The Hidden Forces Behind Every Investment Decision

0:02We want something about the story we are telling ourselves or the analysts or the market are telling us about it to be true. We want it to be true and that will guide our view, our outlook on the company over the long term. Sometimes that story will overwhelm what we see or observe in the data. So like the number one. in life, feelings and facts are both very important. But a feeling is not a fact.

0:42That was Harvard-trained behavioral scientist Julia Darr, author of How Change Really Works. I'm Motley Fool analyst Rachel Warren. Julia joined me to dig into what decades of behavioral research can teach us about picking better stocks, why the stories we tell ourselves about companies can be more dangerous than bad data, and how to read a leadership team's body language from the outside. We hope you enjoy. I'm Motley Fool analyst Rachel Warren, and today I'm excited to welcome Julia Dahr to the show. Julia is a Harvard-trained behavioral scientist and managing director at Boston Consulting Group, where she founded and leads the group's behavioral science lab.

1:19She has spent more than a decade applying experimental behavioral science, drawing from psychology, economics, and neuroscience to large-scale organizational change. She's advising CEOs and leadership teams across a wide range of industries and countries. Her TED Talks on productive disagreement and constructive conversations have been viewed more than eight and a half million times on the web. She's a Forbes columnist who's written for the Financial Times and Harvard Business Review. She's also co-author of the new book, How Change Really Works, arguing that the most important component to change that sticks is behavioral science.

1:55Julia, welcome to the show. Thank you for having me, Rachel. So excited to talk with you today. And one of the things that's so, I think, fascinating about the space you work in, it's obviously applicable to so many different areas of life, but particularly as well to the world of investing, right? And many investors look for an edge in data, but I don't think that we often look for it in human behavior. You've worked for over a decade at the intersection of neuroscience and economics. So maybe just to start off today, but what is behavioral bias and how and why is behavioral science maybe a more reliable indicator of a company's future than just traditional metrics?

2:34So behavioral science focuses on basically why do people do what they do and what are effective strategies and tactics for changing behavior in predictable directions. There could be my own behavior. How do I adopt new habits? It could be the behavior of a group, for example. How do we get consistently better quality decisions, for example, from an investment team or from a fund manager? It could be all the way at a whole of society level. How do we get better cooperation in our communities and that kind of thing? One of the reasons why this combined body of psychology, economics, neuroscience, marketing is so important is human beings sometimes find it difficult to do all of the things that we hoped to do, that all the things that would make us the best version of ourselves, We find it hard to follow through on the things that we committed to do or that we want to do.

3:36And the other reason, especially for economists, that this whole body of research is so interesting, is so important, is that for a long time, we assumed, that is economists assumed, that human beings were rational, utility maximizing. It would say we're able to take in all of the information that was presented to us and make a really good quality decision as a result. That's the whole basis of rational market economics. And that turns out not to be true and is now very well established not to be a comprehensive explanation of human behavior. And the thing that I love is an awful lot of what we talk about as behavioral biases actually reveal really delightful things about human beings.

4:28They show that we are much more generous, patient, kinder, altruistic than rationality would expect. Of course, it also reveals that sometimes we are more impulsive, less deliberate, more self-focused than would also be ideal for us. And so the whole mission of people like myself trying to bring behavioral science into the real world is actually to make it useful for people to say, you have a set of goals and you have a set of visions for your life. You have a set of expectations for your team. How do we make it more predictable, more likely that those can be a reality? Well, and I think it's a really interesting definition as well of just how it works.

5:18And I think it's important for our audience to understand. But how can we leverage behavioral science to when we're looking at a company's growth story, we're trying to see whether that is perhaps a good investment for our portfolio, a business we follow. How can we leverage some of these elements of behavioral science to maybe see what is a better indicator of a company's future growth story than, say, just, you know, financial metrics? Or are there very common behavioral biases that adversely or positively impact investing decisions that we should know of? Let's talk first about our own behavior.

5:52It's delightful to try and change other people, but perhaps the most predictable person that we can change is ourself. I know it's much more annoying to try and change yourself. But you've got to work with where you are. And so the reason I say that is let's talk first about our own behavior, but then also about the behavior inside companies and organizations. So there are two really big challenges or opportunities that we have in our own investing behavior. And one is a tendency that we have when we have a belief or an expectation or a hope in our mind, which, let's be honest, very often is how we start out making an individual investment choice or to continue to buy or sell an individual stock.

6:43We want something about the story we are telling ourselves or the analysts or the market are telling us about it to be true. We want it to be true. And that will guide our view, our outlook on the company over the long term. Sometimes that story will overwhelm what we see or observe in the data. So the number one lesson is to say, in life, feelings and facts are both very important. But a feeling is not a fact. And being able to untangle the difference between a feeling that I have, something that I hope is true, and facts that are being placed in front of me, is perhaps the most valuable skill any of us could learn in all of investing.

