growth
The chances are, the more the research, the more Halos you will collect. After all more garbage in the data means more garbage in the output. One such garbage data point is the absolute growth rate of a company. Absolute growth rate means the growth within the company. All companies strive to grow and will grow as processes and people improve. Well, this is not sufficient to prove that this company will survive. It’s the relative growth. It’s relative to the industry and relative to its peers.
Kmart for example grew its inventory turn from 3.45 in 1994 to 4.56 in 2002. That is a 32% jump. Not bad. But Kmart still failed. Why? Let us find out. Walmart during the same time frame grew its Inventory turns from 5.14 in 1994 to 8.08 in 2002. That is 63%. If you look at the numbers above, Kmart in 2002 was well below Walmart’s number in 1994 (4.56 – Kmart in 2002, 8.08 – Walmart in 1994).
Intel in the ’70s understood this. Andy Grove knew that just growing internally will not lead to the success of intel. Intel will need to oust the growth of the chip industry and its competition in general.
This shows that the only force at work in capitalism is that of competition through innovation. Disruption in technology or product development will impact the course of a company. Ignoring competition and not investing in R&D increases the probability of a doomsday. There is no ordinary playbook to avoid Halos. If I were to prescribe a playbook for investing principles I will be pushing you towards Halo.
Lesson 2 – Compare growth within the sector
While evaluating a company don’t just look for its growth, look across the sector. How did that specific sector in general grow? How did similar companies grow? Avoid drawing conclusions based on actions taken by different companies. Remember you cannot compare Actions. You can only compare numbers and the right data sources.
The only true words of wisdom are to understand the bias in decision-making. Slowing down the thinking process and reasoning every investment decision or any decision in general. Trust your judgment only, question everything that is presented to us. Be it research from well-established sources, trusted colleagues, or even your own analysis. Question everything?
Lesson 3 – Avoid taking things at face value
Don’t take things at face value. Use your judgment and experience in making decisions.
Everyone Makes Mistakes – Choose one with Less
Companies make mistakes, everyone does. The answer to look for is, what is the rate of mistakes. What is the ideal number? Is one bad decision out of ten good? or 2 out of 10 or 3 out of 10? No one knows. You may wonder, it’s the value of dollars lost or gained as a mistake that counts. Well maybe, maybe not. One mistake could be costly enough to bankrupt the company or ten small mistakes will only erase 1% of the market cap. For me later sounds like trouble. I would like to bet my money on companies and leaders that make fewer mistakes.
One example that comes to mind is Meta. Their bet on Metaverse is huge. Pundits are screaming out of their lungs it’s a great bet, it’s the future. Who knows? These pundits will be the first ones to change their tones when things go south for Meta and Metaverse fails. What do the numbers tell us? Meta is spending $18B a year on reality labs. As an investor I have to ask, Is this bet going to reduce my investment in Meta say 10 years from now or will this bet turn out all great with a 20-50x return. My risk appetite is low, hence I moved away from Meta. But I could be wrong. It is your money and you need to decide if Meta’s Metaverse bet makes sense.
Lesson 4 – Mistakes will be made, depending on your risk appetite select companies that make fewer mistakes. (You can also measure mistakes in dollar values. Fewer dollars lost with mistakes could be a selection criterion.)
From what I have written, I have touched on both positive and negative scenarios of Halo. Apple is a positive example. As an investor, I would hope that Halo for Apple keeps on working because that is their USP. On the other hand, I want to proceed with caution and ask myself, how much money am I ready to invest in Apple considering its Halo effect starts to fade say 20 years from now.
Book Recommendations to understand more about Halo
- The Halo Effect – Phil Rosenzweig
- Noise: A Flaw in Human Judgement – Daniel Kahneman, Olivier Sibony, Cass Sunstein
- The Black Swan – Nassim Nicholas Taleb
- Built to Last – Jim Collins and Jerry Porras – The reason I put this is to highlight how this book is filled with Halo Effect
- Investopedia Article about Halo
Cheers to avoiding Halo’s in future