Representativeness can lead investors to make incorrect projections based upon stereotypes. Since investors’ perceptions are based upon current or historical information rather than unbiased expectations, stocks can be temporarily mispriced. An example is assuming a stock will perform well in the future because the firm just unexpectedly announced good earnings over the last period. Assuming the good announcement implies good future performance (a winner), investors buy the stock and push its price up. Likewise, a bad earnings announcement (a loser) may be met with selling pressure, which drives the price down. The result is that overpriced “winners” will tend to underperform and underpriced “losers” will tend to outperform, as their prices return to their intrinsic values. |
