We live in an information saturated world. Most of us are continuously bombarded with news from our TVs, radios, smartphones, iPads and computers. Social media such as Twitter and Facebook merely accelerate the velocity at which information is circulated. Far from needing to search for data, in our daily lives we suffer a surfeit.
One of the larger challenges in the investment world is trying to figure out which data matter (and how much) and which can be ignored, or at least, paid little attention. A great example is the monthly unemployment number published by the US Department of Labour. For the last five years or so the investment community has waited, breathless, for the 8:30am announcement on the first Friday of each month. Violent stock market reactions are not unusual – up if unemployment is less than expected, down if it is more. But here’s the most interesting thing: the data in the monthly announcement are largely meaningless.
Compiled based on surveys, the figures generally show jobs created or destroyed on the order of 100,000 to 300,000 per month. This, out of an employed labour force in the United States of about 145 million. Not surprisingly, the initial survey is subject to error, and is revised twice before it becomes a final number. The error is frequently about as large as the initially announced change in unemployment. In other words, the much anticipated Friday number is often completely wrong, and when viewed in retrospect, told us nothing about the economy. Yet fortunes are made and lost by short term traders and speculators on the basis of this flawed data.
We track a lot of data on a monthly basis, but we do not trade stocks based on a single data point or a single month. We are interested in trends over time that give indications of what might be happening in the economy. Obviously it is important to know what is happening with unemployment, but no one month tells anyone very much. The same is true with the many other pieces of information we receive such as durable goods orders, consumer confidence, Purchasing Managers’ Indices and so on. Taken together, all of this news paints a picture of what is happening in the world. Often the picture is foggy; sometimes the data mislead us; but usually a calm and reasoned analysis of the information over time gives a reliable idea of what is going on.
What is true of the economy is also true of companies. When we invest, we do our homework and try to understand why a company might be a good investment. Usually we look at a long period of time, five or ten years, to see what drives revenues and profits. If we are convinced that prospects for the future are good, we buy shares. When we buy, we hope to own the stock for a long time, certainly a few years at least. But this is not how many market participants think.
As much as market traders are obsessed with macroeconomic statistics, they are perhaps even more fanatical about quarterly earnings. It is not unusual to see a major company “miss” analysts’ expectations and have its stock sold off 5% or 10% in a single day. To us, this is madness. There can be any number of reasons why a company has a bad quarter; there are even more reasons why the analysts may have been incorrect in their assumptions. To think that a company with a market value of say $10 billion is worth $1 billion less because it made one cent less per share in one quarter than expected is just silly. Yet it happens every day.
Instead of focusing on the headline number, we choose to look deeper. Is the company’s business model intact? Has something changed in the market environment in which it operates? Is there a change in strategy, pricing or competitive positioning? In other words, is the company the same as the one we bought? If it is, we will live with the bumps on the road. It is arrogance to think that anyone can predict, to a penny, what will happen with a given company in the future. Moreover, the penny doesn’t matter. What matters is the ability of the company to grow profits, pay dividends and reward shareholders.
We recognize that the news-driven speculator has a place in the market. Much of the daily activity of buying and selling is driven by these traders. They provide liquidity for the rest of us, and keep the stock brokers in business. Without the traders, we would not be able to buy and sell shares based on fundamental analysis. But we certainly do not want to emulate the high turnover, hair-trigger, information junkies.
Developing the ability to filter out the marginal data and the irrelevant news takes years of practice. Yet it is essential for successful investing.