The other day I was reading a research report about the people who attempt to predict how much money companies will make each year. These people are called analysts, and the money companies make is called earnings.
The reason analysts, who work for big Wall Street firms, spend so much energy attempting to predict earnings is because earnings drive stock market returns. The more money companies make, the higher the stock prices of individual companies can go – and the more valuable the stock market as a whole will become.
If you can accurately forecast earnings, you have the potential to make a lot of money.
Unfortunately, it’s not an easy job.
But the research report I was reading was making the case that analysts actually do a better job than it may seem. The crux of this argument was that over the last 25 years analysts’ collective earnings forecasts missed the actual results by an average of 6.3%. Not bad, but definitely not good enough to reliably make money off the predictions.
However, the author of the report explained that if just four years were removed from the 25-year sample set, then the analysts’ forecasts were nearly spot-on to the actual results, off by only 1.1% on average. The four years in question were 2001, 2008, 2009, and 2020. In order, those years faced an attack on America, back-to-back years of the worst financial crisis since the Great Depression, and an economic lock-down from a pandemic.
Analysts missed their mark by an average of 33% in those four years.
In essence, analysts made good predictions most of the time, but terrible predictions on occasion.
But that’s like a golfer saying, “If you don’t count those two holes that I double-bogeyed, I would have finished the round at par.”
Yes, but you didn’t.
In life – and certainly in investing – you can’t simply count the good and forget the bad. That’s exactly why analysts’ jobs are so difficult; they are attempting to divine the future. And if there’s one thing that’s for sure, it’s that the future is predictably unpredictable.
Nothing stays the same. Oddball events come out of nowhere. Reality is sometimes just as strange as fiction. We will never have extended “normal” periods in the market. The world is too unstable. People of this world are too fickle.
Charlie Munger, the architect of Berkshire Hathaway, was fond of saying, “All I want to know is where I’m going to die so I’ll never go there.” But we can’t know the future. If we did, investing would be a whole lot easier.
That being said, uncertainty creates opportunity.
Just look at the four years mentioned earlier. The reason the analysts’ forecasts were so wrong in those years was that something came out of left field – something no one saw coming. In all four instances, the stock market got whacked. Prices dropped. Returns were deeply negative. Investors started panicking.
But all four years also turned out to be tremendous buying opportunities.
While the world was freaking out, investors who kept their composure and silently purchased investments at bargain bin prices were rewarded. By doing something as simple as buying during times of uncertainty and holding those investments until the gray skies turned blue, those investors made a fortune.
Most years the stock market produces pleasant results. Occasionally it cranks out something terrible. We can’t have the good years and avoid the bad years.
It just doesn’t work that way – for analysts, golfers, or investors.