For all of my critiques of quarter predictors, I actually relatively neutral towards them, except when it comes to areas where ethics might be a much deeper shade of grey than not.
Having said that, I too predict quarters to some extent, but only when the information falls on my lap.
Make no mistake, quarter prediction is a lot of work. The kind of work you do is probably different from a value investor, but you will still need to put in long hours in order to obtain the confidence level required.
So how does one goes about it?
It starts with the news. One of the biggest source of predictive data is large swings in,
- Commodity Prices
- Accounting entries / Contract Recognition
- Work-outs (Event driven catalyst)
- Results of linked or similar companies
Now, there are many more factors, such as demographics change, consumer behavior, technological disruption etc etc. But these things take time, and is not that predictable in the short term.
When predicting quarters, the one thing you must understand, is that it is like predicting the weather. The longer out you’re trying to predict, the lower your precision level. At best, you can predict 2 quarters, maybe 3 if you’re really sure and sharp.
The Middle (Part One)
Now that you’ve found this predictive information, you need to decide which company’s earnings will be affected the most. In Malaysia, we only look for positive earnings because we cannot short.
Now, the best ones are where nobody is aware of yet. The absolute best ones, are where it has been beset by losses for some time, or severely compressed earnings, and therefore have people start valuing on a P/B basis instead of a P/E basis.
In addition, it is key for it to be a simple and easy to understand business.
If you try to predict the quarterly earnings of a conglomerate, you are in for a very rude surprise. Conglomerates have multiple income streams, and the points of failure in terms of your research increases exponentially.
Now, having found a sample of the companies, you now want to study very quickly how large the effects will be. You need to aim for at least 4X earnings increase YOY and preferably QOQ, because that is your margin of safety.
Depending on the company, it may not be so simple as to take just the commodity price to predict. The easiest one to show is MSC, everyone though tin price would shoot up for a year or something, and shoot the profit, and as it turns out, there’s a lot more than just tin prices in the market.
Now, let’s assume you chose steel. There are a few things you need to consider.
- Price of steel (this was your starting point)
- Legislation (this was also your starting point)
- Cost of production (It needs to be split into its components and conservative figures must be used.)
- Interest expense
Rate increase can really affect things, especially if its denominated in foreign currency. In addition, for construction or property development companies, some of the interest is usually being capitalized in the construction in progress, you want to make sure the construction is still ongoing, and therefore interest can still be capitalized. Otherwise, you might be a sudden and very material hit to earnings.
In addition, when it comes to these companies, you might be in for a surprise if the quarter you’re predicting is the final one. Because the auditors come in before the final quarter, and if they have been under capitalizing or over recognizing their progress billings, there will be adjustments made, and this will properly screw you over.
- Foreign Exchange
It’s not just the sales and cost, but also any borrowings or cash deposits. Some can be very significant effects. In addition, some companies have very large percentages of trade payables and receivables, which will in turn be affected and thus affect your prediction.
- One off impairments or contribution from associates.
This is again a whole new animal. Especially if the associates are not of the same business.
Now, assuming you’ve done all of this conservatively and with care, and you obtained a range of figure that is 3-4 times higher than the last quarter or previous year quarter, you now need this ask this question.
Is it priced in? What you know does not matter. Do other people also know it? Information that is useful is where only a few is aware of, and most aren’t.
If it isn’t, congratulations, you now have your quarter prediction speculation buy ready, and can now buy up your position.
Now, to set a target price. Well this one is very complicated. Because you are speculating, you cannot set a price you think is fair. Instead you need to determine the price you think other people will consider fair, and the reduce it by 15% of so to be conservative.
The Middle (Part Two)
Now, there is a short cut if you have not noticed. You do not actually need to do your research in such as detailed manner (you still need to be quite detailed as we will show later).
You’ve guessed it. Write an article!
Due to the unique structure of the Malaysian equity markets, its actually quite straightforward to have your day in the spotlight.
I’ve written an article about it here.
The first thing you must remember, is that the purpose of the article is to whip up sentiment, and to inspire greed, hope and the fear of missing out. And the best articles, are articles of some slight but crucial misdirection (ie, you do not actually disclose everything), which are weaved out of threads of truth.
This is key. The important and persuasive facts must back your thesis. Otherwise it would not be convincing. You need,
A Click-bait title.
The first step is to have someone actually click your article. People are greedy, so you must have specific words to catch attention. Remember, everyone wants the green arrow, and QOQ and YOY increase.
Something like “XXXXX EXPLOSIVE EARNINGS UP AHEAD, PER OF 2!”
You need pictures, color, different font sizes and other things.
Remember, you are selling something and your main audience or customers have short attention span. You cannot like me, just write in one color, one font and one size.
