I had been thinking about a Blog that stresses how important it is for us to try to peep into the near Future and it had merely got to the stage of being on the List of potential Blog Ideas (’The Slate’) but the recent fiasco at Utilitywise UTW has given me fresh impetuous to start work on this one because I see particular relevance as Everyone and his/her Mutt hate UTW but it is quite often the case that when something is collectively hated by the Herd, it is time to be buying.
Stockmarkets look ahead, not behind. Windscreen not Rear View Mirror.
“Objects in the Rear View Mirror may appear closer than they are” - yes, I have no idea what Meatloaf was going on about here either. And why do all Harley’s have this engraved text obscuring your vision in their mirrors? Downright Dangerous if you ask me……
I’m pretty sure I have read/heard many times over the years things like “Stockmarkets look 6 months into the Future” or “Stockmarkets look a year ahead” or similar statements - I suspect this is very true as witnessed by the ‘Trump Bump’ when the Markets rallied strongly on the prospect of Trump following Economic Policies which were likely to boost the US Economy and this is probably true at an Individual Company/Stock level as well.
I am sure people are missing a trick here - in particular, many People seem to overlook Recovery Plays because they are stuck in a mindset that taints the Business with the Past when perhaps they should be thinking about the Future and how things are changing. In psychology terms, this is ‘Recency Bias’ where our judgement is clouded by a hangover from the Past so that we overlook what is changing for the Future.
The Attraction of the Past
I may be entirely wrong here, but I get the impression that many Investors put a lot of emphasis on the Past and not so much on the likely Future - to me this is completely the wrong way to be looking at things and for me perhaps my emphasis on Future Gazing is as much as 80% of any Decision to Invest in a Stock (if not more).
I think there are particular reasons why many People focus on the Backwards-looking stuff - and I am sure I have come across many techniques of Fundamental Analysis which are based on a Company’s history - and with very little emphasis on the Future. In a way this makes a huge amount of sense - the Future is unknown (and arguably unknowable) so any attempts to judge what the Future holds for a Company are a total waste of time. However, I just don’t think that is how Stockmarkets work and in reality I suspect that many of the other Market Players who we are competing against / running with are more focused on a likely Future.
It could simply be that in many ways it is easier (lazier? Remember, Daniel Kahneman points out how our ‘Slow Brains’ are very lazy and we tend to default to ‘Fast Brain’ thinking because we don’t like to have to undertake concentrated effort to focus on something) - to analyse the Past we have reams of guff to trawl through, however, to think about the Likely Future we need to be much more attuned to Future Gazing and thinking about how probable Outcomes interact with each other. This is where our ability to imagine stuff comes into play.
This is a key point - obviously nobody can know the Future with 100% Certainty (this comes to the Brexit Debate also - I do laugh when people say things like “Brexit will destroy the UK Economy” - it is nonsense, all they can reasonably say is something like “Brexit might destroy the UK Economy and I put a probability of this happening at 70%”), so what I am saying here is that our Job as Investors is to peer into the Near Future and to come up with a sensible view on what we think is Most Likely to Happen.
In any Purchase of a Stock, we are taking on Risk of the Unknown and we need to use our experience and knowledge etc. to take reasonable guesses at Probable Outcomes and it is best to Buy a Stock which is seemingly Undervalued so that we have a ‘Margin of Safety’ in case we have made significant Errors in our guesswork and of course Risk Management techniques like Small Position Sizes, Diversification and Stoplosses and such like can help reduce the Risks of the Unknown in terms of protecting our Wealth.
By definition Company Accounts are Backwards looking and often massively Out of Date by the time we actually get to see them - in big Companies in particular it would not surprise me if much of what is being reported on is perhaps a year old or more - remember, Accounts are just a Snapshot in Time and a lot gets misreported and collating the Numbers from the bottom rungs of an Organisation up to the Senior Levels can take a lot of time and result in a lot of ‘massaging’.
This backwards element to Company Accounts could very easily drive people to having a Backwards-looking mindset - but I would contend that this is the wrong thing to be doing. In a similar way, Valuation techniques like the Schiller CAPE Ratio which looks at Average Earnings over perhaps the last 10 years, seems a pretty silly device to me. It really makes no sense as the Business World is so rapidly changing and it might only really work for Huge Companies with very stable Sales/Profits/Products etc - I am not really sure many Companies like that exist (that might well have been different in the 50s, 60s, 70s when perhaps the Business Environment was much less competitive/dynamic). Perhaps Mars and Nestle are a bit like that but I have my doubts and clearly for new Businesses that have only been around for perhaps a few years, it is of no use whatsoever but they could actually be superb Investments - just look at BooHoo BOO to see what I mean.
