In this report, we have to look at what may be the likelihood of one these two companies being a good investment and why the other may be a bad investment from a behavioural finance stand point, also to take into consideration the limits behavioural finance in stock analysis, particularly in regards to analysts perspective and an investors perspective. The two companies which are identified are from the US and are well known, one being a company that has been around for a very long time and the other only having been around for a short period. In the context of the broader equity markets since post financial crisis; has stock markets reached their previous highs due to an increase in the fundamental drivers or is there a bubble and a case of “Irrational Exuberance” such as termed by Alan Greenspan during the Dot.com bubble based on sentiment. We will try to identify using data and behavioural finance which may or may not be a prudent investment, taking into context the problems of market sentiment.

Netflix: Firstly, Netflix is listed on the NASDAQ; in measuring past performance against a benchmark, the share price does not track the NASDAQ composite index and the share price has increased from $40 in early 2009 to $386 in 2014 with a market cap of $23bn, whereas the index in the same timeframe has gone from 1400 to 4100. The company has never provided its shareholders with dividends and it has earnings of $1.6bn for 2009, $2.1bn in 2010, $3.2bn in 2011 and $3.6bn in 2012.

In a recent article of Forbes “Netflix currently trades for 325 times trailing earnings and 55 times expected 2014 earnings”, which indicates that the share price is extremely overvalued and there is a lot at play in regards to its substantial increase in share price. It would seem this is a highly speculative investment and its share price does not accurately reflect the fundamentals of the company, this would indicate that this is a very risky investment and that investor sentiment is involved possibly creating a bubble.According to analysts’ predictions (taken from FT) share price forecast for the next 12 months have a median target of $375 p/s, a high estimate of $500 p/s and a low estimate of $175 p/s, the majority of analysts advise that investors should hold and that the shares will continue to outperform the market.Based on the earnings reports and the reported and forecasted results, Netflix has just slightly beaten expectations since 2010 to 2013. For 2013 reported results have been above analysts’ expectations for each quarter, also analysts’ revenue expectations for 2014-15 are double the preceding year with an average growth rate of 134.54%.

Coca-Cola: Secondly, Coca-Cola is listed on the NYSE, in measuring past performance against a benchmark, the share price tracks the S&P 500 Index very closely as the share price has doubled from $20 in early 2009 to $40 in 2014 with a market cap of $171.5bn, so

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has the index from 680 in 2009 to 1840 in 2014. The company gave investors $1.64 dividend per share in 2009 and $1.12 dividend per share in 2013 with net operating revenues of $30.9bn for 2009, $35.1bn in 2010, $46.5bn in 2011 and $48bn in 2012.

In a recent article of the Wall Street Journal it highlighted that “Coke shares trade at 18 times 2014 earnings forecast and recently yielded 2.8%. The yearly payment of $1.12 a share is expected to hit $1.42 in three years. That's 3.6% of the stock's recent price”. This could indicate that the share price might be a close representation of its fundamentals but again might be slightly overvalued by analysts. However, their stock price remains very stable with very little excessive volatility and is seen as a less risky investment, from its historical share price it is seen as a long term investment with consistent dividends. In addition, the shares have gained 23%, in comparison to the 46% gains for the Standard & Poor's 500 index since the start of 2012, which indicates that it is currently underperforming the benchmark.According to analysts’ predictions (taken from FT) share price forecast for the next 12 months have a median target of $45 p/s, a high estimate of $52 p/s and a low estimate of $40 p/s and the majority of analysts advise that investors should buy and that the company will outperform the market.Based on the earnings reports and the reported and forecasted results, Coca-Cola has been in line with analysts’ expectations for each year from 2009-2012, and in 2013 their results have come in line with forecasts for Q1 except for Q2 and Q3 of earnings reported, also analysts’ revenue forecasts for 2013-2014 are an average growth rate of 6.48%.

Analysis: Behavioural finance indicates that companies share prices deviate from fundamental values for long periods due to heuristic-driven bias and frame dependence. Such heuristics that could determine the likelihood of either stock being a good or bad investment, and also whether market are efficient or not. They would be: Representativeness: in which explains why share prices deviate from fundamental value due to investors being overly optimistic about the future returns based on past good performance and overly pessimistic about future returns based on past underperformance, this might explain the excessive optimism in earnings for Netflix in comparison to the conservative estimates of Coca-Cola over the next 2 years. Overconfidence: With analysts’ expectations so high, is it likely that they are correct in their assumptions about both companies outperforming the market? This stems from conservatism causing mispricing as they do not adjust their earnings estimates in response to previous earnings announcements. Therefore, especially in regard to analysts’ expectations about Netflix, is why there has been continued surprises and this explains why they are overconfident, this may be why the stock has higher returns than the overall market. Gamblers Fallacy: When

