(Tremblant Capital Group)

Behavioral Finance

Question 1:
Should the fund continue to invest into the company? Please justify your answer with
financial analysis of the company.

Based on the data available for GMCR, following details are observed.
Past Performance:
• In last 5 years. Revenue for the company has grown with a CAGR of
33.5%, while net income has grown with a CAGR of 28.8%.
(Corresponding figures for the competitor are 20 % and 12.7%
respectively.
• EPS has also grown steadily over the last 5 years form $0.2 to $0.6. P/E
ratio has also consistently remained on higher side (>40).
• In the last 5 years, the share price for the company has grown strongly
with a CAGR of 43%. While the growth in share price for the competitor
has remained relatively weak at a CAGR of 13%.
• Average Year on Year sales growth for Tremblant has been close to 40%
(compared to competitor’s year on year growth rate of 20%).

Future projection:
• As seen in the below chart, the tipping point for the brewer sales is seen
in the year 2008 indicating the adoption of the technology by the
consumers. Tipping point is also driven by the increasing use of K-cups
in 2008 well supported by “network effect” of increasing adoption of
brewers.
Sales figure for Brewers (actual & projected)

1400 Projected Figures

1200
Brewer Sales (1000 units)

1000

800 At-Home Brewers Sold

Tipping Point in
600 Away-from-Home Brewers Sold
2008
400

200

0
Dec- Mar- Jun- Sep- Dec- Mar- Jun- Sep- Dec- Mar- Jun- Sep- Dec-
06 07 07 07 07 08 08 08 08 09 09 09 09

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1
Time Line
 (Tremblant Capital Group)
Behavioral Finance

• GMCR’s coffee business is also expected to do well despite being under

threat from competitors and increasing coffee price.
• Driven by its strong past financial performance, healthy demand in the
market and scope for wider penetration in the market, GMCR is
expected to maintain its current growth rate. A simple growth model for
future years (as shown below) estimates EPS of $0.91 in FY 2009, $1.25
in FY 2010, $1.69 in FY 2011, and $2.27 in FY 2012 against the Rabin’s
projected values of $1.25 in FY 2009, $1.54 in FY 2010, $1.92 in FY
2011, and $2.48 in FY 2012. Table below shows the projected figures
with simplified extrapolation of the past financial data.

Sep-09 Sep-10 Sep-11 Sep-12

Revenues 700 980 1372 1921
COGS 408 579 814 1135
% of Revenue 58.3 59.0 59.3 59.1
Selling, General & Admin Cost 199 274 383 544
% of Revenue 28.4 28.0 27.9 28.3
EBITDA 93 127 176 243
% of Revenue 13.3 13.0 12.8 12.7

Risk factors
• GMCR debt/equity ratio has been close to 0.9 in last 3 years. As the
GMCR’s revenue and growth prospects are heavily dependent upon the
“success” of its Keurig system so the current debt position may not be
the optimal for an innovation based company.
• Keurig system is under threat from latest brewers with new technology.
A stronger and better technology machine may cause the complete
inversion of Keurig system’s demand. Any measure to counter this
threat (through investment in R&D) is not visible at GMCR.
• The soundness of the market channels to handle very high sales as
projected is under question. As consumer products are highly
susceptible to the availability and visibility in the market. It is a key
parameter (and challenge) to maintain the same amount of availability
and visibility in the market.
Summary of GMCR’s profiling
Parameter Indicators Score
Negative Positive
Past Financial EPS, Revenue & profit
Performance CAGR +++
Current Debt/Equity (Financial
Standing/Future health), Management
Projections Team, New market - +
penetration /Growth
(opportunities)
Risk Factors Competitors , Saturated
--
 (Tremblant Capital Group)
Behavioral Finance

Market channels ,
Technology (Threat)
Overall
+
Above analysis indicates that company should continue to invest long in
GMCR while carefully looking at the risk factors. The S&P 500 is going down so
the reaction of the GMCR stocks in the fall 2008 may be due to cumulative
market effect. GMCR is only representative from its industry in Tremblant’s
portfolio, so it is important to maintain a healthy poison in GMCR to keep the
diversity.

Question 2:
Elaborate the investment decision in Question 1 with respect to behavioral finance patterns (at
least 3 behaviors)

The investment decision above is based on the financial performance of GMCR

as well as the related future projections. Following behavioral finance pattern
might have influenced the decision to invest in the company.

