A Wealth Creation Journal

Category: Psychology

Dart Group – Memo post FY17 results

Thomas’s enthusiasm on religiously updating this blog has put me to shame and as such I will share my latest thoughts on Dart post the latest results release last week.

While many investors counsel against sharing investment ideas because it exposes one to commitment bias. Despite the commitment bias risk, I want to document my thoughts ex-ante so that I can remove any hindsight bias should my judgement prove to be wealth destructive. So here we go:

Post the results, DTG share price went on free fall – a whooping 20% drop in 2 days. Just like TC, DTG makes up ~25% of my portfolio. So this was emotionally hard to bear despite all the lessons of rationality that we keep reading about in books.

The market reacted violently because:

  • Operating profit probably did not meet market expectations given the run-up in share price before the results release
  • Huge uncertainty associated with the non-UK ownership issue

I suspect the issue surrounding non-UK ownership was the more important driver is pushing the share price down. As we all know, market hates and punishes uncertainty very punitively.

From an operational perspective, I was very happy with the progress that DTG is making for couple of reasons:

  • The capex numbers confirmed a previous assumption that DTG has ~50% discount on the listing price of the new Boeing 737-800s
  • Revenue growth in winter season continued which is critical as the newer fleet would have to be justified by better utilization rate all year round
  • Advanced revenue jumped 40% YoY which is STRONG indicator of the success of the new bases – Stansted and Birmingham
  • Net debt was very much under control helped by the cash flow generated by negative working capital with growth

The main reason for softer EBIT margin was due to one-off costs and cost ramp up in new airports (Stansted and Birmingham) i.e. the cost was incurred before the revenue came in.

When we decided to invest in DTG in Oct 2016, the biggest risk was that Brexit would lead to a sharp drop in demand for oversea package holidays which would be disastrous for DTG as it was taking on debt to purchase new aircraft. Increasing capacity through debt when demand is about to decline is a recipe for massive value destruction as witnessed in many of the commodity companies.

However the strong advanced sales and the revenue growth in FY17 indicated that the demand for package holiday in the UK has not been affected by the weaker Sterling post Brexit. This corroborates the UK holiday data released by ONS in May 2017. The strong growth in advanced sales is an important signal because it implies that people are booking their summer holidays as usual. In fact the strong demand for FY 2017 summer is particularly encouraging because Britons would have fully digested the impacts of Brexit and still decided to spend on holiday in the subsequent year.

The implication of the above point is that our worst-case scenario is increasingly unlikely to happen and as such the downside risk of an investment in DTG is diminishing. Operationally, the range of outcomes for DTG in the next 2 years is heavily skewed to the base and bull case. (Base case assumed growth associated opening 2 new bases and no growth afterwards and bull case assumes that there is still 5% organic growth in topline after the new bases are up and running at steady state)

Going forward, I think the value of DTG is driven by the following factors:

  1. Normalized run-rate FCF in base case in GBP 120 – 140m which implies an FCF yield of 17% based on the share price today
  2. Pay down of debt will lead to appreciation of equity value
  3. Given a mix of old and new aircraft in the fleet today, DTG can choose to retire old planes more quickly depending on the demand conditions. Full credit to TC for his insight on this point
  4. Multiple expansion as the company proves its success with the new bases and lower leverage in the steady state environment

As such I have added and will continue to add to my DTG position if the price goes down further in the absence of new information.

On the non-UK ownership point, the context is such that both EU and UK requires their airlines to be majority owned by EU or UK nationals. Before Brexit, UK airlines just have to comply with the EU regulations. Post Brexit, UK airlines have to ensure that the company is majority UK owned to maintain its operating license. DTG is proposing to add a new clause to the article of association to force any non-UK shareholders to sell his/her shares. Ryanair and Easyjet already have this clause in their article of association. The worst case is that we are forced to sell when the share price is very low as we are not UK nationals.

Firstly, DTG noted in its announcement that they believe currently non-UK shareholders make up less than 35% of the shareholder base. DTG is 40% owned by its founder, Philip Meeson who is a UK national. Secondly, the company will try its best to avoid activating such clause unless absolutely required. Thirdly, we still dont know how the Brexit negotiation will play out on this issue – maybe it is favorable maybe it is not.