Many Data Mining techniques are based on using Historical Data and as per the success achieved by Stockopedia StockRanks there is clearly some value in these methods. However, I suspect it is the case that the Data Mining methods that use some element of the Future (i.e. they incorporate Growth Rates and Forecast Analyst Consensus figures) as well as some Past History, are the most effective. This is just my hunch, I am sure Stockopedia Experts will have a better view than I do on this - but the point is that just looking at History and ignoring a likely Future is probably missing a trick.
However, please don’t misconstrue what I am saying here - the Past is still of value as it helps us understand the likely Future for a Business and to judge the Culture of a Business and how well managed or not it is. But the Past perhaps should be seen this way rather than being used as a key driver for buying a Stock. Indeed, with Recovery Stocks, an understanding of the previous Company Culture/Management enables us to identify when Changes are taking place that are likely to lead to a big improvement in the fortunes of the Business. In addition, with expansion of Product Lines or perhaps a Strategic move overseas, the Past can give us extremely useful insights with regard to how likely or not the Company is to make a success of such opportunities.
But as ever these things are extremely complicated - for instance, although The Past can give us a good sense/feeling of how good a Management Team is, sometimes the actual reality is that Management can seem very good until they suddenly don’t !! For example, Rob Cotton at NCC was widely believed to be a very capable CEO but now he is seen to be a bit of a wally……
How our own Psychological Biases make us more likely to think Backwards than Forwards
There are the usual Biases like ‘Recency Bias’ (we overweight more recent Events in our mind) and ‘Group think’ that partly cause these effects, but also Chris Dillow in the latest Investors Chronicle (Dated 7 July - 13 July 2017) on Page 16 partly touches on this with a great Article called ‘Misleading Profits - Past returns can distort our beliefs about the future’. Here are some chunks of text that I found particularly relevant here:
“Some recent experiments by Pieran Jiao at Nuffield College Oxford provide a novel explanation for such events. He gave some subjects a long position in shares and others a short position, and then showed them the share price moves, so that some saw profits and others losses. He then asked subjects to predict subsequent price moves. He found that those with long positions who had made a profit predicted higher future prices than others. Conversely, those with short positions who had made profits predicted further price declines.
This is not just a laboratory finding. A study of Dutch investors by Arvid Hoffman and Thomas Post has found a similar thing; investors who have enjoyed profits expect further profits, while experience of losses leads to diminished expectations.
What’s going on here is what Dr Jiao calls ‘pay-off based belief distortion‘: experience of good returns leads us to expect more good returns, and bad experiences lead us to expect worse ones.
Pay-off based belief distortion helps explain why bubbles sometimes happen; having made profits, we expect more and so buy even though valuation measures might be telling us to sell.
Some of this is not to say that pay-off based belief distortion is always an expensive mistake; the fact that momentum investing works tells us that it’s often right to expect past good returns to lead to future ones. And sometimes it is cancelled out by another error - the gambler’s fallacy, the idea that good times must lead to bad (I suspect that a lot of what looks like rational behaviour is in fact errors offsetting each other.)
What it does mean though is that we have yet another cognitive bias to guard against. Next time you’re feeling bullish about a share, just ask; do I have objective evidence for this belief, or am I instead being unduly influenced by my past profits?”
I have hacked about at Chris’ text there but hopefully it sort of still makes a bit of sense - and of course much of that is about ‘The Past’ being when a Stock has done well, whereas much of what I am talking about in this Blog is about when Companies/Stocks have done badly but things are on the change (although the Bullets on Future Gazing further down apply to all sorts of Stock situations).
The important thing for us is that we need to try to be Objective at all times and not stuck with former beliefs that may have been valid previously but are now flawed. We must never be married to a particular stance and if we do have a particular Bear or Bull view, we must be open to the alternative viewpoint and we must constantly test our own view - failure to do this will probably mean we lose Money and/or miss great opportunities. We need to be able to change our minds as the Objective Facts dictate and the ability to move from Bear to Bull and back to Bear etc. at various times is extremely useful - being on the ‘Right Side’ of a Share Trade can be something that changes very quickly even for Long Term Investors.
“Hey Wheelie, how do we see into the Future? You got a WheelieTardis or something?”
Ha Ha, if I had a Time Machine I would be sitting on a beach with Richard Branston Pickles and enjoying his fine accompaniments on a Cheese Cracker……
As I think I mentioned earlier, we can never know the Exact Future for a Company and we will get loads of them wrong, but we can take a ‘Probabilistic’ view and decide whether or not to buy a Stock based on our considered guesswork around how the Future is most likely to play out (and allowing a ‘Margin of Safety‘). Here are some examples of things to look out for which could help signpost a Bright Future for a Company:
- Launch of a new Product that is likely to be successful based on previous Product Launches by the Company or perhaps from Market Trials or success of similar Competitive Products which lack some attractive attributes of the new Product. An obvious and apt example here is the move into providing Water Services to its Customers by UTW.
