There are actually many different kinds of investors. There are growth investors, momentum investors, quant investors, factor investors, and of course value investors. In addition, there are near limitless permutations of each type. Nevertheless, investors can be categorized broadly into two big buckets.
One group of investors try to make money by looking at the outlook and trend of a stock. They try to predict or forecast the future of the stock and they hope to make a profit by making better predictions of the future than the rest of the market. These are the types of people who are right now saying things like, “I think the Coronavirus is going to push more people to shop online, and therefore I’m going to buy Amazon or Shopify, because their business will grow because of that trend.” They are very focused on forecasting and in order for them to do well, they need to be very accurate with their forecasting.
The second type of investor is less interested in predicting the future but is more interested in value and the price they are paying. They would say something like, “I can buy stock in Canadian Natural Resources at half of what its assets are worth, so I’m getting a great deal and should do well on my investment.” These investors are more interested in valuing what they think something is worth right now… and paying less, rather than predicting what will happen in the future.
Now there are no right and wrong ways to invest. What works for some investors may not work for others. When I invest I definitely tend to be more value focused than forecast focused. But I also think that when we look at these two extremes of investing that there is room for some middle ground between the two styles. The important thing is to know where to draw the line.
Let me give you an example. Many things about the future are simply unknowable. As Yogi Berra said, “Predictions are hard, especially those about the future.” No one could have predicted that there was going to be a coronavirus pandemic in the winter and spring of 2020. Some people might have speculated that a global pandemic was a possibility, and still others might have guessed that there would be a recession and they got lucky, but nevertheless the fact is that our ability to predict things like the pandemic is extremely limited. There are simply too many unknowable variables to fashion an accurate forecast. Similarly, trying to predict the outcome of the pandemic is next to impossible. There’s a reason why the models of projected deaths and infections (at least so far) tend to be way off the actual numbers. This has never happened before, so to ask even experts to model what is going to happen with any degree of accuracy is a fool’s errand in my opinion.
Now this does not mean that forecasting anything at all is a fool’s errand. There are some things we can predict with a pretty high probability of being right. For example, I can predict that the sun will rise tomorrow and there is a pretty high probability that I am going to be right. I can also predict that a company like Berkshire Hathaway will presumably be able to weather the current crisis and should still be in business for a long time yet to come. That prediction may not be as likely as the rising sun, but it is still a pretty high probability that I will be correct, high enough that the information is useful to me. The difference that separates these forecasts from the models of casualties from the COVID 19 pandemic is two things.
The first thing is that my predictions about Berkshire and the rising sun are not very specific. The more specific your prediction, the harder it will be to get it right. I CAN’T predict exactly what Berkshire Hathaway’s earnings will be 10 years from now, but I CAN predict that they will have earnings with a pretty high degree of probability. By making my prediction more general, I make it much more likely to be true. Predictions about the exact number of casualties COVID 19 will have, or what the GDP growth rate will be this year, or what the employment rate will be 6 months from now, are very specific predictions and should not be relied upon to be completely accurate, because inherently they won’t be accurate.
The second thing about my predictions is that with each of my predictions, there is a long historical track record that is consistent. The sun rises every day, so it’s reasonable to assume that will continue into the future. Berkshire Hathaway has generated operating profits for over 50 years now. During that time there has been many crises which negatively impacted their business, but through it all they have consistently grown their profits over time. It’s likely that those earnings will continue and will continue to grow into the future. With the coronavirus, there is no past history to look to. The closest we can get is the 1919 Spanish Flu, but that was a world where if people wanted to travel from London to New York, they got on a boat and it took them a week to get there. Not to mention that it is a different disease entirely with different characteristics. Modelling how fast the Spanish Flu spread and then trying to apply it to COVID 19 is not going to get you a very accurate picture for this Pandemic.
So there are some things we can predict, and some things we can’t. And there are reasons why we can predict some things and are simply unable to predict others. With technology, our ability to predict things is actually getting better. I recently read a book by Michael Lewis called The Fifth Risk. One of the interesting tidbits that came out of that book is that weather predictions nowadays are actually pretty accurate. Satellite technology and data mapping has made the weatherman a much more reliable forecaster than in the past. Their predictions are still limited to the very short term, i.e. the next 24-72 hours, but that can still be very valuable information, especially when it comes to forecasting extreme weather. If your meteorologist is predicting a hurricane, you have the ability to get out of town before it hits. There are limits to this still, if your meteorologist is predicting an extremely cold winter in 2021, you probably shouldn’t rely on that too much and go out and buy natural gas futures.
The secret of course is drawing the line between what we can predict and what we can’t. This can be very difficult to do. What makes it harder for investors is that in order for them to do better than the average, their predictions need to be both accurate, and their prediction needs to be something that is not already factored into the price. I can predict that the sun will rise tomorrow, but that’s not really information that everyone else doesn’t already know. That’s why forecasters stretch their predictions and make them more specific, so that they can at least pretend they know something the rest of the world doesn’t.
I think it’s very hard to make money this way, and that’s why I choose to focus more on value. If I buy an investment at a steep discount to it’s intrinsic value based on a conservative and general forecast of future earnings for that company, then I can be really wrong with my forecast and still get a satisfactory result with my investment. That’s why I am not worried about COVID 19 even though I didn’t predict it would happen. It has certainly impacted results in the short term, but it hasn’t really changed our long term forecasts for any of the companies we own. Even if things stay bad for quite a while, the margin of safety we’ve gotten from buying at a discount should allow us to achieve a satisfactory result in spite of the pandemic, and that’s a forecast which I think is quite probable.
- Craig White, BA, LL.B., CIM®
Craig White is an Investment Advisor at Endeavour Wealth Management with Industrial Alliance Securities Inc, an award-winning office as recognized by the Carson Group. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.
This information has been prepared by Craig White an Investment Advisor for Industrial Alliance Securities Inc. (iA Securities) and does not necessarily reflect the opinion of iA Securities. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor can open accounts only in the provinces in which they are registered.