So there is a good chance that this clause is not required. But the important question is if the company decided to trigger this clause how are they going to decide which shareholders to force sell. I.e. if there are 40% non-UK shareholders and DTG wants to bring that down to 35%. How do they choose which 5% of the non-UK shareholder base to force sell?

The company did not comment on this. But we decided to look at Ryanair and Easyjet for inspiration. It turns out that it depends on the chronological order at which non-UK shareholders register their shares with the company. For example, if you are the first non-UK shareholder to register with the company then you are the last one to be forced to sell. And they will first force sell the shareholders who have not registered with the company. So this gave me great comfort that as long as I register my shares with DTG asap, I should be okay.

So I am comfortable with the two issues and continue to hold the DTG shares. Of course I change my mind when the facts change to quote John Maynard Keynes.

MC

Book Review: Influence – R. Cialdini

Influence by Cialdini is recommended everywhere, even Charlie Munger recommends it. Cialdini discusses human decision making shortcuts and how companies exploit them.

Click, whirr – Robert Cialdini

 

influence

The good: the book is well-written with great examples from real life and social science experiments. It summarizes the most important factors or “shortcuts” that influence people in their decision-making.

The bad: my high expectations, and some overlap with other books (Dale Carnegie, Kahneman). Most of the findings were not (entirely) new. Lastly, the defenses that the author proposes against each weapon of influence were kind of common sense (recognizing the technique etc.)

Each chapter in the book discusses one “weapon of influence”.

Chapter 1 – Reciprocity

After giving people something small, they feel very indebted to you. By first giving small things, compliance professionals will compel you to do something bigger back.

Chapter 2 – Commitment & Consistency

Being viewed as a consistent person is highly valued in society, often too high. If people act according to (or state) a certain belief, they will feel compelled to hold on to that belief in the future. This even occurs when people act according to certain values privately, but the effect is much stronger if it occurs publicly. This was my favorite chapter as it contained many great examples I didn’t know of yet. Some examples:

Toy stores advertising a new popular toy heavily in anticipation of Christmas and then under-stocking the stores on purpose.

Step 1: parents promise their kids the toy.

Step 2:  toy isn’t “available” before Christmas, parents will overcompensate by buying a big other toy

Step 3: kids whining to their parents to keep their promise and parents buying the toy in the end after Christmas

Researchers asking people whether they would go to vote on election day causing turn-out to increase dramatically

Many Americans want to go vote but don’t feel like it when the day comes. Just by asking people whether they would go to vote, many that replied yes would make good on their promise to themselves (Anthony Greenwald, Ohio study).

Asking people how they are doing before trying to sell a charity donation to them increases compliance dramatically

Step 1: people will automatically say “I’m doing great”

Step 2: people don’t want to appear stingy for donating to charity while they are “doing great”

American prisoners of war in Communist China starting to believe in Communism by making them write small good things about China

By requesting prisoners to write mildly anti-American or pro-Communist elements in their essays “the USA has its own problems”, “in a Communist country, unemployment is not a problem”, the Americans found themselves pushed to submit to related yet more substantive requests. Prisoners stating pro-Communist or anti-capitalist were subsequently subtly rewarded for those statements (note: if they were heavily rewarded those prisoners could then rationalize those statements to themselves “I just complied to get the reward”. By giving them only small rewards, prisoners internalized the beliefs they wrote down).

The Chinese then used these essays in an anti-American radio broadcast. After feeling like collaborators, those Americans then internalized those beliefs even more.

Getting a client to purchase something big by first making them buy something small

Using trivial petitions to sell people difficult things subsequently

By first committing to something small (sign a petition) for the public good, those people that first signed this petition then had a much higher compliance rate when asked to put an ugly “DRIVE CAREFULLY” billboard on the wall of their house a week later.

This one was my favorite. Before signing a petition, make sure nobody is trying to manipulate you first!

