The Power of Numbers
Stories create connections and get remembered, but numbers convince people. As machine power continues to expand, businesses talk about the use of data in operations and decision making. Investors have also become number oriented with some investors putting their trust entirely on data and sophisticated tools for analyzing those data. We call them the 'quants'.
The notion that numbers are scientific and more precise than stories is deeply held. Another reason why investors are so much attracted to numbers is that they appear to be unbiased. However, like stories, numbers too have their own dangers.
The illusion of precision
Since numbers are objective, investors have a false sense of illusion that they are accurate. For instance, just because investors have come across a valuation through complex data analysis, it would necessarily be accurate. This is a wrong notion.
The illusion of objectivity
People respond to data as per it is framed. In the interests of providing comprehensive statistics, Professor reports the average tax rates for each sector using three different approaches for averaging:
- a simple average of the tax rates across companies in the sector,
- a weighted average of the tax rates across companies in the sector, and
- a weighted average of the tax rates across only money-making companies in the sector.
Each year there are journalists, politicians, and business trade groups that use his tax rate data, often to support very different agendas, like the business trade groups that intend to show that they pay their fair share of taxes, pick the tax rate measure that yields the highest value to make their case.
Similarly, the advocacy groups that believe U.S. corporations don’t pay their fair share in taxes look at the same table and find the tax rate measure that yields the lowest value to bolster their arguments.
Both sides argue that the facts (and numbers) are on their side and neither will admit to the existence of bias.
Illusion of control
Professor Damodaran states that measuring something does not necessarily mean that you are controlling it. Just as a thermometer can tell you that you have a fever but cannot treat it, measuring the standard deviation of a portfolio only tells you that it is risky but does not protect you from that risk. The danger with deluding yourself that you are in control, just because you have a sophisticated measurement tool, is that you may not only let the numbers overwhelm your common sense but that you will not prepare yourself properly for the dangers ahead.
So, what is the solution to it?
The solution is to add a story to the number. But if numbers are dangerous because they come with the illusions of control, precision, and objectivity and can be easily imitated, how will adding stories to numbers reduce those problems?
This is so because when you are forced to unveil the story that backs your numbers, your biases are visible not just to the rest of the world but to yourself. So, for example, if you feel that HDFC bank can grow its revenues at 25% p.a. for the next 10 years, the audience can doubt the statement. However, let's say that your story states that you expect the Indian credit market to expand @15% p.a. and HDFC bank being the dominant player will take market share and hence would be able to grow at a faster rate than the market. This way, it is clear that you expect HDFC bank to remain a dominant player in the future and hence there is a story supporting your numbers.
