Does making financial predictions make you a dickhead?

The good news is making financial predictions won’t make you are dickhead, the bad news is you already are a dickhead!

Before I dive in to the very shallow pool of self congratulations that most financial pundits wallow in, allow me to recap part of my investment philosophy.

As a young lad my mother used to say, “According to you everyone is a dickhead except the Pascoes and Morels”. Bede Pascoe was my best friend and my mum was right. Bede and I thought most people were dickheads!

I was around 14 when I realised that I might also be a dickhead. I remember the incident well, which is unusual for me, and funnily enough Bede was the one who delivered my realisation.

My mantra changed slightly to “everyone’s a dickhead, including me”. The core tenant of my philosophy became that whatever theories or beliefs people held as truths were probably wrong. Yes 2 plus 2 equaled 4, at least most of the time, but I doubted most things, including lots I believed.

So when my interests turned to finance it was no surprise that I thought efficient markets theories were the spawn of complete smegheads.

Predicting the future

But what may surprise you is that I embraced predictions. Yes I have a crystal ball! It may be a tad cloudy, but all you need to make money in the markets is a slight edge. My crystal ball is one of the tools that delivers that edge.

When people believe in efficient markets or scoff at predictions they deliver me an edge.

My focus when investing is predicting the future. Predicting what a company is likely to achieve and how investors are likely to react. Predicting what is likely to happen over the next few years and how investors will respond. This crystal ball gazing works best when the market is mispricing a company, that is when the market focuses exclusively on either the good or bad news surrounding a company.

People are unable to entertain competing ideas let alone objectively price the outcome of those opposing ideas. The larger the herd the easier it becomes to predict the next move.  

Is making financial predictions unusual or bad?

Predictions have a bad wrap, but finance is all about making predictions.

Discounted cash flows are predictions. Not only that, they’re predictions of the worst kind. Predictions should be as vague as crystal balls are cloudy. But by wrapping a prediction in financial mathematics many fools suddenly believe they can predict to the cent what something is worth. They try to predict cash flows 10 or 20 years in to the future and worse yet try to accurately predict them.

Of course wise value investors realise that accurately assessing value in incredibly difficult to do, so they embrace the concept of margin of safety. Buying something for considerably less than you predict it’s worth gives you a margin of safety. A margin to compensate for your cloudy crystal ball.

Soon, I’m going to blow my own horn by showing you one of my predictions and how it played out. But before that here’s a few more predictions.

At around $41 when some analysts were belatedly jumping aboard the Xero (ASX: XRO) rocket and calling it a buy, I said it may be worth a nibble at under $30, but the load up time was around $19. Some people thought I was crazy and Xero would never again see such a low price. Well Xero has traded under $22 this week and you know what I now reckon that under $10 may be possible and under $5 not impossible.

I arrive at those figures by predicting the future based on the reliability of past events and investor reactions. In this case a major market correction or some other major event is likely to occur well before Xero is profitable. When that happens stocks without earnings will be taken the woodshed  and flogged to within an inch of their life. And that is the time to buy a company like Xero.

The wonderful thing is that it doesn’t mater if I’m wrong, it only maters if I’m right. I lose nothing if wrong, but am prepared to win if right. Compare that to those telling people to buy Xero at over $40. If they were wrong there was huge obvious downside, if everything went perfectly there was limited upside.

Here’s another prediction. The current yield chasing craze will end badly. Investors who are currently congratulating themselves on being masters of their own universe will be found to be naked as the yield tide goes out.

On to the main self congratulating event, here’s what I wrote in March 2013. Hopefully you can extract something useful for your future endeavours.

Finger Lickin’ Good

Collins Foods (ASX: CKF) owns, operates and franchises KFC and Sizzler restaurants…

A respected fund manager, Orbis Investment Management, continues to buy Collins Foods, and they now own 17.4 percent of outstanding shares. They’ve bought over 60 percent of shares traded in the last month.

