E-motions: Vol. No. 1, Issue No. 31 Brought to you by California News Tech (OTC BB: CNTE)

By: Tai Nicolopoulos E-Motions Writer 07/21/2006

Credibility Problems Can Hurt Companies Just as Much AS Low Revenue

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1. Emotions in Focus: The Reputational Dilemma

    If investors approached the market rationally, an analyst's rating or a news item about a member of a company's management team would just be one small part of the total evaluation of a company, definitely less important than fundamentals. In reality, however, investors often assess the reputation of a stock like they would make a social evaluation of another person. Despite the great dissimilarities between these two instances, the human decision making process governs each type of evaluation with the same cognitive rules.

    While these rules are generally helpful decision making tools, they are fraught with a variety of problems. The first major problem is humankind's poor grasp of probability. At the most fundamental level, it is desirable for humans as a group to reward pro-social behavior. The chances of one individual's repeated interaction with any other individual is too low. Therefore, passing on a read on an individual's character and competence to others, allows socially desirable behavior to persist and be rewarded. Consequently, humans heavily weight reputational information passed on from others over other data. This information, however, may not always be relevant or accurate.

    Further ensconcing the social importance of reputation, as well as creating more problems, is what social psychologist Lee Ross has dubbed the “Fundamental Attribution Error”, or FAE. The FAE describes the mistake individuals make when evaluating the behavior of others. When the individual looks back on his or her own behavior, he or she can call to mind all of the temporary, environmental factors that led to him or her being in a bad mood, being rude to a co-worker, or any other behavior. Meanwhile, when that same individual evaluates the behavior of someone else, he or she is not privy to all of the factors that led up to the other person's actions. Yet again the individual runs into the problem of not understanding the probability of other people's behaviors. Then, the individual assumes the other person always acts the same way and labels the other as having the fixed personality traits of “moodiness” or “rudeness”. Consequently, once a person or entity acts one way, it gets a reputation for that trait and that wrap tends to stick. For instance, this process can be particularly devastating for a company with a past history of corruption. The problems may have been fixed and the guilty parties removed, but the sense that the company has a “corrupt culture” is much harder to shake.

    A major factor that can boost, or in the case of a corruption scandal, repair, reputation is company or individual credibility. Because it is so very difficult to weigh every piece of information on its own merit, the individual looks to the source of the information for clues. He or she is more likely to believe and value information coming from a high credibility source, even if there are no other indicators that commend the quality of the information. A source can seem credible if it has been reliable in the past or if the person is high status or is at least a highly visible public figure.

    Consequently, investors often fixate on what an analyst says rather than evaluate raw information about a company. Someone as high-profile as Mad Money host and Street.com commentator Jim Cramer is a notable example of this kind of power. Even though other analysts may disagree with him, and it is obvious that thousands of other people will be taking exactly the same investment advice at the same time, many investors will still move into a stock when Cramer mentions a company on his show.

    Conversely, when someone high profile within a company, who ostensibly has a great deal of status as well as inside knowledge into its inner workings, leaves, it becomes a serious blow to the stock's reputation. Even when the numbers tell a different story, the element of personal credibility the executive had previously lent to the company has now been undermined.

2. The Big Movers and Why

    Are you missing out on potential profits from Heads UpTM recommendations? Recently, MediaSentimentTM subscribers using Heads UpTM for Thumbs Up / Thumbs Down recommendations for publicly traded companies were able to take advantage of these Big Movers, moving 5% or more in their recommended directions, after they released earnings.

Big Movers in the Spot light:

    On June 29th, two stocks especially suffered from these kinds of credibility problems. The first, computer Associates, Inc. (NYSE: CA), which designs information technology management software products, went down 5.2% after releasing earnings on a Media Sentiment® Heads Up Thumbs Down recommendation. CA had a weak quarter, and moreover, a history of corrupt accounting practices shadows the company. The problem is so bad that in a recent Street.com article Jim Crammer described a company that cannot escape a reputation for past corruption as suffering from “Computer Associates-itis”. While the company has a new management team, the bad name the company earned in the past is what sticks because investors are laboring under the Fundamental Attribution Error.

    The other stock, Innovo Group, Inc. (Nasdaq: INNO), which designs and markets apparel products worldwide, went down 12.99% after releasing earnings on a Media Sentiment® Heads Up Thumbs Down recommendation. While the company had a mixed quarter, it certainly did not help that one of Innovo's new directors unexpectedly quit after a week on the job. Regardless of the reasons for any member of a management team leaving in hurry, the individual had high credibility, and now he or she has essentially put in a vote of no confidence in the company.

Other Big Movers:

    Monsanto Company (NYSE: MON), which provides agricultural products to farmers worldwide, went up 8.76% on June 29th, after a Thumbs Up Heads Up™ recommendation.

    All figures reflect all Media Sentiment® Heads Up recommendations between Monday, June 26, 2006 and Friday, June 30, 2006, rating companies on the day of their quarterly earnings releases correlated with their stock highs and lows for the subsequent day.

3. How to Use the News

    When researching stocks with credibility problems it is important to understand not only exactly what caused the company problems in the future, but also to get a sense of what analysts and the rest of the financial news media are saying now. Of course, it is important to determine that the stock is no longer suffering from the problems it was before. It is just as important, however, to make sure that the tide has turned for public sentiment about the stock as well. If analysts are just starting to change their minds about a stock that is on the road to recovery, it may be undervalued and a great deal. If the sentiment around such a stock is still solidly negative, it may still have a rocky road ahead, despite its progress.

4. Links you can use

CA Hits Targets, Delays 10-K
Innovo Director Quits After a Week

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