Value Investing: Tools and Techniques for Intelligent Investment

Chapter 9. Placebos, Booze and Glamour Stocks^[9]

Have you ever bought a (cheap) non-brand painkiller, and sworn that it didn't work as well as the (expensive) branded version? If so, your brain is probably playing tricks on you. We seem to have an in-built subconscious dislike of items that are at a discount. It is often said that in stock markets nobody likes a sale. Could a bias against cheapness be one of the causes of the value premium? The good news is that rational reflection seems to ameliorate this particular bias. The bad news is that staying rational while everyone else is losing their head is as hard as ever.

• It appears we are preprogrammed to equate price and quality. Now, in many contexts this may well be a useful heuristic. However, like most mental short cuts it can lead us far astray from rational decision making.

• For instance, which will work better: a painkiller that costs $2.50 per dose, or the same painkiller discounted and selling at just 10 cents? Rationally, they should have exactly the same effect (especially since both pills are nothing more than sugar pills). However, Dan Ariely and colleagues have found that people report the expensive version to be far more effective than the cheap version!

• If you prefer booze to pills, then consider the following. You are given some wine to taste and told it costs $10 a bottle, and then some more wine to taste and told it costs $90. The $90 wine was rated nearly twice as nice as the $10 wine. The only snag was that the ...