Before last Friday Nintendo’s shares increased in value by 56% based on the popularity of Pokemon Go. The meteoric rise in Nintendo’s share price is a great example of the Substitution Heuristic.
The Substitution Heuristic happens when we’re faced with a tough question. If the question is too hard we will substitute the hard question with an easier one.
With Pokemon Go the hard question is how much will the game’s revenue contribute top Nintendo’s bottom line?
Pokemon is actually owned by The Pokemon Company, a privately held company. Nintendo owns a third of The Pokemon Company. The game Pokemon Go was created by another privately held company Niantic. Nintendo owns a piece of Niantic too. Like all apps and games offered on iPhones and Android phones, Google and Apple get a cut of all revenue generated.
Figuring out Nintendo’s share of Pokemon Go’s profit after everyone’s else’s share is hard. It’s not impossible, it just takes time and effort.
The easier question for people to answer is “if Pokemon Go is super popular then which company is associated with Pokemon?”. The answer is Nintendo.
You can see why the knee jerk reaction in the stock market is to push the price of Nintendo’s shares up. If Pokemon GO does well then surely Nintendo will do well too.
Substituting a hard question for an easy one when investing leads to problems. Nintendo’s ADR share price is down around 28% since its recent high and shares in Nintendo’s ADR dropped over 10% after the company answered the hard question for everyone.
On Friday, Nintendo sent out a warning to stockholders explaining all this: “Because of this accounting scheme, the income reflected on the Company’s consolidated business results is limited.” Skittish investors started to sell immediately, and by the end of trading in Tokyo on Monday, shares had dropped to ¥23,320.
When buying a stock you have to ask yourself have you really answered the hard question? Or did you substitute the hard question with an easier one?