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Cognitive biases in investing: a case in point

By natural evolution, people are hard-wired to use mental shortcuts when making decisions. Investing decisions are no exception to this truth.

Research in the behavioral finance field has shown that cognitive biases can affect anybody’s investment choices. In this post, we’ll draw a brief illustration of how these biases enter the investing picture in practice.


Take the case of Nikola Corp (NKLA), a US-based company operating in the emission-free truck manufacturing sector, for example.

In the days following its listing on Nasdaq in June 2020, Nikola’s public market value ballooned to circa $28bn, a highly unusual mark for an unprofitable early-stage company.

In hindsight, little could justify that kind of valuation from a fundamental standpoint.

Evidently, psychological influences played an outsized role. Three of them come to mind in particular:


A ride on the passenger seat

First, Nikola obviously tries to emulate the success of its peer Tesla Inc, starting with its corporate name chosen after late engineer/inventor Nikola Tesla. Consciously or not, many investors were led to draw parallels between the two companies: each recently founded in the US by a seemingly visionary and outspoken CEO/shareholder, each striving to disrupt a segment of the global automotive industry with innovative eco-friendly products. As a result, many must have fallen for the cognitive tendency called the “Representativeness heuristic”.

Representativeness heuristic: “when we’re trying to assess how likely a certain event is, we often make our decision by assessing how similar it is to an existing mental prototype”. (1)

By the time Nikola became publicly-listed, Tesla’s business momentum had already been wildly positive for years, and its market value had increased exponentially to circa $200bn+. With such impressive precedent in mind, Nikola’s valuation upon going public – merely a tenth of Tesla’s after all – seemed a lot more realistic than if Tesla never existed.


What you see is not what you get

Second, Nikola’s management – and more particularly its former chairman Trevor Milton –  went to extraordinary lengths “selling” the company to investors. Not only did they make countless over-optimistic statements about their business, they also presented information in a way that favors a cognitive bias dubbed the “framing effect”.

Framing effect: “when our decisions are influenced by the way information is presented. Equivalent information can be more or less attractive depending on what features are highlighted.”(2)

Consider, for instance, Nikola’s inaugural quarterly-result press release, where the company used virtual rendering to imply that its manufacturing site in Germany was nearing completion (knowing that it hadn’t reached mass production a year and a half later).

Or yet more pernicious, when Nikola produced an official video (https://twitter.com/nikolamotor/status/956576016809340928?lang=fr) of a truck prototype being driven on a public road, and later was forced into admitting, after a scathing report by short-selling specialist Hindenburg Research, that the vehicle was not powered by an engine but simply rolling down a hill.

Farewell, fair value

Third, as often the case in high-profile new listings, Nikola’s sky-high valuation found tremendous support in institutional equity research. Investment banks’ median target price at listing was $79 per share (equating to a $28bn valuation), i.e. more than twice the closing price of $33.75 on NKLA’s first trading day. Considering sell-side research is an important reference for many investors, first consensus data implying this upside likely triggered a form of “Anchoring bias”.

Anchoring bias: “a cognitive bias that causes us to rely too heavily on the first piece of information we are given about a topic. […] we interpret newer information from the reference point of our anchor, instead of seeing it objectively.”(3)

In a matter of days after its debut, NKLA’s share price soared to $79. But never did it trade at that level again since then. In hindsight, a wildly-unrealistic sell-side consensus which happens to be the peak price of a stock strongly points to anchoring behavior among many buy-side market participants.


Fast forward to today, with NKLA trading around $7 per share, and a far more realistic value of less than $3bn. One quote from investment great Benjamin Graham comes to mind: “In the short run, the market is a voting machine but in the long run, it is a weighing machine.

As Nikola went public in 2020, the “voting” process evidently got caught up in a psychological frenzy. But after the market started “weighing”, things came back to Earth.



(1)(2)(3) : source : https://thedecisionlab.com/biases/

Nota: the following content is not an investment recommendation to buy or sell the securities mentioned.

Norman K Group and its related parties have neither buyer nor seller interests in the securities mentioned.