Forecast the Fundamentals
I'll admit it -- my market timing attempts have been poop. Earlier in the year, during the China-led sell-off in late Feb and early Mar, I sold two positions in GE and Bronco Drilling, hoping to lock in the capital loss for tax purposes and buy them back 30 days later at the same levels and ride them back up. Based on my judgment of the sick US economy, I expected the selloff to linger a while. I was only able to get back into GE as the general stock market unceremoniously jumped up shortly after I sold to new all-time highs.
I've also been hit on 2 other positions, Teck Cominco and Mueller Water. In both cases (you can find the reports on this site), I valued both stocks at least 30% above where they were trading. I made these judgments based on pure fundamentals -- how much cash they were earning, company assets, market position, etc. Yet for some reason, I "forecasted" that both stocks would go down in price from when I first bought them and therefore, I didn't buy as many shares as I should have. They both promptly zoomed up 15-20% and cut into my margin of safety enough that I'm on hold before I built a full position.
But who cares about me? I'm just so wannabe stockpicker so of course I'm gonna behave like a schmuck. To illustrate the perils of financial forecasting, let me present the "Bond King", Bill Gross. Gross is head of renowned bond trading firm, Pacific Investment Management Company aka PIMCO. Gross has very publicly pronounced that the Fed will have to cut rates this year (2007) or send the economy into recession. And he's put a good deal of money behind that statement. I actually agree with him. But there's an old adage that you can predict the effect or you can predict the timing but you can't hit both. The Fed has managed to hold steady and Gross has capitulated. He stated last week that long-term rates are headed up past 6% and threw in the towel on a short-term Fed cut.
My point is the ONLY THING dumb money investors like me should be "forecasting" are the fundamentals. Yeah, it doesn't really make sense but it's catchy, no? Forecasting the fundamentals means making decisions based on what I can know now -- current fiscal condition, past performance, contracted backlog, industry conditions, etc. The things I can't know -- future stock price, future commodity prices, future industry prospects, etc -- must be taken into account but these can't be used as the main basis for my actions. If I correctly forecast the fundamentals and put myself in a position where I can be patient, then the markets will eventually mirror the fundamental strength (or weakness) underlying the asset in question.
Because I focus so much on the underlying business foundation as opposed to potential (though both are great!), I usually like a tangible return on my investment, ie a dividend. My thesis is that if the company is making money, eventually the market will have to realize its value. But I don't want to be slave to the market's whim. Without a dividend, the only way to make money on my investment, barring some sort of liquidation or buy-out, is selling the stock for capital gain. I need the market to set that price. But if the company pays a dividend and increases it as it grows, that provides a floor for the stock price. If the market sets the price too low, I'm still reaping the benefits of my investment. As long as I can afford to wait, the only thing that truly affects my investment is whether the company can continue to pay or increase its dividend. That's why I focus on strong companies with good management.
Yes, I know that dividends are out of fashion on Wall Street. But who cares?
Besides trying to predict pricing and market action, the other pitfall is being in a position where you have to sell. Forecasting the fundamentals is great but who knows when the market will wake up? In the meantime, you don't want to be caught in the situation where you have to sell but the market is not giving you a good price on it. So don't invest money that you may need later or worse, buy stocks on margin. If you're using leverage, I hope you have a Bloomberg terminal in your possession.
So in summary, Nostradamus has no place in your portfolio. The truth of the matter is that the economy is such a large system with so many inputs that any useful predictions are too broad to be useful in picking stocks. It doesn't really matter who you are: I listened to Bloomberg talking-heads predict the demise of the energy sector at the beginning of 2007 (nope) and I listened to people like Jim Puplava & James Turk (less mainstream types) predict market pain and $700 gold bull rush and neither of those have come to pass either. Marc Faber is widely recognized as having fairly accurate economic assessments but his timing is usually off a little. Bottom line, forecast the fundamentals and don't pay attention to the noise.
There's nothing new in this article -- it's basically a rehash of Ben Graham's Mr. Market combined with Warren Buffett's great companies at good/great prices. But I forget easily so to me, forecast the fundamentals is my new mantra
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