Let he who is without Science Denial cast the first stone

The Washington Post recently ran an article on how political affiliation and level of religious belief affect support for, or suspicion of, the scientific consensus on various subjects. In it they refer to research by Dale Kahan to argue/imply that opposition to science is primarily driven by conservative ideology.

For example, they have these three very attractive charts, showing that the difference between people of high and low religiosity is small compared to the difference between conservatives and liberals when it comes to global warming,

GlobalWarming

evolution,

.
Evolution

and Stem Cell research:
StemCell

However, as so often happens, their article on causes of political bias ends up displaying some pretty impressive political bias. Unsurprisingly, this bias tends to be flattering towards those who share their political beliefs, and damning of those who don’t.

Firstly, look at those charts again. When looking at on the left-right axis, your eye is naturally drawn to compare the two extremes – to compare the most right wing to the most left wing (especially as the line is monotonic). You note the large difference in height between the leftmost data points and the rightmost, compare it to the relatively small difference between the high and low religiosity lines. The former difference is bigger than the latter difference, so political opinions must be more important than religious ones.

… or so the chart leads us to believe. However, this is hugely deceptive. As you can see, there are 5 tick marks on the horizontal axis, the measure was created from questions using 5 and 7 options, and there are a very large number of little vertical lines. This means they’re using a relatively fine measure of political ideology: they differentiate moderate conservatives from ordinary conservatives from highly conservative people. By doing this, they increase how extreme the extremes are, which increases that vertical difference our eye is naturally drawn to. With religion, however, they only admit of two categories, high and low. Perhaps if they had disambiguated more, so the categories ranged from “More religious than the Hasidim” to “More atheist than Dawkins”, we would have seen more spread between those two lines. As it is, the charts suppress these differences, reducing the apparent effect of religiosity.

That’s not the only problem with the article. The climate change and evolution questions seem pretty good, but the stem cell question does not show what they think it does.

“All in all, do you favor or oppose federal funding for embryonic stem cell research”

Now, in general opposing research for science does seem like prima facie evidence that you’re in some sense anti-science. But not here! There are two other factors at play which conflate the issue.

The first is that this is as much a moral issue as a scientific one. Thinking that stem cell research is immoral doesn’t necessarily mean you disagree with any of the scientific findings, due to the is-ought gap. In the same way that opposing nazi research on cancer (which used a variety of immoral techniques) doesn’t mean you think their conclusions were factually wrong, you can think stem cell research is morally wrong but the conclusions factually correct. Or, to use a clarifying contemporary example, suppose the question instead asked,

“All in all, do you favor or oppose federal funding for methods of treating homosexuality”

My intuition, which I suspect you share, is that the line would slope in the opposite direction – lefties would be more opposed than righties. This isn’t necessarily be because they are anti-science – maybe they simply think we are better off not knowing how to treat homosexuality, or better off not even thinking about the possibility. This moral belief doesn’t, however, mean they disagree with conservatives and scientists on any factual issue.

But there is another, even bigger, problem with this question. It doesn’t just ask about the morality of stem cell research – it asks about federal funding for that research. Conservatives are well known for opposing federal funding of things in general. Yet this research suggests that consistently applying the conservative rule “oppose federal funding of things in general” is suddenly evidence of being anti-science. You would be branded anti-science by this question even if your thought process was

“I think the federal government is very bad at research – it will be inefficiently run, overly politicized, and poorly directed – so I don’t want it to mess up stem cell research. Stem cell research is far too useful and exciting to trust to the government.”

Yet surely such a person should be considered pro-science, not anti-science!

Indeed, it seems that overlooking this issue, and conflating opposition to the state with opposition to science, is a clear sign of political bias on the part of the author. They choose a question which almost by design proved conservatives were anti-science, not by actually measuring the truth, but by simply re-defining opposition to science to include the political opinions they oppose. David Friedman once wrote about something similar – a study which, while claiming to prove that right-wing people were authoritarians, really just defined authoritarianism as ‘respects right-wing authorities’.

Ok, so their choice of data visualization technique was perhaps misleading, and the stem cell funding question was awful. But the other two questions look pretty solid, right?

Perhaps not. It’s well known – or at least widely believed – that conservatives disproportionately disbelieve in evolution and global warming. So if you wanted to prove that conservatives were anti-science, you’d pick those two questions, confident that your prejudices would be confirmed.

Yet there is much more to science than evolution and global warming. There many issues where there’s a scientific consensus at least as strong as that on global warming, yet some people still disagree. For example,

  1. Astrology is nonsense
  2. Lasers are **not** condensed sound waves
  3. The earth orbits the sun

In fact, I would say that science is far more unequivocal on these issues than on global warming – probably around as certain as that evolution is true.

Yet on all these issues, Republicans are more likely to hold the scientific view that Democrats. And there are many more similar examples. If I wanted to make the same charts, but make Democrats look bad, I could easily “prove” that Democrats are morons who believe the sun orbits the earth.

The Washington Post article does contains a homage to data:

But why opine on all this an un-grounded way — we need data.

Unfortunately we need more than data – we also need rigorous statistical techniques.

