Stacking the Odds: Forecasting Growth
Cover Story, by Mark Robertson, Managing Partner April 1st, 2006
Every journey starts with the first step. Take a deep breath and let the marching begin..
What can we learn from the growth trends and characteristics of teenagers that we can apply to investment analysis?
If you invest in stocks, you know the feeling. You’ve done your homework, covered all the bases in your studies and the time comes to click that [Place Order] button. For many of us, a paralysis sets in that usually passes in a few moments. Those with deeper afflictions can point to opportunities lost.
If you’re facing an investment club decision or presentation, the group often does its best imitation of a statue while everybody present is hammered by some form of stage fright. There is no such thing as the perfect crystal ball. Uncertainty and fear are part of life.
We hope that Manifest Investing helps you to know that we’re all in this together, providing some enabling support to suppress the fear and remove the mystery.
Every journey starts with the first step. Take a deep breath and let the marching begin.
No matter how you feel, please know that you’re not alone. It might feel that way but virtually everybody who has ever done this has experienced feelings similar to (if not identical) to what you’re going through now.
As we said, you’ve done your homework and completed a careful evaluation of the merits of a particular investing opportunity. You should also know that despite doing more research than is humanly possible, there is always a chance that the unexpected, unrelated and literally inconceivable will jump up and bite you.
It comes with the territory. Patient and disciplined long-term investors take a deep breath and exercise some faith that we’ve done all we can to stack the outcomes in our favor.
Feel better yet?
Uncertainty ranks right up there with gravity. It’s reliable and sometimes uncomfortable. We think you should relax and accept the fact that forecasting is rarely easy as evidenced by these fearless forecasters that have trailblazed before us. How many of these timeless predictions have you seen before?
Fearless Forecast Hall of Fame
“Heavier-than-air flying machines are impossible.” — Lord Kelvin, President, Royal Society, 1895.
“Who in the world would ever want to hear actors talk?” — H.W. Warner (1881-1958) Founder of Warner Brothers, 1927.
“The stock market has reached what is certainly a PERMANENTLY high plateau.” — Jerome Fischer, Yale University of Finance, Autumn 1929.
“I think that there is a world market for maybe five computers.” — Thomas Watson (1874-1951) Chairman, IBM, 1943.
“There is no real reason that anybody would ever want a computer in their home.” — Ken Olson, President, Chairman & Founder, Digital, 1977.
“640K ought to be enough for anybody.” — Bill Gates, Microsoft, circa 1981.
“Grading” Your Work
The next time you make some harsh assessments of a research report, consider the report card given here:
“Interesting ideas… well-formed, but I must give you a failing grade. In order to pass my class… idea must be feasible.”
Those timeless words were spoken by a Yale University professor to Fred Smith, about his thesis conceptualizing overnight delivery.
Fred left college and founded Federal Express.
Investors: Natural Prognosticators
At a 2001 meeting of the National Association of Investors Corp, CNBC chief economist Marci Rossell talked about characterizing economic (and company) growth using something fairly easy for all of us to recognize. She suggested that growth be explored and understood by thinking of the growth of our children.
The “long-term growth rate trend” changes depending on the age of a child. Inherent growth is predetermined by genetic code, which given proper nutrition delivers some semblance of predictable growth.
To demonstrate, let us try to predict how tall my teenage son Alex will be. (Yes, that’s Alex on the first page.) What questions come to mind? At a recent investment education conference, the audience and I explored the question as we tried to build a height forecast for Alex.
How old is Alex now? He just turned 16 years old.
How tall is he now? Good question and a powerful piece of information. He’s approaching 6-1.
Does he eat well? Those of you with teenage sons will be able to relate to this one. Yes, he makes a difference on the Kellogg’s income statement whenever he sits down to breakfast. Pizza is a staple but his overall nutritional choices are above average.
How big are his feet? Great question! His toes are getting pinched in his size “13” shoes right now.
How tall is his father? On a good day, I approach 6-1 too. Any other tall relatives? Another really good question. He bears a strong resemblance to his maternal grandfather who is 6-5 or so. A great uncle on his father’s side was 6-4. He ate cereal like Alex. His mother is 5-10 or so but her growth was slightly stunted (on purpose) by a medical condition as a teenager.
Have you ever received an estimate from a medical expert as to how tall Alex might become? Wow. We’ve done this a few times and I’ve gotten this question only once. The answer is no, but it’s a really really good question.
Based on the information collected, the average forecast from the audience will typically be 6-5 with a range of 2 inches in either direction. The audiences who ask about shoe size generally estimate higher.
It’s actually a fairly short jump from understanding growth of our teenagers to asking the right questions about the companies that we study. Howhas the growth been achieved? What will the company do to continue to grow and maintain profitability?
Stacking the Odds
Several years ago at a reunion of college friends, the subject of investing came up. This was before the go-go years of the late 1990s. One of my friends observed that stock market investing is not very different from riverboat gambling.
I’m generally reluctant to use gambling examples when explaining the merits of strategic long-term investing, but in this case, the shoe fits. When we develop expectations by studying companies and growing our own assessment of the quality and projected returns, we’re effectively stacking the odds in our favor. We know that we don’t have to play every hand and we can wait for the opportunities that seem more probable to work out in our favor.
I’d compare it to a game of Texas Hold ‘Em. In this poker game, you receive two cards and build the best hand with your two “pocket cards” and five community cards from the center of the table. A player that is dealt “pocket aces” has the highest probability of winning — because this is the strongest starting hand. Mathematically, the probability that pocket aces will defeat another hand is 93%.
We can compare our quest and study of relevant information to being extremely selective about which “hands” to play. Our studies mean that the pocket cards (for every hand at the table) are visible to us.
The average investor chooses their seat at the table without seeing the cards. The choices are made by dartboard or index fund — a really big dart board. Those who chase hot stock tips are playing in a game where the best hands have already been taken.
The Power of Information
We build our forecasts and make comparisons that define our quality rating for the companies we study. Forecasting is usually uncomfortable for for most people. Do not be afraid. Your instincts will lead you to the right questions and answers.
What are the influences on quality and projected returns? Together, we learn where to dig and which seats at the table have the highest probabilities for success. We also know that pocket aces will not always win — but will succeed more often than fail.
Patience and discipline add up to a powerful advantage over the long run.
Mark Robertson
Mark Robertson is founder and managing partner of Manifest Investing, a source for research and portfolio management focusing on strategic long term investors.