The RBP^® Probability tells us the probability that management will deliver the performance to support the stock price. The probability that management will not deliver the performance to support the stock price is also important. Behavioral biases can affect the assumptions that analysts and active managers use in their valuation models, causing prices to become misaligned with management’s ability to deliver. This may be an indication that behavioral biases have pushed the stock price to irrational levels and in such cases we feel that these stocks should be actively avoided.

The Behavioral Risk Indicator is defined as one minus the RBP^® Probability. When this is very high, we feel that the revenue growth required to support the current stock price is not attainable given the company’s historical growth rates. This makes a purchase of the stock risky, but does not necessarily imply poor returns. Nevertheless, by avoiding this type of risk whenever possible, we believe we can achieve higher returns.

In the hypothetical example below, the RBP^® Probability is only 35%, indicating that based on management’s historical ability to deliver, there is only a 35% probability it will deliver its Required Business Performance^®. This makes the company’s Behavioral Risk Indicator relatively high, 65%. At Transparent Value we seek to avoid companies with high behavioral risk such as this.