7:32The second, of course, which I imagine that your investors already spend a good amount of time thinking about is just to be patient. There are enormous returns on patience in a lot of life, but surely in investing as well. And so being able to be a good enough judge of whether you're investing over the appropriate time horizon for you, but also for the company. I try to say to myself, we are always in the middle of the story. Even if today is your first day as an investor, no matter what, we are always in the middle of the story. Now, for companies, I think it's completely different. One of the things that we know for sure now, we now have 50 years of data, is that the return on transformation or big change efforts inside companies are actually pretty disappointing.

8:30Really consistently, those efforts where an organization says we're undertaking a really large transformation, sometimes it could be something like a merger or an integration of another company, unsuccessful much more often than they're successful. They fail about 60 to 75 % of the time. The improvement, the rate of improvement on that is not really changing over the last 50 years, even though we know more and more about how to effectively run a company. Why is that? because companies, leadership teams, investor communities are composed of humans and getting people to do a big thing together is difficult.

9:20However, and this is why I think it is so important for people who follow a stock, who are investors and companies to pay attention to this human element. It's not that no change efforts ever succeed. Plenty of them do succeed and it's not random. One of the things that we, through a really significant body of research on company transformations and on human behavior itself, find is that the companies that consistently pay attention to the ways in which the behavior inside the organization needs to change and makes it easy to do the things that they have announced that they are going to do are much more likely to be successful.

10:04And so, of course, we should pay attention to what companies say, their stated plans and intentions and strategies. And we should pay at least as much attention to what they do, what the follow through on that quarter over quarter is.

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11:37So given all that you've said about really the success and failure rates of organizational change, and when you're looking at a business, is there change readiness or adaptability, if you will? Is that a positive predictor of their growth story? Is that something that can actually be a bit of a detractor from the growth story overall? It's clearly true that there are moments where a company or an individual leadership team is better or worse at changing. I think the number one thing, and this is, of course, much easier to see if you're inside a company, if you're spending a lot of time with the leadership team.

12:16But I think you can discern it from the outside as well, is does the leadership team, the CEO and the board, are they expressing true agreement on what the future direction of the company is? Or do we have false alignment? And so let me give you a really small illustration of this in our own life. Have you ever been in a meeting and where towards the end of a meeting someone very senior says, well, okay, are we all aligned? And the sort of a long-ish pause, it seems pretty clear that the only answer is to say yes, even though there's clearly an undercurrent of many questions left. That's false alignment.

13:06where we might even have a rough view of the direction, but it is not at all apparent that people inside the room have said, I know why we need to change. What are the economic and more competitive forces requiring us to change? I know what exactly we are going to do beyond, for example, saying we will have an AI transformation. that's not a very good example of being specific about what type of change we have. And equally importantly, how we are going to change. What exactly people who work here in this company, the suppliers who serve us, the customers that we reach, how we expect their behavior to change.

13:50And so you can test that fairly well inside a company just by asking people what they think has been agreed to and checking if that is the same thing. I think you can also discern it from the outside. How clear is the strategy when different members of the leadership team speak about their strategy and intentions? Do they speak about them in approximately the same way? They use the same choices of words? Do they explain the reasoning behind the decision in roughly the same way? and equally importantly, and I think it would be wonderful if as an investor community, as an analyst community, when we have the opportunity to ask questions and get clarifications from leadership teams, we spend a good amount of time pressing people on the how of their announcements.

14:37How exactly will we make this shift? How will we know if you have been successful? And continuing to follow up on that over a period of time. So it's not just that we get the early enthusiasm around an announcement, but we actually see whether that success yielded specific results. Yeah, that really leads well into my next question, I think, Abita. Every CEO claims the company is innovating, right? But sort of as you've highlighted, some fail to deliver. So when you're looking at that through a behavioral lens, are there ways that investors can sort of spot the gap between a flashy press release, so to speak, an actual innovation?

15:19One right at the outset is getting and hearing from companies, from leadership teams, what's the story underlying that innovation is or that stated innovation is incredibly important. So we argue that there are three basic types of stories of change in an organization. So there is a threat story, like we must change or we will die. There is a fitness story. So we, as a company, have perhaps gotten a little bit loose in our processes, perhaps a little bit undisciplined in our capital planning, a little bit overconfident about how much customers or the market love us and we need to continuously, consistently develop a better set of habits in order to return profitability or increase profitability and to be worthy of investor trust.

16:24First threat, then fitness. And the third is destiny. By making a set of choices and changes, we can become who this company was always meant to be, what we were always supposed to be creating together, really achieve our purpose. Now, there are two dilemmas that happen inside leadership teams. One is trying to put all of those threat, fitness, and destiny all together into a single story and say, well, it's a bit of this and it's a bit of that. And also it's a little bit of destiny. What that leads to is a really muddled and confusing explanation. But it might also be a sign that the strategy is not very clear.

17:05The second one, and this is very natural behavior for human beings, turns out to be pretty natural behavior for organizations as well. And so as I describe those three types of stories, threat, fitness, and destiny, it's possible, Rachel, that in your mind you said destiny sounds nice. Like that feels like the best of the stories. That's very glamorous. So much of the change that we are trying to make in organizations is not about utterly fulfilling our destiny. It's about fitness and getting consistently better and better at the things that we do every day. And that's just not as exciting as being able to talk about achieving our destiny, but is incredibly useful in terms of actually creating a return on our effort to change.