People need to think that you know what you’re talking about. Good English is a decent start. But more importantly, you must go into detail about the business, the details could be inane and have zero importance, but you need to sound smart saying it. If you did your research, this part should be straight forward.
Select Factor to weave narrative.
Now, out of the factors above, you need to select the best ones that are the strongest in pushing the narrative. The ones that are not so strong, ignore them.
The best way is to split each factor out and explain one by one, with pictures and different colored fonts! And then at the end of the article, combine it all into your thesis.
If you do it right, each factor should build anticipation and emotional rush in the person, and when the full thesis comes, ORGASM!
Select news to back it up
Next, to select news that back up your arguments. If you did your research, and the threads of truth are in place. It would not be difficult. Most news articles and journalist only have first level thinking. IE, Steel price up, therefore profit sure up. They do not, think in terms of the natural feedback’s that occur.
In addition, the nature of the internet means you will always be able to find an article that supports your point of view.
Now, the last and most important part. Remember, use BIG FONTS and RED for this one. Setting the TP.
Now, the key here is to remember. This is a speculation. But only you must know this. The others must not. They must look at it as an investment!
So instead of being honest and saying “I think sentiment will push it up to 7 PE because people are greedy and most people will probably see 7 as a reasonable number to pay, and therefore aim to get out around that figure”.
You must say: “FAIR VALUE should be around 7 times PE, for this company with potential explosive earning moving forward. And bright future due to XXXXXX”
To sound even more reasonable, you will want to compare it with other companies listed in other countries or its peers, or even to nestle etc.
Don’t worry about the fact that the economic quality/ moat or the company as well as interest rates in various countries etc play a major part in valuation. Most people will not ask. And if they ask, dont respond.
If you did this right, and the sentiment all feel correct. You may even get the lottery of Koon Yew Yin buying. Feel free to send him an email detailing this speculation. If it’s lucky to be up-trending soon after, OTB will also buy and recommend as it meets all his criteria, whether TA or Next 2 or 3 quarter earnings.
This will really make you a lot of money.
Now after this, you should also if possible, stick around and answer questions. Most won’t be asking the hard questions. Most will be retirees who have not had experience in valuation and investments that you have. They are easy to settle.
You will also get questions or support from the shrewd traders, who can sense fish and greed swimming. They would have bought the moment they saw your article, and see that it felt right. The questions will be easy as these people know they will also make money off your work.
Now, when you get questions from people that can actually see through you bullshit. Again, very easy way to handle it. DO NOT RESPOND.
You will lose. Your argument will not hold water against them. Just shut up. If you decided to respond, habis, everyone can see you lose, and you cannot delete his comment summore.
Do not worry, the traders will defend you, because they know how key it is for the sentiment to hold up.
Also, make it multipart. As people have short attention span. If you write 2000 to 3000 word article like me, sure habis.
And you also want to build up your argument and narrative, don’t forget. This is a very good tool!
The Final Part
Now here comes the home stretch.
Whenever you do a quarter prediction, you are trading/speculating, and therefore, you must know how to do your EV, or Expected Value.
Now, assuming you didn’t write an article, your calculation is as follows.
If profit XXX (higher QOQ and YOY), return is 40%. Probability 30%.
If profit YYY (higher YOY, but not QOQ), return is 20%. Probability 50%.
If profit ZZZ (Lower), loss is 10%. Probability 20%.
Expected value is (0.4*0.3)+(0.2*0.5)+(-0.1*0.2)= 0.2 or 20% gain averaged out over a large sample size.
If you wrote an article, and things go well.
Well, you would have locked in the profit pretty easily. If OTB and KYY buys, well, you hit the jackpot my man, you would have made way more.
Now, here comes the harder question. How much of it is priced in. Chances are, the answer is all of it. The EV is likely to be negative, example:
If profit XXX (higher QOQ and YOY), return is 10%. Probability 30%.
If profit YYY (higher YOY, but not QOQ), loss is 10%. Probability 50%.
If profit ZZZ (Lower), loss is 30%. Probability 20%.
Expected value is (0.1*0.3)+(-0.1*0.5)+(-0.3*0.2)= -0.08 or 8% loss averaged out over a large sample size.
In which case, you should probably get smart and get out beforehand.
Of course, you cannot tell people that. You need to tell them you think still got some way to run etc.
That is could be a good investment. For good measure, compare to nestle again, and say, look how all these smart sifu is in the stock.
I hope this was useful for you. Have fun! And may you make incredible profits and scare the rest of Malaysia out of this market for me, so that I have less competitors!
Looking at how incredibly detailed some of the research is, and how they pace the stories, as well as how similar the styles are, i wont be surprised if there is a smart fund manager out there, hiring someone to write these articles after they buy in.
If one day, due to your efforts, most people in Malaysia say stock market is for gamblers only and sure lose money one.
Well, I’ll organize a big dinner for everyone!