How a bias can influence a fair evaluation?

As a professional of valuations I try to stick to hard figures and fair assessments however it does not mean the bias is not in. Whenever we analyze data, they tend to be considered as truth because the numbers should actually reflect it but the way the actual prices are built does not prevent them from being the result of a bias. Sometimes the collective prejudice turns the bias into an actual market situation and it what we are going to identify today.

The bias from the guru

Somebody who happens to be good at predicting few events or trends might then become a reference. It is all the more plausible whenever the people have little time or little will for minding thoroughly about it. The stock market is very impressive about it: big movements of money can be triggered by a single advice. This advice is often based on an analysis that takes often many parameters into account but the weight of each one could simply be not well pondered. This is very difficult to find out and only few people dare challenge the professional findings. It would mean that you have to know better than the recognized expert.

The example of the subprime crisis is outstanding: the elaborated scheme looked to work very well until we found out it was based on financial assets completely disconnected from their intrinsic value that was supposed to be backed by low risk mortgage loans. As a matter of facts, nobody really checked the basics that were about overvalued real estate from a very permissive credit policy and the end result was the major financial crisis we all know. Still the situation before this crisis was that many major financial institutions considered these junk bonds as very safe and valuable assets.

Nowadays we think it has all been fixed because the assets have been finally disposed but it was at the expense of the poor people who then became homeless.  It had hurt some financial institutions but others even achieved a comfortable profit while liquidating the packages. Afterward, it is easy to claim we should have seen it coming but the apparent complexity of the financial products keeps the majority of us unable to understand what they are about.

The importance of understanding what makes the value

The financial assets are actually the dematerialization of more tangible things that I classify in two categories:

1. The loan based on the capacity of the borrower to reimburse and the quality of its collateral. Here we find the bonds, the short term loans, the letters of credit, …

2. The shares of a company which value is determined by its ability to return enough profit on the long term and the value of its assets: they are often proposed by the banks in larger baskets

Finally, the banks usually propose to have them both mixed in larger baskets in which you'll have hard time to know exactly what is in because they are in permanent movement with arbitrages from the traders. In the case of the subprime, it was about poor quality mortgage loans that were transformed into financial vehicles and were over-traded until everybody lost track of what they were really about because mortgage did not match with poor quality in the mind of the traders / gurus. Looking at how the financial assets move around the world and at which speed they do, I am not convinced all the transactions are based on fundamental judgment but rather on the short-term profit perspective.

In the case of equipment financing, the machines look easy to identify but from my own experience, most of the knowledgeable financing companies just use a basic formula for evaluating the assets whereas the actual market gives a very different number.

How to be more accurate?

Refuse the simplistic but simply remain focused on the basics. As I wrote in my previous article, even good professional believe an equipment value along the time is a decreasing percentage of its original price but many other factors play a significant role regarding the actual value. The simple but not simplistic approach I suggest is about identifying the major relevant factors influencing the supply and demand balance for each single asset. It is time consuming and requires a lot of investigation by trained people: that is why it is so often neglected and left to the magic formula.

For each machine it is about its age but also its hours (miles for vehicles), the condition, the job it has done: not the same when a machine worked in a steel mill than when moving gently some earth, the economic situation in the sector the machine will be reused, the volumes available on the market.

Each parameter does not need to be exactly measured but at least some knowledge about them makes the difference. Last but  not the least, the collective prejudice must be considered: it is the case for the undue bad reputation of a brand or of the "made in" label.

Another bias is about the trust in the "magic depreciation formula" that although not accurate can be considered in the pricing.

It happens frequently whenever a customer is happy with a value that is just higher than the book value. The leasing companies too often stick to this and jeopardize substantial profits when remarketing their repossessed assets.

Both the wide view and the strong scope are necessary.