Categorization bias

I happen to come across this post about where in the world is Michael Burry on a blog inspired by Michael Burry’s value investing techniques.

One paragraph that caught my attention was about Categorization bias/Categorization bias. For example, as people tend towards stereotyping a lot. We tend think all South Indians wear lungis and eat curd rice, all gujjus are stingy and eat a lot of sweet, and all bongs  eat fish.

It may be true for a majority of people, but some people in that group do buck the trend. Stocks are similar, there will be stocks which are different than the rest of the group in some way, but in frenzy these differences tend to get ignored. Value Investing is not just about trying to find stocks that are selling cheap, but as investor you should be able to answer why is the market pricing it so low? Has the market done a mistake(example: classification bias)?

Here is a transcript of the paragraph:

Categorization Bias: People tend to put different things in different “baskets” and from time to time they put the wrong things in the wrong baskets. For example, if two groups are polled to give average temperatures over the past century for group 1: March 1 and March 11 and group 2: March 25 and April 5, the first group will give pretty similar answers for March 1 and 11, after all there’s just a 10 day difference between the two. But what is interesting is that the second group will give very different answers for March 25 and April 5, the latter date several degrees higher than the first. The reason is people link the idea of “April” to “Spring” and put it in that category. While “March” is still “Winter”. Silly, I know, but this happens all the time in the stock markets as well: Macquarie Group, and Australian bank lost almost 90% of its market capitalization during the crisis. Going from ~3x book value to ~0.6x book value just because it was an “investment bank”. Truth is, Macquarie was a very unusual investment bank with very limited exposure to mortgage-backed securities or eroding asset prices because it did not have any in its balance sheet (or any off-balance sheet hidden exposures for that matter). Well, not Macquarie is back up and outperformed Goldman Sachs, JP Morgan and all relevant financial industry indices during the past year. Check it here