When overconfidence backfires

Andrew Robbens, client portfolio manager, uses the example of two companies in the same sector to look at the impact an overconfident management team can have on a company.

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Nov 13, 2017
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Making investment decisions on the basis of fickle emotions—rather than cold, hard fact—has always been a risky business. In this article, we take a look at overconfidence and an example of how it has had a direct impact on the share prices of two companies in the same sector.

Overconfidence

The overconfidence effect, where individuals have excessively rosy perceptions of their own abilities, has been described as “perhaps the most robust finding in the psychology of judgement.”[1] Individuals tend to be overconfident in their abilities across a wide range of fields.[2] Perhaps the most celebrated of these findings is Svenson’s (1981) observation that 93% of American drivers believe they are better than average.

Company management teams can often demonstrate overconfidence and lead to overestimating their ability and performance. This can lead to bias towards best-case scenarios for any decision they make, whether this relates to a change in direction for their business or, indeed, to guidance they give to investors.

The perils of overconfidence

“Athleisurewear”, the trend for people to wear sports shoes purely as a fashion statement, provides a striking demonstration of what can happen when companies let overconfidence divert their focus away from product quality. Rival UK sports retailers JD Sports and Sports Direct that should both have been well positioned to benefit from the athleisurewear trend. JD Sports—the self-proclaimed “king of trainers” —realised that both the supplier and the consumer were critical to maximising the potential of this trend.

Targeting the supplier, they revamped their stores to showcase the products to maximum effect and kept premium pricing levels. In return, suppliers like Nike and Adidas gave JD Sports their new-release trainers: this created a virtuous circle by attracting consumers into the store to buy the trainers at full price and keeping the suppliers happy in the process. This has created a situation where consumers are prepared to camp overnight outside stores to ensure that they are the first to own a new style of trainers. Indeed, this year, there were reports of teenagers in Dublin queuing for three days outside a JD Sports store to be the first to buy a new style of trainer.

Now let’s take a look at Sports Direct. Newsflow for this company and its management team has not been entirely favourable over the last couple of years to say the least. In 2016, the company suffered negative press relating to employment conditions and then, this year, boss Mike Ashley found himself facing a court case, which he won, but the press coverage that came with the case has nevertheless been damaging.

Sports Direct opted for a different approach to JD Sports. Once the largest sports retailer in the UK, the company believed it was bigger than its suppliers and could therefore do without them. The company used the heavyweight brand appeal of Nike shoes to drive footfall into its stores, but positioned them right next to Dunlop shoes—its own brand—which it then sold to customers at a 50% discount. Nike, unwilling to have its prices undercut by an own-brand shoe, responded unequivocally by simply cutting off Sports Direct.

In the end, Sports Direct had comprehensively alienated both its suppliers and its consumers. As a result, customers switched allegiance to JD Sports, driving a dramatic downward spiral in the share price of Sports Direct that has seen the company significantly underperform its competitor since 2014.

At J.P. Morgan Asset Management, we believe these behavioural biases, such as overconfidence, create anomalies in the market. Our European Equity Behavioural Finance Team has developed a disciplined investment process which aims to objectively select stocks and manage risks while seeking to avoiding the same emotional biases that we try to  exploit.

The JPM UK Equity Core Fund

Specially designed to capitalise on the market inefficiencies created by behavioural bias, our UK Equity Core Fund is built on a proprietary, bottom-up investment approach.

Find out more about the JPM UK Equity Core Fund here


[1] DeBondt and Thaler (1995).

[2] Psychologists (Oskamp, 1965), physicians and nurses (Christensen-Szalanski and Bushyhead, 1981), entrepreneurs (Cooper, Woo and Dunkelberg, 1988), managers (Russo and Schoemaker, 1992) and, alas, market professionals (Ahlers and Lakonishok, 1983).  

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Go to the profile of Andrew Robbens

Andrew Robbens

Client Portfolio Manager, UK Equity Group, J.P. Morgan Asset Management

Andrew Robbens is a client portfolio manager within the J.P. Morgan Asset Management UK Equity Group.

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