College fraternities and primitive tribe initiations

The rituals to get into a tribe seem very harsh from outside (many exhausting and dangerous tasks to this day. Every year people die to get in fraternities: beatings, very long cold exposure, thirst, threats of death). According to Cialdini, this is not because of sadism of the members. Something else is at play here: the more difficult time people have to get in, the more they will value their membership afterwards and commit to it. These rituals are actually commitment devices to make members very loyal to their tribe.

I think this example is related to the sunk cost fallacy.

In sales: “Throwing a low-ball”

Baiting clients to psychologically commit to buying something by showing them a very good price and after having spent time on filling in documents (e.g. for a car), moving the price up again to the market price after telling them you “made a mistake”.

I experienced this tactic when booking a flight ticket:

1) SkyScanner showed me the cheapest re-seller and I bought my ticket there

2) The website calls me later on to tell me they made a mistake and the price is actually [market price]

I intuitively got that I was the patsy here and it didn’t work on me as I took it as an insult “do they think I’m stupid?”. However, I can perfectly understand that many people will just comply with these dishonest practices, having already decided and invested the time.

Another experience I had is a smart combination of both reciprocity and commitment. When I was in China I wanted to check out a digital camera in a store. After I asked to see it the lady disappeared to go look for it for a long long time. Meanwhile, the other salesman told me I could take a seat. Two things occurred:

– I felt committed to buying now as I already spent considerable time waiting just to get the camera (~sunk cost fallacy)

– I felt indebted to the salesperson as she had gone through considerable pain to get me the camera (or not)

In this case, I actually fell for it.

Chapter 3 –  Social Proof

Man is a social animal. One shortcut to know if a product is good (or a behavior is moral) is to check if it is popular with others. Examples:

  1. Bar men prefilling tip jars with high denomination bills.
  2. Discos creating artificially long waiting lines outsides

Social proof works best when

  1. the environment in which we have to make a decision has a lot of ambiguity and/or uncertainty (the day that 900 US cult members committed suicide in the ’70s, which accounted for the highest non-war US death count after 9/11, happened in an unusual environment, i.e. Guyana, far from home. This made them more susceptable to the manipulations of their leader)
  2. the people that we observe are very similar to us

The case of Cathy Genovese (Wikipedia), “pluralistic ignorance”:

  1. people’s sense of personal responsibility is reduced in a large crowd
  2. more importantly, if nobody helps a person in need, it will create a confusing but very strong social proof that nothing serious must be going on because otherwise somebody would have already stepped in. 

Chapter 4 – Liking

People will buy faster from people that they like. Likability factors:

  1. similarity
  2. physical attractiveness (through the halo effect) – surprisingly strong evidence is given in the book
  3. compliments
  4. contact & cooperation (a sense of liking will develop with people you cooperate, not compete with, on a frequent basis. For a salesman: create a common enemy to create a cooperation environment with the client, e.g. your boss that disapproves the favorable conditions to clients you will have to sell to him. Another example is the good cop bad cop technique)
  5. conditioning and association (“don’t shoot the messenger”, alas, people actually do shoot the messenger.
    1. Example: advertisers trying to tie good experiences or beautiful celebrities with their products, e.g. Coke: from a rational point of view it does not make any sense.
    2. Another example is people with low self-esteem trying to associate with a winning football team we won” while in the other case saying “they lost”, or groupies. Here it is about inflating the ties to successful people.
    3. Another technique is inflating the success of people you are associated with, e.g. the “stage mother”)

Chapter 5 – Authority

This chapter discusses the Milgram Electric Shock experiments. It was insightful to read about all the variants that were tested. Bottom-line: people did not carry on giving subjects electric shocks because of sadism or apathy. When the elements of authority were taken away (e.g. two experiment professors commanding conflicting things: go on/ stop), the person giving the electric shocks usually stopped.

 

Authority cues:

  1. fancy titles: senior vice president (makes clients feel treated by important people)
  2. clothes: many experiments show that strangers will listen more to absurd commands from men in suits
  3. trappings like jewelry and cars

Chapter 6 – Scarcity

People will value things more if they are limited in numbers or time. Swindlers and companies alike will often use this element. When you add the element that the information about a product becoming scarce is itself scarce (i.e. nobody except your dear client knows that beef will not be available next week in the supermarket), people will overreact the most.

