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Executives have two different types of investment war stories: those that are akin to the proverbial fish that get away and those that involve overestimating opportunities. An example of the first type is the situation where Blockbuster had the chance to purchase Netflix. For the second, look at Eddie Lampert buying Sears for over ten billion dollars and how it went bankrupt later.

We are just not good at conducting analyses for “size of the prize.” Under- and overestimation problems have a few errors in common. The first is confirmation bias. Every expert brings confirmation bias to the table. The next two mistakes could be considered sins of omission. They involve treating this purely as a theoretical math exercise. Consumer passion must be factored in lest the size of the prize is too low. But practical application must also be factored in lest the size of the prize is too high.

The first error is an integral part of this task’s most common approach, which is seeking out a comparable example or comp as an analogy. Investment bankers are fond of comps because they give a quick shorthand in examining potential EBITDA or earnings before interest, tax, depreciation, and amortization multiples about other transactions. For comparison, this is somewhat like what an agent of real estate does to assist in valuing your residence before you make a sale. But what happens, to follow the analogy, if the comps selected are single-family homes and the property in question is a luxury condo happening to be within the same zip code? This is, unfortunately, something that happens far more frequently than we realize.

Executives also experience confirmation bias. Some have powerful incentives to select a potential opportunity and throw darts at it, not only because the majority of acquisitions has an unfortunate habit of failing to pay back; they also have to integrate and deliver promised results. Other executives might overestimate the benefit of a brand new category as they are hoping to buy growth or seeking to cement their legacies fully.

As regards the second error, the misunderstanding of consumer passion typically forms the root cause of the reasons why an analysis for the size of the prize is too low. One way consumer passion is miscalculated is treating everything via an approach of problem and solution, which is rational but lacks an emphasis on the upsides from passion and emotion.