It would be unfair to blame the original researcher. In his article, he also includes a chart on nuclear power, where conservatives have the more scientific view. Mysteriously, the chart that was flattering to conservatives doesn’t make it into the Washington Post article. Ironically, it turns out the Washington Post article was right – politics really is the mindkiller. It’s just hard to spot when you’re the one getting killed.

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How to Pitch a Growth Stock – Cognitive Bias Edition

Growth investors focus on trying to pick the companies that will grow rapidly for many years to come, hoping to be rewarded by a consummately increasing share price. This can be anywhere from Venture Capitalists investing in tiny startups to enormous mutual funds betting on whether Twitter will continue to put up such strong growth. These companies tend to have high share prices compared to their current level of profitability, but have a good story, and will have rapidly grown in the past.

There are certain strategies that people use when trying to persuade someone to invest in a growth stock. This could be the startup team pitching to a VC fund or an analyst in a hedge fund pitching to his portfolio manager. I have more experience with the latter, so this will focus on companies with market caps above $100m.

Many of these strategies are intellectuality illegitimate. As such, I intend this as a sort of ‘Defense Against the Dark Arts’ – how to spot people using these rhetorical strategies in the wild. Perhaps this will also help people employee these strategies – if so I apologize to the world. I take the virtue of silence seriously – but in this specific instance I think sunlight is the best disinfectant – and hopefully it will make for an interesting blog post.

Choosing a growth stock to pitch

The first step is to choose the right stock. Pick something which has seen strong increases in share price over the last few years. A relatively smooth glide path up is best – don’t pick something that rose 20% in one day and has done nothing else. The goal here is to use the halo effect1 to make people confuse the historical share price movements with the company itself – to make it seem like the company itself actually has the property of steadily growing, rather than this just being a property of history of the market’s valuation of this stock.

However, it can be a good idea to pick something which has very recently seen a sharp fall in the share price. This way, your PM won’t feel like they’ve “missed it” – they’ve got another chance to get in. Regret Avoidance is a powerful effect, and you save them from this. Plus, the recent sharp fall means they’re safe from being the guy who bought in at the peak. That guy will look very stupid, so they’re happy to be safe from his fate.

Of course, you need an explanation for why these have happened. The steady rise is easy – the company is also steadily growing. The sharp fall is harder – people don’t want to invest in things that fall! – but there are some easy explanations on hand. ‘Hedge fund de-levering’ is always available as an excuse, and with any luck will act as a semantic stop-sign.

So far this has actually been pretty intellectually respectable. Or at least epistemically lucky – the first requirement, for steady share price growth, probably means the stock has strong momentum, which has historically been a strong predictor of returns (albeit with high kurtosis and negative skew, so beware!). The recent share price fall means the stocks will do well on short-term reversal, which has also historically been a good predictor. The next steps, however, are more dubious.

Total Addressable Market and the Conservation of Conservativeness

Having selected your company, the first step is to work out what the Total Addressable Market (TAM) for your stock is. Is it a household product? Take the number of households in America and multiply by the frequency of purchase. Is it a car? Look at the total number of cars. A better type of steel? Look at total US steel consumption. The key is to get a really really big number. If the number is insufficiently big, just look at a larger category of which the true market is a subset.

Next, multiply that number by their expected market share. As the company has been growing rapidly, it’s probably been expanding its market share of its current niche. So say you assume they’ll keep their current market share even as that niche grows into a major market. This assumption is conservative, you’ll say, because actually they have been growing their market share. This number should be reassuringly small – say 1%. It’s small size will help reassure people that you’re being conservative. If you want increase the total market they’ll eventually control, scope insensitivity means its easier to increase the TAM size than their market share. It’s obvious that 20% market share is a much more aggressive assumption than 2% (especially if their current market share is 2%), but not nearly so clear than $100000000000 is a more aggressive TAM estimate than $10000000000 – especially if you only present one of the numbers.

Next, assume a profit margin. If their current profit margin is high, just say you’ll conservatively assume no economies of scale. If their current margin is low, or they make no profits, just compare to vaguely similar companies and go for a slightly lower number. If ‘comparable’ mature companies have a 30% margin, say 20%. This sounds very conservative, but actually only reduces their profits by 33%.

Finally, assume a valuation multiple. The company is currently trading on a very high multiple, because the market is expecting rapid growth – maybe 30x earnings, or maybe 500x if you’re Amazon. So simply say you assume they’ll get a market multiple. Going from a 30x multiple to a market 15x multiple will cost you 50% of the valuation – but gain you a lot of apparent conservativeness.

The key principle here is the conservation of conservativeness. You want an estimate for them that is both very large and sounds conservative. To do this, you take advantage of scope insensitivity and arbitrage between the TAM stage and the company-specific stage. By making the company-specific stages (market share, profit margin, valuation) sufficiently conservative sounding, you can get away with an aggressive TAM estimate while keeping the whole thing sounding conservative. Scope-insensitivity means you can increase the TAM estimate at a lower cost of conservativeness than you can the company-specific elements, so there are gains from trade.