Another finding is that a product in scarcity is valued most if it was previously more available (as opposed to having always been scarce). We hate losing freedom of extra choices. This is how revolutions start: middle-class that had something that is taken away. Examples: American black uprising in the ’60s, the downfall of the Soviet empire after taking away the rights that Gorbachev had given the people.

When it comes to freedoms, it is more dangerous to have given for a while than never to have given at all.

One application to raising kids is to be consistent about enforcing discipline: by not being consistent, one will have to take away a freedom that was granted for a few times because of inconsistency, this will create rebellious kids.

Lastly, if the cause of scarcity is competition demand, the effect is much larger (this throws in social proof to compound into a lollapalooza effect).

Examples

  1. open auctions: one product being bid by many people instantaneously (scarcity in number and time plus social proof). Organizing an open house and working through potential buyers consecutively, creating a pecking order “this gentleman was first”, can do this. Corporate bidding wars are another example.
  2. censoring of certain pieces of information creates huge amounts of attention to those bits of information (Taleb’s assertion that authors are antifragile with respect to their reputation, the more variation the better, bad or good)
  3. Romeo-and-Juliet effect in romances

Epilogue

The author makes a very good case that modern society creates more not less shortcut behavior. Indeed, the pace of modern society increases and so does the need for decision making with limited time, and hence limited information (gathering information consumes time).

This reminds me of the words of the man that coined the term Bounded Rationality:

“What information consumes is rather obvious: it consumes the attention of its recipients. Hence a wealth of information creates a poverty of attention, and a need to allocate that attention efficiently among the overabundance of information sources that might consume it. ” – Herbert Simon

In general the shortcuts or heuristics discussed serve us very well. The only problem is that the increasingly widespread knowledge of them is used by companies and swindlers to manipulate us.

Applications in investing

 

Social proof: the more people think an idea is correct, the more we will deem it correct.

This mental shortcut is especially dangerous in investing. When consensus is the highest in investing, this usually means an asset is already overpriced in the direction of that consensus. Therefore, using this mental shortcut is extra dangerous.

Reciprocity

Can’t seem to relate to this factor in investing.

Commitment & Consistency

This is an easy one. People will start thinking differently about a stock once they own it. Only one example is to anchor decision making on the historical cost of buying. The stock does not care at which price you bought however. Another example is to actively look for reasons why you bought and didn’t sell yet, actively enabling confirmation bias.

This is a very strong feeling to resist. Belief me, I try it every day. For those who don’t know this feeling, I highly recommend owning some stocks to learn.

Social proof

Do any of Cialdini’s key findings ring a bell in investing?

Social proof works best when:

  1. performed by people most similar to you
  2. uncertainty is high

My answer is a resounding yes:

  1. if value investing friends like an idea I automatically regard it more worthwhile to look at
  2. when do speculators herd most? When economic uncertainty and volatility reaches peaks: in a stock market crash. Consensus is peaking very comfortably to the bearish side in this case in sentiment surveys.

Liking

“Falling in love with a stock” after it made you a lot of money arises perhaps because of several factors of likability:

  • “compliments”: it compliments your own intelligence by confirming your investment success
  • conditioning and association: you associate positive feelings with this stock
  • contact & cooperation: you’ve been involved for a long time and know the company, this makes you like the company more

Authority

If a great investor states something, I usually feel more need to belief what he says and “learn” from what is said, instead of critically evaluating it.

Scarcity

A stock tip’s value is limited in time, this already creates scarcity of time. Additionally, pump-and-dump operators and the like (see Wolf of Wall Street for example) will try to make it feel that the information itself is highly exclusive/scarce. Double whammy scarcity!

Any other examples in investing are welcomed.

Comments are very much appreciated.

Note: I just realized I read this book because of social proof and authority, just read the first sentence to verify. Click, whirr indeed.

Best

TC

© 2021 Pembridgecap

Theme by Anders NorenUp ↑