Irrational Exuberance & My Calculator

Irrational ExuberanceWhen I first started my career, I had a business partner. As an entrepreneur, I would come up with all of these great ideas and run them past my partner. Every time I had a new idea, he’d bring out his 10-key calculator and say “Okay, walk me through it.” He wanted me to run the numbers to check if it was actually a viable idea. The thing is… It’s really easy to be rich on the calculator. Enter the concept of irrational exuberance.

What is Irrational Exuberance?

The term irrational exuberance, originally coined by Alan Greenspan, is defined as “unsustainable investor enthusiasm that drives asset prices up to levels that aren’t supported by fundamentals” (Investopedia). This term stemmed from the dotcom bubble of the 1990s. The market was overvalued and disaster seemed imminent, and it was.

Irrational exuberance was meant to be a warning sign. Wikipedia quoted Greenspan during his “The Challenge of Central Banking in a Democratic Society” talk on December 5, 1996 (see below). Because of these statements, companies around the world decreased the values of their products or services to accurately predict and forecast the future.

“Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?”

In very simple terms, irrational exuberance is the essentially when you value a product/service much greater than its actual worth. This is a direct result of being calculator rich.

Irrational exuberance can destroy your company’s value. Good new for you! Click here to download the Top 10 Destroyers of Value whitepaper where we go in depth why it’s a destroyer and how to avoid it (and improve the value).

What is Calculator Rich?

Let’s start with a question to define “calculator rich”… Have you ever came up with a brilliant idea that you thought would be a million dollar deal? You start with 1,000 widgets and sell them for $10 each. Great! That’s $10,000! But what if you sold it for $25? That’s $25,000. After 20 minutes of running the numbers, you’ve grown 1,000 widgets into $1B business based upon a price that the market likely won’t bear.

Have you ever been “calculator rich”? If you’re shaking your head no, then you are most likely lying to yourself. It’s incredibly easy to punch figures that seem normal into the calculator, but when you put those figures into the bigger picture, your forecasts are dramatically skewed and irrationally exuberant. I will be the first one to admit that I have to consistently train myself not to be calculator rich. We’re all guilty of it at some times.  It’s so darn easy to dream with a calculator.

Irrational Exuberance & Calculator Rich

Being irrationally exuberant and calculator rich can go hand in hand. If you already have unrealistically optimistic expectations, it’s not hard to justify those expectations with calculations.  A calculator rich mentality is often the direct result of an irrationally exuberant environment.  The extent of that exuberance or richness is dependent on the numbers used.

How to Fight “Calculator Rich” Tendencies

Having unrealistic expectations can be a huge destroyer of value. If you have a bias to be calculator rich, there is a strong chance you are also irrationally exuberant. There are four major actions that you, as the financial leader of your company, can take to correct this normal but potentially destructive behavior.

Recognize the Bias

Being irrationally exuberant has caused hyperinflation and/or bubbles in the general market. Just like we saw in the mid 1990s, Greenspan expanded on how this type of behavior impacts spheres as large as the stock market. Recognize the bias to overvalue, overestimate, over project and correct accordingly.

This bias is not necessarily wrong, but it can be destructive if you fail to recognize it and solely rely on it.

For example, one of my team members has a business idea that she is investigating to determine whether or not it is a viable opportunity. I advised her to be realistic when measuring the opportunity, to consider all costs and benefits and to avoid being calculator rich.

Lean Start Up

As an adjunct professor for the Wolff Center for Entrepreneurship, I consistently tell my students to do things in a small way first. This allows you to fail fast and pivot into a better direction.

Do not let your excitement carry you away. Whether you are the entrepreneur, the CFO, or an aspiring CFO in your company, it is critical for your success to all be on the same page. Dysfunction (and loss of value) occurs when members of the management team do not see the company in the same light. Shave off some of the fat of the company and further develop your “lean, mean, entrepreneurial machine“.

Bring Objectivity

Particularly if you are the financial person in your company, it is essential that you guide your entrepreneur without putting out the creative fire. What do I mean by that? Sometimes, entrepreneurs have wild ideas that from the first hearing may seem outlandish. Instead of splashing water all over their idea’s spark, bring objectivity to the conversation.
The first way you can do that is to simply take away the calculator. Don’t let the person who is more prone to being overly optimistic calculate the potential upside. Your job is to help identify and mitigate the risks of this new idea, not to quash it. Put together projections, then explain how objectively the idea works or does not work.

Understand an Outside Investor’s Viewpoint

One of the Top 10 Destroyers of Value is simply not understanding an outside investor’s viewpoint. Why does this matter or relate? If you overvalue your product or service when seeking capital from outside investors, the truth will be discovered and your credibility can be called into question.
The investor pool is a small world, just like the business world. It is essential to your success that you try to remain as realistic as possible when dealing with those investors. Otherwise, you may risk being “blacklisted” from the investor pool. This happens all the time. Start by understanding how investors look at your company, and build value accurately and truthfully.

How calculator rich are YOU?

Feel like you may have overvalued your product or service? Or pursued that million dollar idea that is really only worth $10,000?Identify how calculator rich you are. Then, start fighting those habits to go from being calculator rich to actually rich. If you’re looking to sell your company in the near future, download the free Top 10 Destroyers of Value whitepaper to learn how to maximize your real value.

Irrational Exuberance

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Irrational Exuberance

2 Responses to Irrational Exuberance & My Calculator

  1. Peter Chisambara June 6, 2017 at 5:04 am #

    Great post Lauren.
    This is mostly the case with financial and operational forecasts prepared by businesses. Too much confidence is placed on what numbers will be achieved and not on how they will be realized. Unfortunately, many business falter when it comes to executing their so called brilliant plans. Why? They ignore both internal and external signals influencing performance, and fall straight into this “fallacy of planning” trap. There is a mistaken belief that “we are better than so and so and do things differently” and thus decision makers fail to learn important lessons from past failures. Bringing objectivity to the conversation is very important.

    • Lauren Broderick June 6, 2017 at 8:38 am #

      Hi Peter! Thanks for reading and commenting! I definitely agree and have seen entrepreneurial types completely ignore warning signs. Sometimes, sheer luck will help them through. But most times, it comes back to bite them. As a financial leader, you can help guide them, point out those red flags, and steer them towards a financially successful path.

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