A bonafide value investor regards any company worthy of investment as a business that he could own and calculates it’s intrinsic value based on the owner’s earnings that represent what a private buyer might pay for the specific business. Value investors, when determining valuation, focus on value of a security right now.
Most of us overestimate our own intellectual capacities and exaggerate our abilities to shape the future. Our capability even to forecast the future, much less control the future, is extremely inadequate and is far more limited than we want to believe. Nobel Prize winning psychologist Daniel Kahneman discussed “planning fallacy” in his best-selling compilation of research, ‘Thinking, Fast and Slow’. We have a tendency to underestimate the time, efforts, expenses, and risks of future actions and simultaneously overestimate the benefits thereof. Our inability to forecast with any reliable degree of precision or accuracy is what makes us think something might not take as long to achieve as it actually does, and why our projects tend to cost or take more time and resources than we expect.
The Fallacy of Forecasting
Even mildly bullish forecasts are regularly held to account, but preposterously bearish ones are hardly ever held accountable. Forecasts are wrong precisely because of this reason—that most forecasts prove to be wrong and are made to entice you to trade.
Warren Buffett’s disdain for macroeconomics is legendary. Berkshire Hathaway does not pay much attention to the outlook for the overall economy. There’s just too much uncertainty surrounding economic forecasts for them to be of any significant use. In Janet Lowe’s, ‘Value Investing Made Easy’, Warren Buffett is quoted:
I have no use whatsoever for projections or forecasts. They create an illusion of apparent precision. The more meticulous they are, the more concerned you should be. We never look at projections, but we care very much about, and look very deeply, at track records. If a company has a lousy track record, but a very bright future, we will pass on the opportunity.
You cannot know what lies ahead in terms of the macroeconomic future. Few people if any estimate more precisely than the consensus about what might happen to the economy, how interest rates and markets might behave in the future. An investor’s time is therefore better spent in a well-researched investment process to determine what’s predictable with a reasonable degree of accuracy: the prospects of the industries, companies and securities. The more microeconomical an investor’s focus, the greater the likelihood that the investor can ascertain things others don’t or cannot. In the 1982 annual meeting of Berkshire Hathaway’s shareholders, Warren Buffett stated,
We spend essentially no time thinking about macroeconomic factors. In other words, if somebody handed us a prediction by the most revered intellectual on the subject, with figures for unemployment or interest rates, or whatever it might be for the next two years, we would not pay any attention to it. We simply try to focus on businesses that we think we understand and where we like the price and management. If we see anything that relates to what’s going to happen in congress, we don’t even read it. We just don’t think it’s helpful to have a view on these matters.
Most Forecasts Prove to be Wrong
When the proverbial Mr. Market is filled with fear and anxiety, astute investors will see relatively more micro bargains for individual stocks. Conversely, when the macro market is filled with greed, investors will not see micro opportunities for individual stocks. Even mildly bullish forecasts are regularly held to account, but preposterously bearish ones are hardly ever held accountable. Forecasts are wrong precisely because of this reason–that most forecasts prove to be wrong and are made to entice you to trade. In the 1994 annual meeting of Berkshire Hathaway’s shareholders, Warren Buffett stated,
We try to price, rather than time, purchases. In our view, it is folly to forgo buying shares in an outstanding business whose long-term future is predictable, because of short-term worries about an economy or a stock market that we know to be unpredictable. Why scrap an informed decision because of an uninformed guess?
We purchased National Indemnity in 1967, See’s in 1972, Buffalo News in 1977, Nebraska Furniture Mart in 1983, and Scott Fetzer in 1986 because those are the years they became available and because we thought the prices they carried were acceptable. In each case, we pondered what the business was likely to do, not what the Dow, the Fed, or the economy might do.
If we see this approach as making sense in the purchases of businesses in their entirety, why should we change tack when we are purchasing small pieces of wonderful businesses in the stock market?
James Glassman and Kevin Hassett, in a fit of irrational exuberance during the stock surge of the late 90s, wrote a cheerful prediction about “Dow 36,000” and introduced the book by declaring, “If you are worried about missing the market’s big move upward, you will discover that it is not too late. Stocks are now in the midst of a one-time-only rise to much higher ground—to the neighborhood of 36,000 on the Dow Jones Industrial Average.” Even the renowned economist, John Maynard Keynes who invented macroeconomics chose not to predict macroeconomic trends as an investment innovator. Peter Lynch, in the influential volume on intelligent investing, ‘One Up on Wall Street,’ called out the fallacy of overanalyzing the so-called market indicators and forecasting macroeconomics:
Thousands of experts study overbought indicators, oversold indicators, head-and-shoulder patterns, put-call ratios, the Fed’s policy on money supply, foreign investment, the movement of the constellations through the heavens, and the moss on oak trees, and they can’t predict the markets with any useful consistency, any more than the gizzard squeezers could tell the Roman emperors when the Huns would attack.
Dealing with the Uncertainty of Economic Forecasts
Ben Graham, Warren Buffett’s mentor, once commented, “The last time I made any market predictions was in the year 1914, when my firm judged me qualified to write their daily market letter based on the fact that I had one month’s experience. Since then I have given up making predictions.” Investors should favor stocks that are more predictable—stocks of businesses that have a strong durable competitive advantage (moat) and a lengthy operating history—and stocks that are in the investor’s circle of competence. Stop contemplating that the talking heads making macro-economical predictions could guide your investment decisions. Ignore them. Think for yourself! Consider what Warren Buffett wrote in the Berkshire Hathaway’s 1992 Chairman’s letter and annual report,
We’ve long felt that the only value of stock forecasters is to make fortune tellers look good. Even now, Charlie and I continue to believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children.
To keep things simple, keep in mind that risk and losses come from not knowing what are doing. Therefore, invest only when you know what you are doing.
The ambiguity of economic forecasts doesn’t cast any doubt on the aptitude, integrity, or work ethic of the forecasters. Instead, the inaccuracies demonstrate that the economics of business are too complex a system—the variables too many and formless quite often—to be sufficiently portrayed by modeling techniques with any ideational fluency. In the minds of investors, a balanced response to this recognition of the inaccuracy of economic forecasting should be a combination of skepticism, a healthy disrespect for history, and prudence. If your approach to investments necessitates a relevant forecast of future events, be very cautious. And the more precise and specific the forecast needs to be, the more careful you should be.
Recommended Reading on Warren Buffett & Value Investing
- ‘The Warren Buffett Stock Portfolio: Warren Buffett Stock Picks: Why and When He Is Investing in Them’ by Mary Buffett, David Clark
- ‘The Essays of Warren Buffett: Lessons for Corporate America’ by Warren Buffett, Lawrence A. Cunningham
- ‘The Snowball: Warren Buffett and the Business of Life’ by Alice Schroeder
- ‘The Warren Buffett Way’ by Robert G. Hagstrom