Can analysts predict the future direction of a stock?

June 3, 2014 0 comments

After seeing that analyst target prices in Asia are inaccurate, the obvious next question was whether they could at least predict the direction of the stocks they cover so intensely. I was an analyst for most of my career but what I realize now is that I never had time to stop and think about what I was doing. Well, now I have more time…

So the question I asked in this recent research was “can analysts predict the future direction of a stock?”

I started the study with 16,500 stocks in Asia ex-Japan from year-end 2003 to 2013, then removed 9,000 stocks that were small, had low trading volume or were inactive during any of the years. I then removed the 2,200 China A-shares stocks, leaving 5,300 available stocks across Asia. The last step was isolate the stocks out of this group had at least three analyst predicting target prices. This left me with a universe of 1,200 stocks over the 10 years. It was this universe that I performed the following test on.

Here is how I constructed the test. At each month’s end I used the analysts’ average 12-month target price to find the upside/downside from its current price of each stock as predicted by the analyst.

If consensus predicted a stock would have an upside in the next 12 months and the stock moved in that same direction then I assigned a 1 for that month, if not a 0.

I then summed the monthly 1’s and divided this by the number of months that had target prices – if the result was above 0.5 it meant analysts’ average target price gave the right direction for that stock in that year. I then calculated the percentage of stocks where consensus gave the right direction for each year, relative to the total number of stocks covered in that year.

The result was that analysts’ estimates of whether a stock would go up or down were about as accurate as a coin flip. Analyst positive bias was also proven as they tended to be more accurate in a rising market. All this reiterates my message, don’t waste time with target prices.

Target Prices Destroys Value

May 27, 2014 2 comments

When managing your portfolio one important thing to consider is to limit the downside. To limit your downside is very important for your terminal wealth, and your terminal wealth is what matters. If you can limit your downside, the compounded returns will do the job for you building your terminal wealth over a longer time period. An important lesson to learn is that markets’ rebound, but stocks’ don’t always.

Now to the title of this blog post, “Target Prices Destroys Value”, what do I mean by that? Actually, I mean exactly what it says, they will destroy your value. I’ve done research on Asian markets to see how accurate analysts’ target prices are. As you probably already know, no one can foresee the future. With that in mind I would define a target price as accurate if the the target price is within the range of +/-10% of the actual price of the stock 12 months after the target price was set. Unfortunately, in Asia, only 18% of analysts’ target prices are accurate per this definition. What is even more scary is that more than half of the time analysts’ miss their target prices by more than 30%, being both overly optimistic and overly pessimistic.

In the slideshare below you can find out whether analysts’ at least can predict when the market turns. My conclusive advice to YOU is to make sure to limit YOUR downside and stop relying on target prices!

Do YOU Know How to Make Money from Dreams and Nightmares?

May 20, 2014 0 comments

Know the ‘Dream Factor’ to make money in stocks

Understanding where stock market returns come from in Asia’s markets

One dollar became 258, but where did it come from? If an investor put one dollar in Asian stock markets (excluding Japan) in 2000 and let it grow until the end of 2013 they would have ended up with 258 dollars. But where did this return come from? It came from five factors, four of which are related to the fundamentals of a company and the economy it operates in, while the fifth has to do with how the investing public feel about the future – hence we call this last one, the “Dream Factor”.

Four factors are about business fundamentals

The first and largest factor is inflation, which over that time contributed about 44% of the total gain. The second highest factor, the real growth in book value per share, contributed nearly 40% of returns. This is the core “growth” objective of business. Growth in book value comes from retained profit, which in turn comes from either growing revenue, reducing costs or both. So book-value growth is proof that a company not only has demand for its products, but that it can operate efficiently enough to make a profit.

Incorporated in the growth in book value per share is the third factor, which is the impact of a company issuing new shares in the stock market. If a company raises money by issuing a large number of shares, but uses that money for less profitable investments, then it will be a drag on book value per share, diluting an investor’s ownership interest. This element is embedded in growth in book value per share.

The last fundamental factor is dividend yield, the portion of profit that is paid out to shareholders. This contributed about 30% of return.

Factor five is all about dreams of future growth and opportunity

When investors in the stock market are willing to bid up the price of a stock, even though the underlying factors didn’t change, it means that they are more positive about the future growth potential of the business. If the underlying book value of a stock does not change and investors push up the price-to-book (PB) ratio from say 1x to 2x, a multiple expansion, it is an expression of their dreams of the future. When those dreams are crushed, they could just as easily push the price back down to 1x PB, which would cause the stock to collapse and de-rate. In the case of Asia, the “Dream Factor” has been reduced to such a point over those years that it has actually been a drag of 10% of the total return of 258.

Knowing where we are to know where to go

It is important to know what factors are driving performance to give yourself a guide for what to do next. In the case of Asia ex-Japan, the low “Dream Factor” makes us relatively comfortable to invest in 2014.

Thai Politics: It’s a Street Fight

April 29, 2014 0 comments

This presentation was done in late January 2014, however it is still relevant though the political situation in Thailand still remains unstable.The presentation is a short historical analysis of what have actually happened in Thai politics since the 1980′s. It will bring some insights to the political turmoil that started in late 2013 and has not yet (29 April 2014) been solved.