17:56So that's the very first thing we can do is say, is the story of underlying that innovation clear? Why are you trying to innovate? Is it directly in response to a threat, either competitive or existential or disruptive technology? Is it fitness? Are you basically doing continuous improvement in order to maintain the discipline of the organization? Or are you trying to either find your way back to who you were always meant to be or to stretch yourself further and further into a new horizon for the company? If that's even a little bit ambiguous, if it's hard to classify what you're hearing into one of those, I think that's a really good sign to dig a bit deeper.

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19:59Now available in Canada too. That's quince.com slash motley for free shipping and 365-day returns. quints.com slash motley study and play come together on a windows 11 pc and for a limited time college students get the best of both worlds get the unreal college deal everything you need to study and play with select windows 11 pcs eligible students get a year of microsoft 365 premium and a year of xbox game pass ultimate with a custom color xbox wireless controller Learn more at windows.com slash student offer. While supplies last, ends June 30th. Terms at aka.ms slash college pc. The other thing we've talked about in this conversation is this idea of, you know, founders being and leaders of companies being such a strong and integral part of the business and the growth story over the long run.

20:53And, you know, here at The Motley Fool, we love founder-led companies as well. I mean, many investors sort of bet on a founder's instinct as a primary reason to buy. There's many examples of public companies where that's the case. But I'm curious, you know, through a behavioral science lens, is there an advantage with a founder-led company? Or is it possible that it can actually stifle innovation? What are your thoughts on that? It could be both. One of the things we know about founders, it's actually true of executives overall, by the way, is they have a very high appetite to change and a very high enthusiasm for change.

21:32It is often what leads someone to found a business in the first place, that they are frustrated with the way the world looks right now and want to do something about it. Um, you kindly said at the beginning that we just finished writing this book about how change really works, which is called How Change Really Works. And the primary motivation to write it at the beginning was to answer that question. Um, is it true that most people just don't like to change? Do people just hate to change? And then there's something really unusual about founders or very senior leaders that they love to change. And the thing that we discovered was, indeed, founders and very senior executives, generally speaking, do like to change.

22:15If you ask them about any type of change, about 70 % of them say, I feel positive or very positive about that. About 45 % of employees, individual contributors, line managers in a large organization feel the same. So there's clearly some amount of distance between a senior leader, a founder, and everybody else in an organization in terms of how much energy and appetite they have for change. And I think that change distance is actually the danger zone. And it doesn't really matter whether it is a founder-led company or you are on your second or third or tenth post-founder CEO. it is were we able to appreciate that that change distance existed you don't have to accept it as a founder you can continue to raise people's expectations and increase their capacity for change but you have to agree that it exists and continue to find productive ways to close in because otherwise then we do hear and there are plenty of stories out there of situations where the vision of the founder and the capacity of the company to execute ran away from one another.

23:31And so what should have been a kind of extraordinary story of unlocked growth and potential ended up being disappointing. Well, and that leads me to my final question as we draw to the close of our time together today. You know, as long term investors, you know, we're looking at businesses five years, 10 years or longer that we're looking to hold in our portfolio. How can we identify both behavioral blind spots as it applies to our investing as well as sort of leverage maybe a couple principles of behavioral science to drive our investment strategies as long-term retail holders? Especially in organizations that have really large workforces, so you might have tens or hundreds of thousands of employees.

24:17When listening, for example, to the quarterly earnings calls or annual general meetings, do company executives, leaders of the board, speak about employees of the company with the same interest, compassion, curiosity, specificity that we talk about the customers of that same company? We know so much, we have so much richness, often so much empathy for customers and what are their issues getting through a funnel? What are the ways in which our product offering might be too complex for them? And surprisingly, we often don't pay that same amount of care and attention to employees who we know even better, by the way, often times.

25:07So that's one that I think can be really meaningful because it is hard to replicate that quickly. It's deep in the cultural DNA of the company. The second one is where you see evidence that company leadership is not only willing to change strategy, but are open, honest, specific about the ways in which they themselves have changed or the ways in which they operate and steer the company is different in response to changing circumstances. So it's not just that they have been able to change their mind about something in response to a changing set of facts, but are flexible enough to be able to change their behavior.

25:56If we don't have leadership teams who are able and willing to talk about the ways in which they have changed their behavior, it's not a great sign that we should have confidence that they could change the behavior of others or even maybe that they care very much to do so. I think so many incredible, valuable takeaways from today's conversation for investors. I'm so glad we got to chat, Julia. Thank you so much for joining me. And for our viewers and listeners, check out her new book as well, How Change Really Works. Thank you so much, Julia. Thank you for having me. As always, people on the program may have interests in the stock they talk about.

26:33and The Motley Fool may have formal recommendations for or against. So don't buy or sell stocks based solely on what you hear. All personal finance content follows Motley Fool editorial standards and is not approved by advertisers. Advertisements are sponsored content and provided for informational purposes only. To see our full advertising disclosure, please check out our show notes. For The Motley Fool Hidden Gems Investing Team podcast, I'm Rachel Warren. Thanks for listening. We'll see you next time.

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