Forecasts, feedback loops, Dan McCrum and status - the best investing blogs and podcasts from the past week

Sep 23, 2022

An age-old dilemma faced by investors (and one that reaches well beyond investing) is that attempting to forecast the future with any degree of accuracy is a waste of time. Yet buying and selling shares is predicated on just that: making a judgement about what’s likely to happen next.

It’s probably fair to say (and I’m choosing words carefully) that some predictions are more grounded than others. It’s not that unreasonable to think a cost of living crisis will put the brakes on consumer spending in places. That prediction might be likely, but it’s not very useful. Yet the more you expand the idea and try to make specific predictions from it, the less chance there is of you being right.

One area where really close attention is paid to forecasting is company earnings. Earnings (which are essentially a company’s net profits) are one of the most popular measures of performance and progress. Forget cash flows, forget anything else, ‘earnings season’ in the States is called ‘earnings season’ for a reason - it’s where everyone is looking.

So it’s understandable that there’s a natural demand for short, medium and longer-term earnings forecasts. Some might argue that valuing companies is difficult without them. That’s why there’s a whole industry of analysts out there whose job it is to do just that.

But the credibility of these forecasts has always attracted scepticism. Analysts - and it’s hard not to feel some sympathy for them - are criticised for being over-confident, over-optimistic, herding and other flaws that make them prone to errors.

But what about one of the biggest inputs to earnings forecasts: company management? Surely the guidance they give to analysts and the wider market plays a massive role in setting accurate expectations? Is this a variable that isn’t considered enough?

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Well, according to a recent study (here), management ability does have a very big influence on the predictability of company earnings. In short, switched-on, highly effective managers know their businesses and industries well, and that makes them better at guiding earnings forecasts.

To measure management ‘ability’, the US researchers used a framework from an earlier study (here). It’s basically a measure of how good bosses are at using the resources at their disposal to generate revenues. Importantly, it focuses on their effectiveness, not those of the business generally.

It turns out that analyst earnings forecasts are much more accurate when the company has high ability management. You also don’t get as many earnings surprises. But when these companies do meet and beat earnings forecasts, the market has a stronger positive reaction to them.

What’s the takeaway? Good management is hardly new when it comes to desirable characteristics in a company. But don’t underestimate the rippling effects that good management can have on things like accurate forecasts.

Here’s what I’ve been reading and listening to this week…

Top posts from the past week

Wes Gray, Alpha Architect - Has the Stock Market Systematically Changed?

I once met Wes Gray, the boss of quant investment first Alpha Architect, at his home (which was doubling as the company’s office) in Philadelphia a few years ago. He was incredibly friendly given he hardly knew me and really had no idea why I was interviewing him. Anyway, like all value ‘junkies’, the past 12 years have been a real test of the theories behind buying ‘cheap stuff’ - a strategy that Wes is fully signed up to. This post from him skips the sometimes heavy academic-driven work that his team puts out. Instead it focuses on a sense that the nature of the stock market has changed in recent years. Spoiler alert… it hasn’t. It’s just that the volatility you might be feeling right now is just part of the regular course of returns.

Joe Wiggins, Behavioural Investment - Learning to Be a Good Investor is Hard

Why is it so easy to make mistakes in investing that you sometimes feel you never learn from? It could be the negative impact of hanging on to troubled shares for too long… or selling at the wrong time… or having too much concentration in your portfolio. According to Joe Wiggins, part of the answer is that feedback loops in the stock market are far too long and noisy to teach us crystal clear lessons. When bad decisions don’t have an immediate impact, or when our own experiences just can’t teach us enough, it can be hard to join all the dots. This article is all about ways of managing those challenges.

Investors' Chronicle - Dan McCrum: Lessons from the Wirecard scandal

There was a time, back around 2018, when you’d be hard pressed to visit the FT.com website and not see an article about Wirecard. Suspicions about the German payments processor apparently first came to the attention of FT journo Dan McCrum in 2014. But it was after it listed on Dax and started making bold statements that things really heated up. Ultimately it turned into an incredible battle between the paper and a litany of unsavoury characters that wouldn’t be out of place in a James Bond film. It must have been terrifying for McCrum - it’s a story that certainly warrants both the book and Netflix show that have spun out of it. In the end, Wirecard was found to be utterly fraudulent. Its loss-making business was just a front for complex money laundering. McCrum is a great story-teller and this podcast is a must listen, especially on the subject of just how hard it is for investors (even professionals) to change their minds when faced with overwhelming evidence.

Capital Employed FM - Narrative Shifts with Adam Rackley

Adam Rackley runs Cape Wrath Capital. His firm uses what he calls a “differentiated value strategy”, which aims to take advantage of changing narratives in the market. Essentially, this means looking for stocks that have sold-off hard but could recover if something changes. Rather than picking on particular types of firms, he goes looking for situations. This conversation goes to some interesting places in terms of what he looks for and what’s important to him. In particular, he spends a lot of time looking at the credibility of cash flows and debt to really understand the value he can get out of it. One of the best parts of this interview is when he explains the thinking behind his investments in Enquest (North Sea oil) and Somero Enterprises (specialist concrete levelling). It’s interesting to hear how he interprets what the market is thinking and how that all fits into his own positioning.

A Long Time In Finance - Remembering Black Wednesday: Part Two and Part Three

Last week I mentioned the first of three episodes on remembering Black Wednesday by Neil Collins and Jonathan Ford at the A Long Time in Finance podcast. The first - covering the build up - was excellent. The second came out this week, covering the immediate build up and events as the day unfolded. The third came out this morning, and reflects on how the country’s economic regime changed after Black Wednesday and some of the lessons learned (and not learned) by politicians. In all, it’s a really excellent look back at what happened.

Infinite Loops - Will Storr - The Status Game (EP.122)

Jim O’Shaughnessy has been relentless in his podcasting lately, but I’ve picked this episode from early September because it covers some pretty universal ideas, many of which link up with investing. Will Storr is a British journalist and author whose latest book The Status Game, is all about the influence that status has on peoples’ actions - good and bad. At an hour and 20 minutes, it’s in depth and wide ranging. Among other things the discussion touches on David Irving, cults, pecking orders, religion, war and how we get things wrong. It sounds heavy but it isn’t and Will Storr has some interesting ideas.

Have a great weekend,

Ben

PS. Catch up below with the best of the rest from the past week…