Representativeness heuristic

The available financial data is used to establish the soundness of the company
prospects. The data might have been interpreted to bring the favorable
outcome. EPS, Net income, P/E etc have been analyzed for increasing trend in
last 5 years. So, the growth in EPS, Net income is given more importance.
Despite that fact actual earning follow a random walk, in line with behavioral
finance biases, importance has been given to establish a steady trend in
growth of key financial parameters.

Due to fast, selective interpretation of the available information, the outcome

can be narrow & weak than expected but the analysis takes into account that
the present decline in the stock price which may be caused by recent news
about the company ignoring the past financial performance. Recent fall in
GMCR’s share may be due to the immediate conclusion drawn from the insider
stock selling by the GMCR chairman.

Under reaction:

In general people under react to information about short term prospects of the
company such as earning forecast, stock price etc. Though there has been
reports of poor performance of the stock, including the independent research
report which graded GMCR poorly on its earning quality, the financial
 (Tremblant Capital Group)
Behavioral Finance

newspaper baron’s articles about high stock prices of GMCR, selling of $5.7
million stock by GMCR chairman along with the reports about vulnerability of
the Keurig brand and development of short seller interest in GMCR, still these
facts were not given significant weightage when taking the above decision to
maintain a long position in GMCR. The anomaly under reaction is exhibited
due to investor overconfidence and biased self-attribution.

Overconfidence/Optimism

Self attribution contributes investor confidence in over estimating its ability to

value stock and predict future prices. Confirming information in public arena
encourages the investors but disconfirming information doesn’t discourage
them, which exactly is the case in the above scenario. Though we have some
disconfirming information available in the public domain, still we don’t pay
heed to it while taking the decision. In general individuals are overly optimistic
and overconfident about their abilities. In the given scenario, the above
decision is also based on the fact that Tremblant has been better in evaluating
a firm’s future prospects, irrespective of what the market thinks and have
previously bought firms that have been perceived as overvalued by other
investors. This shows the overconfident on Tremblant’s part. Also, in making
this decision there has been more focus on potential returns and not on
possible losses.

Disposition Effect

Disposition Effect explains the behavior of investor to keep past winners in

their portfolio and sell past losers. It relates to the tendency of investors to sell
shares whose prices have increased, while keeping the shares that have
dropped in price. This is driven by the fact that Investors are less willing to
recognize losses (which they would be forced to do if they sold shares which
are falling in value)

Tremblant established its position the company at stock prices >$20, so when
the stock prices are below $20, the dispersion effect lead the investor to
maintain its position. Same disposition effect is in fact causing the under
reaction to the news related to accounting impropriety, insider stock sales etc.

Moreover, it is also leads to overconfidence in investor in terms of biased self

attribution anomaly, over estimating the skill to invest in a market and making
the right choice.

As per the disposition effect, it has been decided not to dilute the position
GMCR instead it is being recommended to consider increasing the stake in the
company thereby avoiding the recognition of losses.
 (Tremblant Capital Group)
Behavioral Finance

Confirmation bias

Confirmation bias is a behavior in investors to favor information that confirms

their preconceptions or hypotheses regardless of whether the information is
true or not. It is again driven by the disposition effect where investor tends to
keep the loosing shares. The investor would gather evidence selectively, and
interpret it in a biased way to substantiate his position.

Accordingly, various financial parameters have been interpreted in a way to

prove that the GMCR’s past financial performance out weighs the current
stock price decline, hence the under reaction.

Investment Anchoring

Short interest in GMCR is increasing which is explained by the investor’s

behavior of basing the investment decision on irrelevant figures and statistics
which may not be truly important like an isolated event of insider stock selling.

Investors invest in the stocks of companies that have fallen considerably in a

very short amount of time thereby anchoring on a recent "high" that the stock
has achieved. Thus, drop in price provides an opportunity to buy the stock at a
discount. As it is clear that that there is no major changes in the business
strategy/scope of GMCR which would otherwise cause the GMCR stock price
to decline, it may be interpreted that the decline in stock price is temporary,
hence a good opportunity to strengthen the position in the company.
Basically, the position of the company is strong with its key revenue
generating product reaching the tipping point.