Is this the best way to predict a company's future?

Jan 27, 2011

In this issue:
» China will have to keep buying US treasuries
» Auto industry could be the next big thing for IT industry
» Marc Faber gives one of his most provocative interviews ever
» India Inc is having a robust quarter so far
» ...and more!!

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Open any brokerage report and you will invariably come across one common element. The tendency of research analysts to predict a company's financials 2-3 years into the future that is. After all, crystal ball gazing is an exercise that is too tempting to resist. However, have you ever tried to figure out whether this exercise is worth the effort? Have analysts been able to correctly identify important turning points in an industry or a firm and helped you make tons of money or avoid losing the same? Certainly not we believe. The results have been dismal to put it mildly. Analyst forecasts have always come up short when it comes to predicting important turning points.

Thus, if forecasts aren't quite cut out for the job, what then is the best way to predict a company's future one might ask? We are of the opinion that forecasts shouldn't be made at all.

What better authority to turn to than Warren Buffett if you are not quite convinced. It is believed that the Oracle of Omaha has never ever in his investing lifetime tried to do any kind of future earnings estimates. All he has done is dig deep into the company's past track record and has tried to come up with evidence that the underlying business is as much resistant to any kind of change as possible. If in the last 10 years, the business model has changed 2-3 times, then it may not be a good business to invest in as per Buffett.

We sincerely believe that other investors should also do the same. They should ideally look into the 10 year financial history of a company and if at all they find evidence of frequent changes in the company's business model, then such a company may not be fit for investing after all. We believe such a method will prove to be far more useful than the other one of trying to profit from a financial forecast 2-3 years into the future.

Do you agree with our views or you have a different take on the situation? Let us know or comment on our Facebook page.

 Chart of the day
Gold, silver, copper, crude oil...the list goes on. Apart from the fact that these are all commodities, there is one more thing that they share in common. The prices of almost all of these commodities have tested multi year highs in the recent past. It should be noted that March 2009 was the month when most of these commodities began their ascent and have certainly not looked back since then. Today's chart of the day makes an attempt to plot the point-to-point gains of some of the top performing commodities from their 2009 lows to their most recent prices. As can be seen, with gains of more than 180%, copper leads the charts. Silver and crude oil aren't too far behind either. Going forward though, would these commodities be able to repeat their past performance? Certainly not we believe. But given how China and India are growing, inflation beating returns can at least be expected from these commodities.


Marc Faber recently gave what could be touted as his most unpleasant interview ever. He uninhibitedly criticised the US President for being a dishonest person and doing a horrible job. But that may be hardly surprising and scantily useful for investors. So what does he think about investments? Well, he thinks emerging markets and industrial commodities have done great so far and are poised for some correction. He foresees around 20-30% correction in the emerging market universe. He doesn't find China to be a good bet at the moment. On the other hand, the US has underperformed everything. And now there could be a temporary reversal. Though he thinks the S&P might correct around 10%, he finds the US Treasury the best place to be for the coming 3 months, if not more. Of course, he doesn't forget to point out that in the long run, US treasuries and most government bonds would be suicidal investments. So this potential hike in the US dollar would be just a temporary breather before it continues dipping further.

The third quarter of FY11 is turning out to be quite a robust one for India Inc. For the 450 companies that have declared results so far, average net profits grew by an impressive 25% YoY. This despite the fact that input costs have been steadily rising. The last time when India Inc. declared a strong set of numbers was in the fourth quarter of FY10. That was when companies enjoyed high year-on-year growth due to unusually low business sentiments in the quarter ended March 2009.

The healthy performance was not only on the profit front. With respect to revenues, these grew by a healthy 26% YoY (excluding oil & gas companies and banks). Strong domestic demand was the key growth driver as the overseas markets continued to be mired in a recession. Whether such a strong performance will be sustained in the coming quarters is a big question mark though. Input costs are rising and with inflation refusing to ease off, interest rates are also expected to rise. All this is most likely to put pressure on profits. Hence, a few more quarters will give a better picture of how the economic scenario for India Inc. will pan out.

