Almost every release of company or economic data is preceded by a forecast. For example, analysts continually seek to estimate how a company’s revenue and profit will change on a quarterly basis. Likewise, economists aim to accurately forecast jobs data, inflation figures and an economy’s growth rate.
However, all of those forecasts are trying to predict figures that are inherently unpredictable. Certainly, estimates can sometimes be close to, or even exactly the same as, the data they are trying to forecast. But on many occasions, they are just plain wrong. As such, investors who rely on them to make decisions on how to apportion their capital may need to revise their views after the real data has been released. This suggests that forecasts are of little, if any, use to long-term investors.
Indeed, Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) Chairman Warren Buffett (Trades, Portfolio) has previously commented on the lack of value forecasts provide. He said, “Forecasts may tell you a great deal about the forecaster; they tell you nothing about the future.”
Known-knowns
Of course, forecasts are heavily relied upon across the investment industry. As such, avoiding them may seem like a radical approach to managing a portfolio. However, beyond providing some justification or comfort for investment-related decisions, estimates are unlikely to be of significant value in the investment process. The fact they are a forecast for an unpredictable event rather limits their ability to positively impact on how to allocate capital.
In my view, it may be more logical to instead focus on "known-knowns," rather than the "known-unknowns" that forecasts seek to accurately predict. Known-knowns include historic data, such as a company's debt levels, interest coverage ratio, return on capital employed and many other facts and figures that can be used to judge its performance over a period of time.
They can be used to determine the risk of a specific company, in terms of the threat of permanent loss of capital, as well as whether its shares trade below their intrinsic value. Buying stocks with sound fundamentals can shift the odds further in an investor’s favor.
A simple strategy
Of course, using historic data to make investment decisions also has its limitations. Notably, it is quickly out of date after being released and is very unlikely to be perfectly replicated in the future. As such, a simple strategy that contains other elements, including diversification and a long-term view, could reflect a sensible approach to portfolio management.
Moreover, since forecasting is impossible, investors must prepare for any eventuality in future. This means ensuring they are not reliant on one or more companies for their returns and that they provide their holdings with sufficient time to recover from the downturns, corrections and bear markets that are part of the stock market’s fabric, but which cannot be seen ahead of time.
