You Say Valeant Pharmaceuticals Share Is Still Worth US$200? – Anchoring

How to recognize anchoring

What would be the reason for someone to think that a Valeant Pharmaceuticals share is still worth US$200? There may be many reasons for sure, but one of them is bound to be that the investor first bought the share at US$200 and, therefore, has anchored themselves to that price as the share’s value.

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What is anchoring?

Anchoring is when we fixate on past information and then base our future investment decisions on this. One way is to anchor to the price you originally bought a stock for, but another is to anchor to the price target you expect it to achieve and then stick to your anchor even when new information suggests you should do otherwise.

Why is anchoring a problem?

Let’s say you bought Valeant Pharmaceuticals share at US$200 in April 2015, but then the price-hike scandal hit. Despite this turn of events, you bought it at $200 so your anchor remained that the stock cannot be worth less than this. But by the end of 2015, the share price was about half your buying price, and you would have lost 50% on your investment (plus even more if you had still kept it till today).

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The world around us changes, and so do the fundamentals of the companies you invest in; as there are a variety of influences that can affect share price. Sticking to your anchor doesn’t make rational sense, as most of the time your anchor might not even have been set by rational principles. Yet, even if it was rationally set, as things change so should your estimated value.

How to deal with anchoring

Research has not really reached a consensus about who is more or less prone to be affected by anchoring. Some studies have found that experts or people with better cognitive abilities are less affected by anchoring. Others have shown that even court judges are affected by anchoring when they sentence people. One thing most studies have in common though, is that everyone seems to be affected by anchoring at least to some extent.

As with many of our cognitive flaws, awareness is the best medicine. Just by being aware of your anchor and acknowledging that it can become irrelevant due to new information, should you be able to deal with this bias. And when it comes to stocks, if you should anchor to something, anchor to value, not price.

Read more books of the Behavioral Bias Bible

Article by Alexander Wetterling, Become a Better Investor

About the Author

Dr. Andrew Stotz, CFA
Dr. Andrew Stotz, CFA is the CEO of A. Stotz Investment Research, a company providing institutional investors with ready-to- invest portfolios in Asia that aim to beat the benchmark through superior stock selection. The company also provides buy- and sell-side clients with financial models to value any company in the world and World Class Benchmarking to determine what companies are financially world class. Previously, as Head of Research at CLSA, Andrew was voted No. 1 Analyst in Thailand in the Asiamoney Brokers Polls for 2008 and 2009. He was also voted No. 1 Analyst in Thailand in the 2009 Institutional Investor magazine All-Asia Research Team Report. Andrew earned his PhD in finance at the University of Science and Technology of China in Anhui province, with a focus on answering questions raised by fund managers and analysts during his career about picking stocks and managing portfolios. In addition, Andrew has been a lecturer in finance for 22 years at various universities in Thailand. Since 2013, he has been the president of the CFA Society of Thailand. He is also the author of How to Start Building Your Wealth Investing in the Stock Market.