I am developing an idea that any form of forecasting at all with regard to investing and economics is pointless due to the 'butterfly effect', chaos and randomness....
This comes out of various things I have been reading and applied experience. Forecasting any metric for a business is really impossible to do with any meaningful level of certainty. Regardless of the history of earnings, cash flow, profit, revenue, margins, debt, or any other metric, events we cant even imagine can entirely change the outcome.
It can be small changes or large changes, sometimes the effects are out of all proportion the the change. The key problem is because we cant know which of the infinite potential events will transpire, we cant possibly forecast what their effect will be.
So where does this leave the poor old fundamental investor?!
That is the question I am pondering now.
My initial thought is that while we cant possibly forecast any of the metrics used to measure a businesses health, if we are backwards looking and only invest in the healthiest companies, then we should be afforded some protection from the more common lumps and bumps in the investors path, if we combine that with seeking out management that appears to truly have shareholder interests at heart, hopefully that will increase the chance of the business recovering from events we didnt see coming.
We should also accept that there will be 'black swan' events that will at times wipe out businesses that otherwise exhibited all the advantages described above - but hopefully they are few and far between and we can make enough from the businesses that dont suffer from a black swan event to still do better than average.
For me this means less time spent looking at the potential intrinsic value of businesses and simply looking for the best possible businesses we can find and adding to our holdings whenever the opportunity presents.
The criteria should include,
Low debt
stable history of earnings & revenue growth
Ideally, faster earnings growth than revenue growth (increased margins)
Stable history of dividend payments
Shareholder focussed management with skin in the game
Stong free cash flow and a good conversion rate
Moat/competitive advantage
We should also continue to watch for opportunities where un expected and negative events have a stong depressing effect on share price whereby good businesses can be brought at a discount. Great caution needs to be taken with this strategy given the dangers involved.
Some second level thinking about this issue and I realised the other side of the coin is also true - randomness & chaos means the risk can manifest as positive outcomes where unexpected events cause share prices to rise much more than expected.
