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Look at past long term performance of company instead of forecasts when investing: View

Instead of investing based on forecasts, look at long-term track records of businesses. Their past can guide you about their future performance.

Apr 01, 2019, 06.30 AM IST
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Most equity investors believe that if they gather enough knowledge and apply it all, they can be assured of an investment’s performance.
By Dhirendra Kumar

Recently, I came across the transcript of a speech on investing. It was delivered almost 40 years ago by an otherwise forgotten investment manager of a long-gone fund management firm named Batterymarch. The speech has acquired legendary status. It has been shared on the Web and on social media as a classic: clear thoughts and fundamentally useful investing ideas. One of the most interesting bits of the speech is the analogy between physics and investing:

“...The foundation of Newtonian physics was that physical events are governed by physical laws. Laws that we could understand rationally. And if we learned enough about those laws, we could extend our knowledge and influence over our environment. That was also the foundation of most of the security analysis, technical analysis, economic theory and forecasting methods you and I learned about… There were rational and predictable economic forces. And if we just tried hard enough… If we learned every detail about a company… If we discovered just the right variables for our forecasting models... Earnings and prices and interest rates should all behave in rational and predictable ways. If we just tried hard enough.”

However, just as in physics, the investors’ reality is more like quantum mechanics. Those events just don’t seem subject to rational behaviour or prediction. There is just too much evidence that our knowledge of what governs financial and economic events isn’t nearly what we thought it would be.

Most equity investors believe that if they gather enough knowledge and apply it all, they can be assured of an investment’s performance. We all implicitly believe that a research report or an article in the business press can predict the future. But can they? It depends on what you mean by the future. Do you mean financial numbers of well-known companies in the near future, or do you mean the something that has a bigger impact? The answer to this question becomes clear when we look back to determine what could have been predicted and what could not.

Think of what has happened in the last quarter century in the Indian economy and the stock market. Could any of it had been forecast? Think of both the big long-term and the short-term trends. In the late eighties, could you have forecast the astonishing rise of the Indian software services? Was the rise in urban Indian living standards predicted by anyone? Was the coming drop in interest rates and the easy-money economy predictable in 1995? Was the resultant housing boom predictable? In 1996, when a cheap, basic mobile phone cost Rs 20,000, did anyone make a correct prediction of how many mobile connections India would have in 2008? Was the near collapse of the global financial system in 2008 foreseen two years before that? In 2009, when the equity market hailed the return of Manmohan Singh as India’s Prime Minister with a stronger mandate, was the sorry mess of the next five years predictable?

Needless to say, there are many experts who can now reason why these events happened. They can say that the vast pool of English-speaking and technical manpower made the rise of IT and ITES exports inevitable, and that mobile telephony followed a predictable path in the fall in prices of mobile phones. But these justifications are because of the benefit of hindsight.

The movements of the stock market has been as surprising as the events cited earlier. The direction as well as the sharpness of each bull and bear market of the past two decades was utterly unpredictable even a year or two before it happened. Does this mean that investors have no basis on which to try and forecast the direction of their investments? Not quite.

In fact, the lack of predictability means that what remains is truly valuable. Judge quality businesses on the basis of long-term track records. Hold a large and diversified portfolio, so that the short-term problems of a company and sector-specific events can be evened out. This approach is fundamentally different compared with investing based on future forecasts. This is about taking a reasoned look at the past and the present and attempting to judge whether the things that have happened will stay the course.

(The writer is CEO, Value Research)
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
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