- New Factory Facilities to enable a Ramp-up in Production of the Goods the Company Sells - a great example of this is Accsys Technologies AXS which is massively increasing its Capacity to produce Treated Wood in the next few years. Boohoo.com BOO is doing a similar thing with a huge ramp up in its Warehousing/Distribution facilities in coming months.
- New Sales capabilities - from memory BTG the ‘Varisolve’ Varicous Veins people did exactly this in the US a couple of years ago so that they could push the products out to Customers on a far larger scale.
- An Acquisition that is highly likely to boost Earnings and is complementary to the existing business - especially if funded by sensible amounts of Debt so that there is no Cash Outlay and need for Capital Raising which would dilute existing Shareholders. Obviously getting over-indebted for such an Acquisition could have totally the opposite effect to that which is desired though !!
- Overseas Expansion as long as it is controlled and likely to be undertaken in a careful and measured way - beware of Strategic Overreach !! UTW moving into Germany is a clear example.
- A Business Model which has clear Growth Features embedded within it. For example, Avation AVAP has been flagging for years that it has loads of Options to buy ATR Propeller Aircraft and there is a clear Delivery Schedule for when these are due to be bought by AVAP. Each time they get a new Plane and they Lease it out, this adds to AVAP Revenue/Earnings - this was fairly predictable (even I managed it !!).
- A new Partnership with a Large Company with direct access to Potential Customers - for example Utilitywise UTW has a deal with Dell whereby they promote UTW Internet of Things (IoT) Energy Saving Products.
- A history of Broker Forecast Upgrades - if a Company continually gets its numbers upgraded, this is a trend that might suggest more of this kind of thing is likely in the Near Future - I think Fevertree FEVR has done this but I might be wrong and I think Tristel TSTL has been quite good at this kind of expectations management.
- If the Company operates in a Sector that is a pretty obvious ‘Big Theme’ for the Future, then it could do very well. Such things as Robotics, Cybersecurity, Driverless Cars, Additive Manufacture (3D Printing), Big Data Analytics, the Gig Economy, Internet Shopping, importance of Media Content, Biotech, Low Carbon Energy, IoT, Nanotechnology, ePayments, Water Scarcity, etc. etc. etc. Quite often if the Sector is growing fast enough, even a fairly average Business can do very well. This was certainly the case back in the TMT (Telecoms Media Technology) days of the late 90s Dotcom Boom when any old garbage shot up in price (note, this can operate in 2 ways - the Business could do well if in a Growth Sector but also the Share Price could do really well if it is in a hyped up bubble sector.) Telit Communications TCM is a great example of a business which plays the IoT Big Theme.
- On the flipside, the likely Future for a company in a declining Industry can often be seen quite easily - for example, Newspapers have been suffering for years as so much moves online and this has made life hard for Newspaper Groups like Trinity Mirror TNI and Distributors like John Menzies MNZS. Others are Kodak when photography moved swiftly away from Film to Digital and the other classic is Blockbuster who collapsed very swiftly once Films went to Netflix etc.
- On the other side of the above, ‘Market Disrupters’ like Purple Bricks PURP, Boohoo.com BOO, On the Beach OTB etc. etc. are exploiting ways in which Online Technology destroys old Business Models and creates opportunity for new ways of addressing Customer needs.
- Changes in Foreign Exchange (FOREX) - this has been particularly the case with the Pound tanking after the Brexit Vote and has made Dollar/Euro earning Companies see a nice boost to their Sales/Earnings.
- Changes in Regulation - for example, the recent UK Government changes to Pension Freedoms meant that Companies like Hargreaves Lansdown HL. saw very strong rises in their Share Prices. Needless to say this was a change that I did not really pick up on myself, but had I thought about it much I suspect it was fairly predictable (easy to say that with Hindsight Bias LOL).
- A troubled Business selling off a difficult or Loss-making Division and removing this drag on Earnings from the rest of the Business and perhaps getting some nice useful Cash to invest in Growth - 2 recent examples of this are Molins MLIN and Quantum Pharma QP. Such disposals are often the catalyst of a big move up in the Share Price (as I recently mentioned on Twitter, MLIN still looks really cheap to me). Aviva AV. was a great example of this when the New CEO Mark Wilson came in and divided the 47 or so Business Divisions up into 3 Groups - Growth Divisions, Cash Cows and ones to Dump.
