“To be, or not to be” was a line made famous in Shakespeare’s Hamlet play that touched on the topic of existentialism.
A similar version in investing would be — “to predict, or not to predict, that is the question”.
There is a very pervasive (and at times unhealthy) practice that I see within the investment industry — that of predicting the earnings, revenue, or margins of numerous listed companies.
Almost every analyst at major brokerage houses is engaged in this incessant activity.
The churning out of reports that project or estimate earnings down to the last cent is a rampant practice.
Why, exactly, is there such an obsession with predictions?
And what good does it do for us?
Fear of uncertainty
One overriding reason why analysts are falling over themselves to predict is because of a fear of uncertainty.
This fear of the unknown has been a part of mankind’s psyche for centuries.
Throughout the ages, men and women have engaged in a variety of methods to divine the future, dealing with everything from crystal balls to tarot cards.
A variety of “wise men” have also been consulted — soothsayers who claim to know what will transpire.
Nostradamus, a famous 16th-century seer, has gone down in history as having predicted a variety of disasters centuries after his passing.
Back in the present, investors take comfort in the predictions of a bunch of analysts who expend an inordinate amount of time and effort trying to estimate revenue, earnings and dividends.
Setting up expectations
And therein lies the problem.
Wall Street is fanatically obsessed with predictions such that each time a company releases its earnings, it is scrutinised and compared against the “consensus” to assess if it had beaten, or fallen short, of forecasts.
The “consensus” in this case refers to an amalgamation of forecasts of revenue, earnings, margins and other financial cum operating metrics provided by analysts who cover the company.
Investors have been so conditioned to react to these predictions that even if the actual earnings are lower by a cent or two, the stock is viciously sold down.
We’ve seen this in action in the last couple of weeks as several growth stocks listed on the NASDAQ Composite Index suffered sharp declines due to missed expectations and weak forecasts.
Meta Platforms (NASDAQ: FB), the owner of social media site Facebook, saw its stock decline by 26.4% in a day when it reported its first-ever quarter-on-quarter decline in daily average users for its fiscal 2021 fourth quarter.
Streaming TV giant Netflix (NASDAQ: NFLX) suffered a 21.8% plunge in its share price in late January when it revealed a weaker-than-expected forecast for member growth for its fiscal 2022 first quarter.
And the list goes on, with payments platform PayPal (NASDAQ: PYPL) and e-signature specialist DocuSign (NASDAQ: DOCU) also suffering similar sharp one-day declines.
Get Smart: Prepare, don’t predict
These sharp plunges make great headlines, but they distract us from what’s important when investing in a stock.
And that’s the fundamentals and growth prospects of the business.
Quarterly predictions and forecasts are there to provide jobs for the analysts and prognosticators.
They make good coffee shop talk and are the basis for many water-cooler discussions.
But to a long-term investor, these can be distractions.
The best thing you can do in investing is to prepare (for uncertainties and surprises), rather than predict.
By positioning your portfolio to tackle the occasional nasty piece of news, you will be well insulated from sudden shocks, and can also invest more calmly.
And the peace of mind you’ll get for not engaging in this mindless activity is priceless.
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Disclaimer: Royston Yang owns shares of PayPal and Meta Platforms.