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Sifting Through Bias to Find Value

2024-03-06, Amit Shah

As investors, we must be attuned to nuanced qualitative and quantitative signals in financial markets and the overall economy. At the same time, we must be able to think and act independently of these signals. To help recognize and counteract the mental shortcuts to which our brains are susceptible, we can borrow from detailed cognitive psychology studies on behavioral biases.

One common cognitive shortcut is availability bias, the tendency to incorrectly believe that recent events will persist. This is especially common in financial modeling when short-to-mid-term projections are often based on recent historical trends without a bottom-up perspective on the factors that may allow certain growth, margins, or multiples to persist. Narratives or subjective viewpoints that people construct to explain data they observe can further compound this bias. Adopting predominant or consensus viewpoints may be easier than independently analyzing observations from the bottom up, but it’s a trap that can lead to bad decisions. Instead, we construct our own independent viewpoints that incorporate recent and longer-term trends, which are then subject to critical discussion with our broader team.  This is a key part of the QV process that helps combat cognitive biases.


Let’s illustrate how this cycle may play out with recent results from Aritzia, a fashion retailer that we own in our Canadian small cap strategy. As shown in the chart below, the company had high levels of growth, well above its longer-term average, from the first fiscal quarter of 2022 (corresponding to Mar-May 2021) through the first fiscal quarter of 2023 (corresponding to Mar-May 2022). As a result, the share price increased and the valuation multiple (forward EV/EBITDA) expanded to as high as 22x compared to its long-term average of 12x.

The company benefitted from several factors, including the reopening of stores as pandemic restrictions lifted, higher consumer spending levels, and higher popularity of casual fashion as work-from-home became more common. While these trends seemed like they would fade over time, the narrative was that high growth rates were sustainable given that the brand was just starting to gain momentum in the US market. We overlayed more ‘normalized’ growth, margin, and multiple levels to our analysis of Aritzia and recognized that valuation risk had increased even though many other parts of our investment thesis were still intact, including good growth prospects, high insider ownership, and a strong balance sheet. Subsequently, we trimmed our position in light of a less attractive risk/reward.

Source: S&P Capital IQ


Starting in the second fiscal quarter of 2023 (corresponding to June-August 2022), as growth started to decelerate and margins began to contract, negative sentiment caused the multiple to contract to as low as 8x EV/EBITDA. The company was impacted by weaker consumer spending, changing consumer behavior from the shift to hybrid working arrangements, and supply chain investments that further pressured margins. The narrative now shifted to a high level of uncertainty around the attractiveness of the brand and its potential runway in the US market.

Our analysis was grounded in an understanding of the margin benefits from higher prices that the company was putting through, supply chain investments, and other cost-cutting initiatives. While part of the margin contraction was self-inflicted due to supply chain investments, we agreed with management’s rationale to invest in a new distribution center with more capacity and greater automation capabilities that would be margin-enhancing in the long term. We continued to see a long runway to grow sales and build scale in the US, including further margin expansion from pricing products in the US at parity to Canada (~35% higher on a Canadian dollar basis). In addition, we felt further insulated by a multiple that had re-rated well below the longer-term average, high insider ownership, a strong balance sheet, and the company’s good track record for successfully navigating through prior tough economic periods. With this more attractive risk/reward skew, we added to our position. Our timing was fortunate – since then Aritizia has shown sequential recovery in growth and margins and has re-rated higher.

Irregular patterns and large fluctuations in growth, margins, and multiples over relatively short periods of time are inherently difficult to analyze and understand. During pockets of ambiguity, while it might be most comfortable to go along with the crowd or predominant narrative, this often just proliferates biases. Instead, adopting a comprehensive investment process and consistent philosophy helps safeguard us against biases. Our focus on independent analysis and open discussion helps steer us towards a more objective prospective reality.

All views and projections are the expressed opinion of QV Investors Inc. and are subject to change without notice. This Update is provided for informational purposes only. QV Investors takes no legal responsibility from any losses resulting from investment decisions based on the content of this Update.


Amit Shah | Research Associate

Amit analyzes investment opportunities and monitors existing holdings for QV’s small and mid cap strategies.