Selling Bad Stocks Before The Problem Materializes

Dow Chemical shareholders escaped significant capital loss in the 1960s when it sold a dietary suppressant called Ayds to Purex and then Jeffrey Martin, Inc. It was a multi-million dollar business that had become one of the leading weight loss products in the early 1980s. That strong brand, however, witnessed an 87% decline in sales between 1983 and 1988 as the HIV scare created a mental model connection with acquired immunodeficiency syndrome. Anytime you are trying to build brand equity, you must be aware of associational risks that trigger the horns and halo effect.

Previously, we have discussed how an individual person is able to generate a halo effect. Because Warren Buffett has amassed a lot of money, doesn’t engage in ostentatious displays of wealth, and has a lively sense of humor, he is able to receive the benefit of doubt in many other areas of life (people assuming his political and economic commentary is unbiased, for example).

Sometimes, when the positive association with a brand is so strong, a mere hint from an unrelated firm can tap into such a halo effect. For instance, it is a common practice for car salesmen in St. Louis to decorate their dealerships and advertisements in red and even play “Take me out to the ballgame!” in the background. The purpose is to reach and grab some of the favorable sentiments that St. Louisans have towards the baseball Cardinals, and derive some economic benefits from the unearned halo effect.

On the other side, Coca-Cola pulls its advertisements during periods of national catastrophe. You didn’t see any Coca-Cola ads right after 9/11. There is no Coke ad on the cable network before you hear the grand jury results from Michael Brown. As Charlie Munger said, “Coca-Cola doesn’t want to be associated with presidential funerals and so on.”

Although this strategy may seem obvious, it not common in the industry. Coca-Cola negotiates clauses in ad contracts with networks that permit it to pull advertising entirely when some type of adverse national event occurs. The customary industry practice is to negotiate reduced ad rates during unattractive advertisement periods, but Coca-Cola decides that it doesn’t want any type of horns mental model to affect its brand. It should be remembered that Coca-Cola has the type of deep pockets to dictate strategy.

This is why I am more sympathetic than most citizens to the attempts of Disney, the NFL, and corporate America in general to aggressively protect their trademarks, copyrights, and general brand associations. The ability to charge premium pricing, and maintain strong sales growth, is heavily related to that flash second of click-whirl thought that people have upon hearing the sound of your brand.

The slings of fate can be cruel–just look at Gerry Sandusky, a sportscaster in Baltimore. He now has to spend his entire life dissociating himself from the Jerry Sandusky of Penn State infamy (a man whom he has nothing in common besides a name). It is so bad that Gerry Sandusky’s Twitter bio states “I am Gerry with a G / No relation to the former Penn State Coach.” In a world of thirty-second elevator pitches, he has to spend fifteen seconds explaining to you that he is not associated with Jerry Sandusky. In the world of brands, you can be forced to carry a cross for sins you did not commit.

Take a look at something like Credit Sesame. It is an app tool that has very rich venture backing from the likes of Menlo Ventures and Inventus Capital. The growth has been staggering, as the registered users have uploaded over $35 billion worth of loans for analyzing. It may very well go public in the next few years, and will undoubtedly tout its wild earnings growth, low capital intensity, and bright future to gain market share in the new internet world economy of finance. And founder Adrian Nazari deserves all the credit in the world for putting in the years of hard work to bring to reality his entrepreneurial muse.

But, even setting aside my usual bias against IPO investments, there is no way I would purchase stock in Credit Sesame. That is because China is launching Sesame Credit, a credit monitoring service that will be mandatory for all Chinese citizens by 2020, to create credit scores tied to online purchases and social media postings. It’s the scariest human rights violation waiting to happen that is yet to reach the mainstream: spend some time researching the scoring algorithm of Sesame Credit and you will quickly realize the underreporting of this issue is one of the great failures of the mainstream media in recent years.

The American Civil Liberties Union has issued this warning: “The system is run by two companies, Alibaba and Tencent, which run all the social networks in China and therefore have access to a vast amount of data about people’s social ties and activities and what they say. In addition to measuring your ability to pay, as in the United States, the scores will serve as a measure of political compliance. Among the things that will hurt a citizen’s score are posting political opinions without prior permission, or posting information that the regime does not like, such as the Tiananmen Square massacre or the Shanghai stock market collapse. It will hurt your score not only if you do these things, but if any of your friends do them. Imagine the social pressure against disobedience or dissent that this will create.”

In short, China is aiming to use the score created by Sesame Credit to determine eligibility for loans, job, housing, and other benchmarks of societal participation. Everything will be monitored. If you purchase work boots and healthy food, your score will improve. If you debit junk food and are “Facebook friends” with someone critical of the government, your score will go down. It is expected that you will get bonus points for tattling on social networks–if someone you know complains about the Chinese government and you rat it out with the click of a button, your ability to get a loan and your eligibility for jobs just improved. I imagine this program will ripen into an intense matter of public debate eventually.

But the backlash in the United States that will eventually occur in response to the Chinese application Sesame Credit will eventually harm the long-term prospects of the American credit-reporting app Credit Sesame that has no relation to the Chinese efforts. It won’t matter that they are unrelated; the association model will impair the prospects of Credit Sesame. Heck, I’m writing an article on the matter and I had to double-check to make sure that I am distinguishing Credit Sesame from Sesame Credit properly (and heck, some of you might have to look back in the article to determine which one is which). If Credit Sesame were a publicly traded stock, I would sell it immediately. Under no situation would I consider the IPO. The risk of human rights abuses from Sesame Credit are substantial, and it will almost certainly cast a horns effect over Credit Sesame’s long-range growth. If I were CEO Nazari, I would rename the app immediately, take the hit, and rebuild. It is unfair, but after the initial pity party, I would rather correct a problem than compound it.