Pearson: Three Lessons In Behavioural Finance

16th Dec '22 by Megan Boxall

10 comments 1133 reads

I have written before about my strong dislike of Pearson (LON: PSON) the international textbook company and former owner of my old employer, the Financial Times. My dislike isn’t unfounded. Under the leadership of John Fallon (2013 to 2020), the company sold off its most profitable assets, leaving it with an education business which was unprepared for a digital world. That poor management resulted in a series of increasingly depressing financial results and moribund returns for investors.

I must admit that my inherent bias has, on occasion, been a source of pride. Between 2015 (when I started at the FT and joined the army of anti-Pearson journalists) and 2020 (when I left), the company’s share price fell 68%.

But this year, that bias has proved rather unfortunate. In 2022, Pearson has been the top performing stock in the FTSE 100, its share price is up 56%.

I am not alone in ruing a missed opportunity. Most people I know who have ever worked for a Pearson company (or former Pearson company) dislike the stock. As do many of the members of the teachers union, who like to disrupt Pearson AGMs with questions about price inflation and poor quality text books. And spare a thought for famed fund manager Nick Train who called time on is 18-year holding in April this year.

So why have so many of us got it wrong this year? The answer provides an interesting lesson in behavioural finance.

Lesson One: Confirmation Bias

Confirmation bias is a human tendency to seek out information which supports your belief and ignore information which contradicts it.

This can be explained by the following example of a Wasson Selection Test:

The correct answer to the question B) To test the rule you should turn over cards A and 7. Turning over A will help you confirm the rule, turning over 7 will allow you to disconfirm it if necessary (i.e. If a vowel is appears on the other side of the card, we will know that the rule is incorrect).

Did you select A and 4? If you did, you’re not alone. Psychologists have used iterations of this test since it was first constructed in 1966 and more than three quarters of respondents get it wrong. Human inherent bias is to seek out information that confirms what they already know (or think they know)…

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Silver Moon

16th Dec '22

Hi Megan, this week I have been digging deep into my methods in investing. They leave a lot to be desired and your article I just read is inspiring. Only yesterday I made this footnote to my delving:

Mostly every instance of investing that caused me to rue my buying has been “just because you bought them at the wrong time”.

My own system one is impetuous, My Plan A has been to re-invest dividends as they come in. I determine that my New Year's Resolution (Plan B) will be to save the dividends up and give system two a fighting chance.

Happy Christmas,

William

anthonyburns1979

Very insightful and thought-provoking article, thanks for sharing, Megan.

In your defence - how much value in the business has been destroyed over eighteen years for a (relatively) small increase in the share price in this one year and is it this outperformance sustainable anyway?

I know nothing about Pearson as this is not a share that I've ever been interested in thoroughly researching or adding to my portfolio, but just putting that thought out there.

Ant

Rusty2

"In February this year Pearson had a StockRank of 86 and a share price of 640p. If I had added it to my portfolio then, I’d have made a 43% return on my investment this year, not including dividends."

Yes Pearson has done well. I did a NAPS in January, which are the top 20 VM and QM stocks in each sector. It has performed poorly this year, down around 18%, some stocks are down around 50% or more. Pearson was not selected.

So just using the stockranks is no guarantee it will outperform, many on NAPs have done poorly. 6/20 have lost 40% or more, only 5/20 are showing a profit.
It is easy to pick the winners with hindsight.

timarr

Well, the article isn't really about that. Clearly Pearson (LON:PSON) was a terrible investment for many years and has been a great investment if you picked it up around the bottom of the Covid crash (it's doubled and thrown off more than 10% in dividends).

The point is that people anchor on past performance and their experience of that past performance rather than looking at the current situation. People only look for the information that confirms their existing beliefs.

We see this all the time on Stockopedia, especially when herding effects trigger groupthink - the Boohoo thread was a classic of its type as investors desperately looked for reasons for the share price fall other than the obvious, that the stock was an overhyped dog led by a team who were more interested in their own enrichment than the returns to shareholders. Anyone who pointed this out was outed as a woke, racist, blinkered socialist (I exaggerate, but all of those were raised as issues at one time or another).

Coming back to Pearson, viewed rationally it was clear that it had a virtual monopoly in academic texts and was suffering from the rollover from physical books to online ones. Students were passing on old copies of physical books, rather than paying the hideous fees for the online content but it was a matter of time before that stopped working. Ultimately it was Covid that did for it. Basic lesson - digitisation of businesses takes far longer than anyone expects.

The lessons here are (1) look for evidence that contradicts your existing beliefs, your brain is wired to do the opposite, (2) don't beat yourself up if the result of your analysis goes wrong, investing is fraught with uncertainty, we can't possibly forsee every outcome every time, (3) when things go wrong - sell first, reflect later. It's surprising how often your view of a stock changes when you no longer hold it.