So once you’ve multiplied your TAM, market share, profit margin and valuation, you come up with an estimate for what this company could be worth in the future. However, you now deny that this is an estimate. Instead, it’s just an idea of the size of the market – you don’t actually expect they’ll reach it. This explicit denial protects you against any accusations of over-optimism, but you’ve successfully primed your audience on a really high number. If market sentiment is a battle between greed and fear, you’ve helped the greed side.

And a crucial subtlety – that valuation that you didn’t make is what the stock might be worth in the future. Because of the time value of money, you would need to discount that back to get to a current valuation. Since it credibly might take 10 years for the market to mature, even with a moderate 10% discount rate your valuation should really take a 61% hit. But by denying it was a valuation, you’ve avoided this step.

Downside Protection

The next step is to argue that the stock has “limited downside” or “downside protection”. This will reassure your audience that even if everything goes wrong, they won’t be fired. You’re trying to quieten their tendency towards fear, so that greed may reign.

Your goal here is to come up with a plausible story for why the worst-case scenario is 10% downside. 10% is just high enough that it sounds vaguely plausible, but low enough that it sounds reassuring.

There are a variety of ways of doing this. One is to name some assumptions you’re making, reduce them slightly, and claim that is the worst case. If the worst case looks pretty bad, just increase your original assumptions, so the haircut versions are higher.

Another is to look at some recent M&A in the sector, pick the most expensive deals, and argue that if the share price fell at all they’d be acquired on that valuation. There is always some expensive M&A going on, so this excuse is always available.

Finally, don’t forget to add that if the shares fell by this much, you’d think this represented a buying opportunity. This is totally misleading – the fact that the shares might be lower in the future is an argument for buying them then, not now, but it sounds level-headed and responsible. It also helps re-direct attention back to the optimistic forecasts of TAMs.

The actual valuation

Since you denied the TAM was actually a valuation, and the downside estimate was definitely the worst case scenario, you haven’t technically actually done any valuation just yet. Since that is ostensibly what you’re doing, you should actually have a go at estimating fair value. Doing all this has probably taken a long time so far, so you won’t have much time left for this stage.

There is an easy way to do it though. Project a high rate of revenue and earnings growth for the next 2-3 years. Place a multiple on the 3-year-out numbers that is lower than the current multiple. Discount that value back, using a high discount rate, to arrive at a share price 30% above the current level.

Fending off criticisms

Since you know more about the stock, you’ll probably be able to come up with a counterargument to any specific concern they mention, and they won’t be able to judge the issue. Any major concerns you have you can simply omit to mention.

If people ask you about execution risk, agree that it’s a risk, but then explain that’s why you used such a high discount rate. This suffices to rebut their attack. This is totally illegitimate. The discount rate (and implicit Equity Risk Premium) compensates investors for the variance of expected future earnings/dividends. It does not compensate you for lower expected earnings/dividends. Their concern is for the latter – your model implicitly assumes everything goes perfectly, whereas a true calculation of expected profits would include probabilities of lower performance. Your attacker will almost certainly not appreciate this fact. If by some misfortune they do, explain in an exasperated manner that you’ve already covered the downside case, and then change the subject.

As a last resort, simply utter the sacred words: “high risk, high reward.” People treat this utterance like magic – we want high rewards! Of course, it’s also nonsense. The phrase should be “high risk, high expected reward.” There is no guarantee you will get the reward! That is why it is ‘high risk’. But as people intuitive understanding of risk is terrible, you can safely abuse the phrase, just like everyone else.

Conclusion

So there you have it – how to pitch a growth stock. Or hopefully, how to spot the intellectually dishonest manoeuvres that are frequently used in growth investing.


  1. At least I think Halo effect is the right one. It also seems to have something to do with the Fundamental Attribution Error 

How Politics Makes Vox Stupid

Vox had an excellent article a while ago on how politics makes us stupid. It describes a number of ways in which people behave systematically irrationally about politics.

For example, there is research suggesting that showing people more evidence makes them hold their existing beliefs more firmly – regardless of whether the evidence supported or contradicted their beliefs. It talks about how people avoid evidence that threatens their self-identity.

But Vox made one big mistake with the article. When writing apolitical pieces, designed to reach across party lines and improve the state of political rationality, there is one rule you must always obey. Failing to observe this rule will lead to one side rejecting you and the other side failing to learn the lesson at hand. Failure to observe this rule leads to mindkilling, and Moloch.

The rule is:

If you use a political example from one side, you must use an equal and opposite example from the other side.

If you’re writing an article on irrationality in politics, and you have an example of republicans being irrational, you need to have an equally important example of democrats being irrational, with the same emotional salience, and the same amount of pagespace dedicated to it.

Vox totally violates this rule. And it does it in the predictable direction. It’s a left-wing site in general, and it’s specific examples of irrational behaviour (apart from those lifted from papers):

  • Climate change ‘denialists’
  • Sean Hannity (a conservative commentator)
  • Fox News
  • Antonin Scalia

Every single example of a person or a group they used were right-wing. Did they notice this? If not, then they need to do some serious work on their own bias. If they did, they have done their left-wing readers a great disservice.

The point of learning about biases isn’t to gain a new weapon with which to attack others. The point is to turn the knife upon yourself and cut the cancer from your own mind.