Sunday, December 6, 2009
Game Theory and my girlfriend
I was just thinking about subtle ways in which game theory applies to my daily life and I realized that relationships are the biggest games of all. Many decisions in a relationship can easily be framed as prisoners' dilemmas. (not that I feel like a prisoner in my relationship:) For example, my girlfriend and I have different preferences on what we do for New Year's Eve this year. If I give let her decide what we do, I'll end up at a party with all her friends and probably not have a great time, but she'll be happy. If I refuse to be flexible and make her go to my party, I'll be happy about the event, but will have an unsatisfied girlfriend. The nash may be that we go to one party for a while and then the other. This will lead to some satisfaction from both of us, but not as much as if one of us had completely gotten their way. So, as the game plays out both of us will try to convince the other that the pain of going to the other's party will be less than they think in order to get the biggest payout for ourself. This could actually increase the risk involved if this argument is effective. If I convince her to only go to my party, I will feel as though I have gained the greatest payout possible, but she may end up even more unhappy if she doesn't like the party and will complain to me, thereby reducing my total payout. That is just one example and it is a game that is not easily quantified. However, the give and take of a relationship is probably one of the most strategic games we play in life, whether we know it or not.
Monday, November 30, 2009
The Winner's Curse
It's looking cheap.
By Pat Dorsey, CFA | 02-06-06 | 06:00 AM | E-mail Article
Suppose you read this in your favorite financial daily:"Acme was outmaneuvered by Jones & Co., a much smaller rival, for control of TargetCorp…When Jones raised its bid, Acme was left dumbfounded, unable to respond."
About the Author
Pat Dorsey, CFA, is Director of Equity Research for Morningstar and author of The Little Book that Builds Wealth and The 5 Rules for Successful Stock Investing.
Sure, a J&J/Guidant combo would have been a powerhouse. And yes, few health-care companies are better than J&J at fixing the kind of manufacturing problems that Guidant has been suffering. But Johnson & Johnson hasn't created one of the world's best multidecade corporate track records by ignoring financial common sense. Everything has its price, and Guidant's simply got too high for J&J. So it did what any prudent investor would do--walked away. Far from being "unable to respond" to a higher bid for Guidant--see the quote above--J&J prudently declined to raise its bid. Big difference.But perhaps J&J was being too tight-fisted, and the product recalls at Guidant that caused J&J to lower its bid will wind up being not that big a deal in the long run? Maybe--but consider that J&J had been poking around Guidant's operations since the initial deal was struck in December 2004, while Boston Scientific only started getting an inside look at Guidant a full year later. I think that it's a safe bet that J&J was the more knowledgeable party, and if it thought the issues at Guidant merited a lower bid, it's probably right.
We think that J&J shares are worth $76, substantially above the current price. As you can see in the chart below, Johnson & Johnson is generating substantially more operating cash flow per share than it was five years ago, yet the stock has largely traded sideways. Moreover, the current price/earnings ratio of 16 is not only lower than it has been in a decade, it's also lower than the market--and I think it's an easy stretch to call J&J an above-average company. Add a 2.2% yield to the 9%-plus earnings growth rate, and you've got a decent prospective total return before taking any multiple expansion into account. Finally, I like J&J because I can clearly identify why the stock is mispriced: The market thinks that J&J is worse off for not having won the Guidant bidding war, and investors seem to believe that slowing pharmaceutical growth is a long-term worry. Given that J&J would have overpaid for Guidant, and that the firm's drug pipeline looks pretty good to us, we disagree. As I've written before, my confidence in an investment thesis is stronger when I can put a finger on why I disagree with the market.
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