- When a Business that has been in the poo gets rid of the incumbent Management and brings in a new Team, it nearly always results in a Turnaround and rise in the Share Price - recent examples are MLIN, Rolls Royce RR., Rentokil Initial RTO, and QP. again. Oh, and don’t forget Moss Brothers MOSB where the CEO has done a stunning job of turning things around from a fuddy duddy tired Business to something which is clearly in growth mode. This is obviously happening at UTW and another great recent example is that of Bovis BVS which got itself in a right mess but they quickly took action to appoint Greg Fitzgerald as CEO who was formerly seen to do a very good job at Galliford Try GFRD - already he is improving things at BVS.
- Retail Rollout Stories - there are so many great examples of these where a successful concept is ‘Rolled out’ to new Sites and funded by CashFlows from the existing Group - examples are PETS (which is also shoving in Groomers and Vets4Pets in existing Stores), Patisserie Valerie CAKE, Supergroup SGP, Dunelm DNLM, Fulham Shore FUL, Dominos Pizza DOM, etc.
- This one is similar to Regulation and Thematic Changes, but Social Changes like the move to more People Renting rather than buying their own Homes is driving demand for the Private Rented Sector (PRS) as ‘Big Business’ moves into this Sector with Companies such as Watkins Jones WJG and Telford Homes TEF in particular being well placed. This change is also being assisted by Government Policy to make life harder for Individuals who want to rent out Houses (some say this is accidental but I suspect this is deliberate - Governments tend to hate ‘The Little People‘).
- More people going to University - obviously helps WJG, Unite Group UTG, Empiric Student Property ESP, GCP Student Living DIGS.
- Trend towards Discount Retail as hard-pressed Consumers try desperately to save money leading to the growth of Lidl, Aldi etc. at the expense of the Traditional Grocers like Tesco TSCO, Sainsbury SBRY etc. To play this theme, Accrol ACRL and Card Factory CARD might be interesting.
- By using Analyst Consensus Forecasts (and adjusting them a bit if we think that appropriate), some of the task of peering into the near Future has been done for us. This can enable us to get an idea of Valuation for a Stock and possible Targets - you may have seen in my ‘Stock Buy Rationale’ Blogs that I use these techniques all the time. And while it is in my mind, I rarely if ever look at things like ROCE (Return on Capital Employed) - although the reasons for that are for another day really.
- It is important to consider how likely a Stock is to be a Takeover Candidate - this is very much linked to the Valuation bit above and obviously an assessment of the Qualitative Factors of a business. I have written about this in the past but it is often the case that a particular Stock is widely discussed as a potential Takeover Target and there are several examples (like Entertainment One ETO and Iomart IOM) where previous Bids have already been lodged and this gives us a good idea of the Value in these Companies. I have included a Link to a Blog about this at the end of this one.
- Often a Company has a huge Cash Pile (often as a result of selling off a Business Division or Property or something) and is also generating more Cash - in such examples, a Special Divvy might be very likely and/or Share Buybacks which the Market tends to like. Moss Brothers MOSB could be in this category.
- Back on the Valuation theme, there is some evidence that Low P/E Ratios tend to predict Higher P/E Ratios and vice versa. I suspect ‘Mean Reversion’ is a powerful force here.
- Director’s with a previously very strong Track Record of success. For instance, as I covered in depth in the Blog I did on CAKE a while back, Luke Johnson has a very good record of growing businesses.
- A change of Fashion - for example, a new trend towards colourful Lipsticks is creating a strong growth market for Warpaint London W7L.
- Technical Events on the Chart of a Stock can be a predictor of the Future - my favourite of these is the 50/200 Day Moving Average ‘Golden Cross’ which I often mention in my Weekend Charts Blogs. The opposite is of course true when a 50/200 Day MA ‘Death Cross’ occurs. Such Technical stuff is a huge topic in itself and many ‘predictors’ are for only short periods of time.
- Competitors facing specific problems can help certain businesses - for example, recently Google got into trouble with the EU over its Search Engine Results and Stocks like Go Compare GOCO and MoneySupermarket MONY benefited from this.
I am sure you will agree that is a pretty full list of Bullets (although no doubt I left countless other factors out) but the key point to appreciate in all of these is that they are Forward Looking and it doesn’t take exceptional Future Gazing skills to spot these highly likely changes. Of course this is not the complete answer to how to make Dosh on the Stockmarkets, but thinking in this way about the Future rather than dwelling on an outdated Past is far more likely to bring you success.
You might need to use your imagination a bit though….
Here’s one about Takeovers that I bashed out ages ago: