Have you got too much faith in the forecast?
Here’s a chart you may find interesting. It shows how the consensus broker forecast for BHP Billiton Limited (ASX: BHP) 2015 Earnings Per Share (EPS) has evolved over the last number of years, together with the BHP share price during that time.
What you will notice is that the consensus EPS traffic has been very much one-way for more than three years: with few exceptions, revisions to analyst forecasts have been monotonously down. What this seems to show is the analyst community as a whole being slow to recognize the changes that have taken place in commodities markets, and preferring to make countless incremental adjustments that turn out to be more an indicator of what has already happened, than a bona fide indicator of where things are going.
We don’t hold this against the analysts, because in our view it is extremely difficult to predict commodity prices with any accuracy, and it is a brave analyst who sticks their neck out. As investors, we can acknowledge our inability to forecast accurately instead try to invest in things we can better understand. It’s much harder for an analyst charged with covering BHP to declare “too hard”.
It’s also worth keeping in mind the incentives that analysts face. Making a bold prediction that falls well outside consensus means potentially risking one’s career with a spectacular error. Far safer to be just a little way outside consensus, and a little closer to the correct answer than others. For this reason, it makes sense that consensus forecasts would move a little like a caterpillar, with one analyst after another making measured adjustments to move consensus along, and no-one ever making a large break away from it.
The message in this is to be cautious about placing too much faith in forecasts, even where the rationale is well articulated by a smart person wearing a nice tie.
And if you have the luxury of playing the “too hard” card, be sure to use it, where appropriate.
Tim Kelley is Montgomery’s Head of Research and the Portfolio Manager of The Montgomery Fund. To learn more about our funds please click here.
Marita Concepcion
:
Thanks for sharing an insightful thoughts with us Tim; to think that perhaps, somehow, we might be having the same observation, and yet maybe a little bit skittish whether to bravely admit it or not, – hoping that things might turn around somehow… Unfortunately, it would be too late, even if it turns around in the last moment. *Sigh* It’s time to wave our hands in the air and bid farewell.
Lloyd Evans
:
I prefer to listen to investors who can articulate their methodologies succinctly, with valid reasoning and don’t wear nice ties.
As an aside, I have notice most of the MIM team don’t wear one….(except for Ben) sorry Ben.
I think your onto something Tim.