8/22/2019 Behav Finance - Aswath Damodaran

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Research in Motion (RIM) on Sept27, 2012, on their quarterly performance declaration claimed that

they suffered a revenue loss of $235 million i.e. by 31%. Despite this performance, the stock rose by

18% since the analysts and the general public expected a much bigger loss from the company and a

mere 31% loss gave them a hope for a better future that the company can perform better in the

subsequent quarters. On the contrary, Apple was coming out of a massive iPhone 5 release with the

first weekend sales of over 5 million units expecting to break all past records. However the free Map

App debacle with false addresses became the bigger news and Apple came under fire for the same,

since people expected every Apple product to be perfect, best in its class. On account of this, Apple

lost $40 billion in market value in two weeks on account of the expectations the people have with

the company.

The above two examples highlight the importance of human expectations in the financial world.

Aswath Damodaran says that expectations are present in all aspects of life and play a major role in

decision making. Sometimes, these expectations may know no bounds and can seem perverse. Since

it is an integral part of human psychology, it cannot be ignored and the expectations game must be

judiciously played and efficiently managed.

Aswath Damodaran suggests that the expectations game is also an integral part of the duty of the

CEO, apart from just the company performance. The CEOs must be adept in talking down

expectations without talking down share prices. He says that there are multiple factors involved in

an expectations game. Firstly, the Analysts. How a company can use the analysts can play a major

role in the companys performance since the analysts play an integral role in guiding investors on the

right choice of stocks. A company must learn to communicate with the investors and skilfully use

analysts as messengers for the company. Secondly, a company must explain the investors about

their quarterly performance and give them honest reasons about the same to build trust towards

the organization. Passing on false information will lead to distrust towards the company and all

future company disclosures will be considered suspect. Thirdly, building credibility by efficiently

moving the expectations, both up and down. If an organization only tries to talk down expectations,

they will lose long term credibility. Lastly, results and their declaration should be efficiently

managed.

On account of this, he suggests some ways which can help investors make money out of the system.

The Investors must have sectoral and company specific knowledge so that they can actively keep

track of the movement of the financial markets. Using forensic accounting skills to identify if the

company is properly disclosing its quarterly results and detect any aberrations to forecast their

future results. He also gives importance in appropriate timing of investments suggesting that the

stocks dont have absolute value, but are relative to the price at which they are traded.

Therefore, it is extremely important to understand the expectations game and account for them

during all investment related activities. Therefore, Aswath Damodaran, looking at the nature of the

expectations game, suggested that companies should simply ignore financial market performance

and focus on long term future of the company.