WarrantStar

Megan,

With respect to the test at the top of the page. The ONLY thing that we were asked to do was to test the rule "If the card has a vowel on one side, then it must have an even number on the other side". The logical answer to the question is A & 4 should be turned over. That would confirm or disprove that the rule applied on those two particular cards.

We were never asked to investigate what might be on the other side of cards showing consonants or or odd numbers. We were also never asked to consider how useful the stated rule might be.

Also it could have been possible that the rule only applies sometimes. Nobody would know for sure that turning card 4 over must result in it having an even number on the other side, just because the rule happened to be correct in an earlier example.

Other possible situations were that the other side of the cards could all be blank or all show pictures of animals! Or that there was never any connection between what is on the front of the cards and what is on the back.

However, I do agree with you that we always be on the look out for information which contradicts our earlier conclusions.

My other conclusion is that we should give a lot of thought to both 1) Whether our testing methodology is correct and 2) Whether our testing methodology is actually any use in sorting the good from the bad.

I expect that some people will consider that I am being rather pedantic. I tend to dislike analogies because I see their short comings.

I did enjoy the rest of your article and have learnt from it. Thank you.

You're being asked to test the rule, not whether there are examples that confirm the rule.

Turning over 4 could reveal a vowel, but that doesn't prove the rule, because the rule only says that if there's a vowel on the other side then the number will be even. It doesn't say that if the number is even there's a vowel on the other side. So if you turn over 4 and there's a consonent then the rule still stands.

If you turn over 7 and there's a vowel you've disproven the rule. If you turn over A and there's an odd number then you've disproven the rule. Cards Q and 4 can provide no useful information relating to the rule.

Of course, it's also the case that there's actually no way of proving the rule from these cards - it's an example of the scientific method, that a hypothesis is only valid until we find disconfirming evidence. Which is the point of the article really.

As it turned out the Wason Selection Test is context specific - place this in a real-world context and people tend to get the answer correct. But the stockmarket is sufficiently abstract that it seems to apply there.

Timarr,

Thank you for a very respectable answer. The original question was very tightly framed. Which cards would we turn over? Whatever answer we give to the question, we would not then have enough information to be sure enough to give a definitive answer to the question If the card has a vowel on one side then must it have an even number on the other side? So thanks to Megan & you, I have now updated my process with a difficult question which is "What information is missing from my analysis? Provide this information and comment on it." I suspect that this question will generally take me too long to properly answer for each company. But I will give it a shot. Thank you to Megan & Timarr for your thought provoking pieces.

17th Dec '22

On further reflection, most people assume that the same rules must apply to every card. But the puzzle does not state that this is the case. So if you turn over number 7 and find a vowel it does not disprove the rule. It could be that a different rule apples to every single card, letter or number. We need to be very careful about our assumptions.

Also, we were only asked to test the rule. Turning over card number 7 does not test the rule, it is testing some other hypothesis which we were not asked to do. People may argue that turning over card 7 has some validity in that it tests the the converse of the rule. But it cannot test the converse of the rule because a different rule could apply to every single card as outlined in the above paragraph.

jimrog64

Really well articulated. I have read Thinking fast and slow several times and recommended the book and the lessons it contains to many people. I still have to work very hard to put those lessons into practice, especially when it comes to investing. A review of my decision making in relation to investments in 2022 illustrates this well. As you suggest it is important to keep searching for evidence that contradicts current beliefs ( and avoid emotional attachment to a share) and then avoid being too hard on yourself when things don’t work out as you hoped.

aflash

In the knowledge that the herd has System 1 'fight or flight' reactions, algorithms are programmed according to support and resistance levels with volume considerations.

The remaining human buyers and sellers have all the biases explained here.

I subscribe to a service that analyses candlestick patterns of indices and individual stocks without any fundamental considerations. The underlying assumption is that the largest markets dictate the direction of the smaller ones.

Pursuing the 'blank paper investing' thesis I then put my Stockopedia choices through the candlestick analysis to avoid preconceived notions. It may be a good company but is it a good time to buy ?

Does it work? Of course......... except when it does not.

I went back to Kahneman's text but our 'apparent inability to acknowledge the full extent of our ignorance' from the preface merely echoes a succinct summary in the article. So then I tried to question Megan's cure limit trading times with my introduction which suggests you should trade according to the general direction of the market.

Does it work? I believe so but obviously I shall have to look for evidence it does not.

With indices in a downtrend PSON is just that. With little value it has gone up all year.

Pearson: Three lessons in behavioural finance

Lesson One: Confirmation Bias

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Megan Boxall

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