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Durability Bias

"The future will be like the past"

What is the Durability Bias?

Durability bias is the subconscious inclination to forecast past events or occurrences forward to the future. In other words, durability is a type of cognitive bias with the assumption that the past will continue into the future. The term durability bias is commonly used in behavioral finance and forecasting.

 

Durability Bias Chart

 

Implications of the Durability Bias

The durability bias can have a significantly adverse effect on decision-making for investors. To illustrate the point, imagine an investor that believes a company that has regularly outperformed analyst estimates for Earnings per Share (EPS) will continue to do so, simply because that’s always what’s happened.  Imagine then that the competitive landscape in an industry changes, and the company doesn’t alter its business model in response. Over time this company would start under performing and prove to be a bad investment.

In this example, using the past as a reference for the future was not a good idea. Instead, an investor should look forward at what they think will happen, independent of the past.

 

Example of Durability Bias

US markets are seeing significant growth, with stocks yielding unprecedented returns in part due to a booming market and expanding economy.

John is a retail investor and current business student that recently took an interest in investing. He notices the impressive gains in a stock called “CFI,” which has seen a price surge of 15% year-over-year. John concludes that if he invests $10,000 in the stock today, given the year-over-year gain of 15% on the stock, he will end up with $20,000 in five years’ time ($10,000 x 1.12 compounded over 5 years).

In the example above, John is exhibiting durability bias. He assumes that since the stock of CFI has seen a gain of 12% yearly, it will continue into the foreseeable future. It is important to note that the past performance of the stock is not indicative of future performance.

 

Case Studies of Durability Bias

Listed below are two well-known companies that failed to innovate or change their business model in an ever-changing business environment, which was attributed to durability bias, leading to their demise:

 

Blockbuster

Founded in 1985, Blockbuster was one of the most iconic brands in the video rental space. Blockbuster, at its peak, employed over 84,000 people worldwide and boasted over 9,000 stores. The company, blindsided by its success in the video rental space, failed to transition towards a digital business model and filed for bankruptcy in 2010.

Ironically, Netflix approached Blockbuster in 2000 with an offer to sell their company for US$50 million. However, the CEO of Blockbuster thought that Netflix was a very small niche business. Today, Netflix counts over 100 million subscribers worldwide with revenue upwards of $9 billion.

 

Toys R Us

Founded in 1957, Toys R Us was a world-renowned toy store chain. In the early 2000’s, Toys R Us was doing extremely well in its brick-and-mortar stores. With the prevalence of e-commerce and several new companies such as Amazon, Toys R Us decided to stick to its traditional business model and not pursue an e-commerce presence. Toys R Us missed the opportunity to build up its own e-commerce platform, and as a result, the company filed for bankruptcy in September 2017.

 

Key Takeaways

Durability bias exerts an adverse impact on businesses – companies and individuals who are able to avoid the durability bias constantly questions whether their growth rate assumptions hold into the future. Companies that are caught up in the durability bias and do not alter their business models in a changing environment are subjected to very poor performance and results.

 

Related Readings

CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ certification program, designed to transform anyone into a world-class financial analyst.

To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:

  • Confirmation Bias
  • Narrative Fallacy
  • List Cognitive Biases
  • Guide to Financial Modeling

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