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an individual erroneously believes that the onset of a certain random event is less likely to happen following an event or a series of events, therefore people tend to apply the law of big numbers to small numbers and in doing so incorrectly predict a reversal; so in the case of both companies investors and analysts may believe that because they are suffering with overconfidence in their beliefs that continual growth will occur. In regard to Netflix, according to analysts stocks could fall with a broad market decline but it will continue to outperform the index, even though it has increased dramatically, they predict that it will continue to go up. The problem with this is, analysts were predicting the same leading up to the stock crashing from $280 p/s to $70 p/s in 2011, even though it beat analysts’ earnings estimates it crashed because 800,000 subscribers left in a very short period of time. Anchoring: Analysts have their expectations anchored in the past and this explains why they are continually being surprised by the earnings announcement, this is certainly the case for Netflix as all expectations have been well below the actual earnings, whereas the case for Coca-Cola is very different as their expectations and the reality are the generally the same, which helps to explain the stocks stability.

I would argue that heuristics are playing a role in the deviation from the shares fundamental value, this is certainly the case in Netflix as there seems to be a herding and bandwagon effect by investors, as positive news regarding its performance is having a big impact on the companies share performance over the short term which could explain how its price has increased tenfold since 2009. According to the Barberis, Schleifer & Vishny model; there is an under reaction of stock prices to news such as earnings announcements, and overreaction of stock prices to a series of good or bad news. As both of these companies are watched very closely and news continues on matters relating to the companies this will invariably impact on the price, but this is going to be of much greater impact on Netflix than on Coca-Cola as news may make prices much more volatile.

In regard to Netflix, in the context of this model as it has had a long record of good news it has led to its stock being overpriced and eventually would have low average returns after it, therefore its overvalued price will eventually revert to its mean. As it has continual good news, it will invariably impact on its price in an upward direction, but just as in the in the late 90’s with the Dot.com bubble investors should be wary of a company that has not consistent concrete performance with erratic share price movements driven by herding and news announcements. This will invariable mean that the price will continue to be volatile and may drop considerably to revert to its fundamentals, as an investor looking for a solid long term investment, it is not a good option, however for a short term risk loving investor investing in Netflix may produce short term rewards but will not remain so for long.

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However, in regards to Coca-Cola analysts and investors could be using representativeness as a heuristic, because Coca-Cola is seen as a growth stock because of its consistent earnings growth; this does not mean that it will sustain this in the future, on the flip side if it continues to produce consistent growth it would be a less risky investment for the medium to long term in comparison to Netflix. Also investing in Coca-Cola, people must be careful to avoid Hedonic Editing, in which they would see the income from dividends as a separate frame, indicating that they perceive the income as a silver ling against loss if the stock doesn’t perform and the income is seen separately as a bonus when prices increase. It is important for an investor not use metal accounting and to make the distinction between capital gains and dividends as they are one in the same and any income should be reinvested to gain from compound interest. According to Barberis et al (1998) “when a positive earnings surprise is followed by another positive surprise, the investor raises the likelihood that he is in the trending regime, whereas when a positive surprise is followed by a negative surprise, the investor raises the likelihood that he is in the mean-reverting regime”. Based on this assumption, this would indicate that Netflix is in a trending regime and that Coca-Cola is in a mean-reverting regime, which could mean that Coca-Cola is following the mean (average) therefore having greater stability, whereas investors perceive Netflix to be in a trending regime going upwards, but how far can it go up. Therefore based on their theory, stocks with consistent good news and past high returns are overvalued and investors can gain abnormal returns by betting against the overreaction to consistent patterns of good news (Netflix), whereas stocks that have had a history of bad or mediocre news become undervalued and investors can gain returns from investing in these stocks(Coca-Cola).However taking these biases and heuristics into account, there is substantial contradictions between modern theories of investment and those of behavioural finance (e.g. an accurate measurement and investor tolerance for risk), the behavioural theory will not accurately predict or explain stock price movements or investor behaviour from the past or to the future, it only seeks to look at it from a cognitive perspective. As this field is still in its early stages it may be prudent to take this into consideration from an investment standpoint and be cautious with any decision, whether it is based on fundamental, technical or behavioural analysis.

Conclusion: In summary, with the limitations of behavioural finance as a tool to identify which stocks may be a good or bad investment, from the analysis above it would seem more prudent that for a secure investment would be in Coca-Cola. Whereas, Netflix short term performance is outstanding, and an investor with a high appetite for risk may invest, it is obvious that the company’s share price is being impacted by much more than its fundamentals and analysts’ expectations.

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