The global auto industry has borne the brunt of the global crisis. But recent figures have shown that the industry is witnessing a turnaround. But their fortunes are driving the growth for another industry as well. We are not referring to automotive ancillaries. We are referring to the IT industry. In-car connectivity demands and technology for interactions has opened up a whole new market for the IT industry. So it does not come as a surprise that the Indian IT industry is targeting this huge market as their next growth driver. Companies like TCS have already partnered with the likes of Ferrari to provide technology solutions to the latter. Infosys is looking at targeting innovation that is focused on providing infotainment within the car. Even within the Indian auto market, the potential for IT is abundant. With this new focus, the Indian IT industry has another driver for growth in its portfolio.

The more we read about the future of China-US relationship, the more we are intrigued by it. One is a rising sun, the other is in dusk. But the future of neither of these global heavyweights is without challenges. The US is partially freezing government expenditure to lower deficit. Although this may bring down their deficit at the end of 5 years by US$ 400 m, it may not materially improve the US' colossal debt problem. China on the other hand is reliant on vending cheap wares to the US to preserve its economic status. So, where or not it likes it, China has little option but to keep lending to the US.

Economist Nouriel Roubini believes that China will keep buying US Treasuries as long as the former remains dependent on exports. If that indeed turns out to be true, the double digit growth rate that China boasts of may help the US more than China. We think that chasing growth rates for the sake of it has not served any economy's long term interests. Nor will it serve China's. As long as India's sustainable GDP growth rate is free of encumbrances, having it in single digits should not be a problem.

Meanwhile, Indian benchmark indices continued with their southbound journey today as well as the Sensex was trading lower by around 110 points at the time of writing. Heavyweights like Infosys and M&M were seen exerting the maximum pressure. Other Asian indices though closed mostly in the positive today while Europe has also opened on a positive note.

 Today's investing mantra
"Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results." - Warren Buffett

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15 Responses to "Is this the best way to predict a company's future?"

Sarath Chandra

Jan 27, 2011

Indian markets are imperfect, and have seen the real growth only from 1995 till date after financial reforms kicked in. A period of 1.5 decades that's it. There's perhaps nothing much to talk about the Licence Raj, and/or during that period of time where capital markets were simply out of the reach for a common Indian investor (BSE-Only days!).

With that being the background, how apt/fit would it be to apply Buffet's wisdom of looking for 'No Changes to Business Model' over the last one decade to make future investment? That is, from 2001 to 2011? Isn't there a possibility of missing "Tomorrow's Infosys" applying that criteria?

This is not to say "Earnings Forecast" is THE ONLY WAY to go forward, or the recommended alternate leading to dabbling in the shares of in less than 10 year old microcap businesses.

Perhaps the line separating the two exists somewhere, specially in the context of Indian markets/business environment (extrapolating a bit higher, Emerging Markets' Context). If not 10 years without more than 2 or 3 changes in business model, may be, not more than a couple of changes over the last 5 years?!



Jan 27, 2011

While I more than agree about doing past analysis than future result forecasting, even Equitymaster Stockselect focuses on forecasting rather then analysing past 10 year data.


Ajay Changia

Jan 27, 2011

How exactly do we find out from financials about change in business models?



Jan 27, 2011

Agree with what you say. But you do have research reports that mostly predict the future earnings and does little research about past years (certainly not 10years. Hope you will go by what you said i this article and ammend your research report methods. Recently it is noticed that many of your recommendations especially on Mid& Small cap are not doing well (not even the down side is protected)


Harit Shah

Jan 27, 2011

If you truly believe that this is not the best way to predict a company's future, why do you yourselves do it!?!? You yourselves have future forecasts for the companies under your coverage, isn't it? Obviously you don't exactly believe in the phrase, "Practise what you preach"!!!

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