Orbis has been virtually the only buyer of Collins Foods. The stock, a recent IPO at $2.50 per share, is seemingly hated and/or ignored by virtually the rest of the investing population.

Imagine how low the price may have fallen if Orbis had not been buying! $1 or less? Now that would be a one-foot hurdle!

We may still get $1, but at around $1.10 Collins is a good two-foot hurdle.

Orbis can only buy 2.6% more of Collins Food stock, so patient investors may soon be rewarded with a great entry price. Naturally there are no guarantees that we’ll get a lower price, but the odds are in our favour.

Over the medium term a rebound in Queensland trading conditions should stabilise the business and earnings.

Here’s a couple more comments I penned on Collins.

March 2012
Collins Foods (ASX: CKF) was close to being our top pick last month and again this month. If it weren’t for low trading volumes, this purveyor of grease and starch may have made the starting lineup. Institutional investors remain shy, and most retail investors are yet to notice the opportunity.

Investment arms of NAB sold down their holdings in December and January; respected Orbis Investment Management was a buyer. With bad news baked into its share price, any positive news will send shares rocketing, while further bad news is unlikely to have much effect. In sum, Collins presents limited downside risk with the possibility of a double within two years.

February 2012
Collins Foods (ASX: CKF) has been trading in a tight range since its disappointing inaugural results as a listed company. Institutional investors remain shy of a company that has already burnt several of their brethren, and most retail investors are yet to notice the opportunity.

Collins has now doubled! And after hitting $1 as I said it might.

Collins Food Group ASX:CKF share chart

While it may appear I’m simply blowing my own trumpet, I’m really sharing this for the lessons that can be learnt. It’s basic stuff that most people simply don’t make part of their investing DNA.

  • If the bad news is priced then the upside potential is probably being ignored and mispriced.
  • Be prepared! Imagine what could happen based on the facts at hand and be ready to respond to what occurs. I predicted share price could hit a $1 when Orbis could no longer buy, it did.
  •  Think about companies from a future perspective rather than linearly extrapolating historical data.

It’s that simple logic that led me to Acrux (ASX:ACR). The downside was more than priced in. Today’s price jump is no surprise. It wasn’t rocket science or advanced financial maths — there’s an oxymoron — it was simply assessing whether the risks were being over-weighted. The downside was priced in! That puts you in the wonderful position of any good or even alright news will be an upside catalyst.

Acrux Axiron sales increase chart

Here’s another example from 2013 using pSividia.

pSivida is hoping third time’s the charm. Alimera has submitted  ILUVIEN for FDA approval for a third time. The outcome is expected in October. If rejected, watch out below, pSivida longs will be  crushed. Here’s the crucial point for those looking for better odds. A rejection would make pSivida worthy of attention as it will still have the growing European cash flow, a promising pipeline and the possibility of eventual FDA approval if Alimera coughs up and performs the additional trials the FDA have always wanted. It may also have a share price starting with 1 — ouch!

The approval was rejected and that proved to be a great time to go long. While pSividia didn’t drop below $2 it did get within the ballpark.

So the next time people laugh about crystal balls you might want to ask them what they’re basing their investment decisions on. DCF? That’s the worst type of prediction. Historical financials? While useful, it’s what is gong to happen that counts.

Whatever they’re basing their decision on its most likely a crystal ball going by another name. They’re simply dickheads without enough insight to know that.

My name is Dean Morel and I’m a dickhead! A lot of my predictions are wrong, but as they cost me nothing I can keep making them all day. Sometimes my guesses are right and I take a swing.

Disclosure: You’re a dickhead, but you’d be an even greater one to think this is anything more than the ramblings of an idiot.  I’m long several of above mentioned companies. Needless to say this ain’t advice. Here’s the advice, pull your head out of your arse, look at the future, figure out what is likely to happen and what is priced in. Or like me, if you discover your head is too far up your arse then keep forcing it further up until it finally pops back out your neck. I’m not sure mine has popped out yet, but it’s getting close ‘cos it no longer smells like shit in here.

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