"Dartwielding monkey" - Insightful FT article

How not to be a dartwielding monkey - EQUITY RESEARCH - Research is wasted if managers don't know what they are looking for, writes Mark Sellers.
By MARK SELLERS
13 August 2007
Financial Times

Should you spend countless hours researching a stock before buying it, or just a few hours? The common wisdom is that the more time you spend on research, the better your investment results will be. But is this correct?

Not according to studies on the subject. At least two I have seen came to the conclusion that anything more than a cursory review of a company's prospects is a waste of time.

One study showed that sell-side stock analysts, who spend 50-80 hours a week on research and presumably have loads of information at their fingertips, are no better than a monkey with a dart at predicting a company's five-year earnings growth rate. In fact, they are worse than a monkey with a dart because they tend to project the recent past into the distant future, rather than assuming growth will revert to the mean. If the analysts' projections had been simply random, the results might have been closer to reality.

Furthermore, large mutual funds tend to hug the return of their benchmark more closely than smaller funds do, in spite of the fact that larger funds have more resources and presumably are able to do more research. They can pay an army of analysts to research every nook and cranny of a company's business and come up with proprietary earnings estimates and valuation models. Yet more research does not equate to better returns, at least among mutual funds (and I suspect the same is true of hedge funds).

It would, therefore, be easy to conclude that research is a waste of time. But I have a different take on this issue. In my view, the problem is not with research per se. The problem is with the type of research people do. They miss the forest for the trees.

The typical fund manager is bombarded with dozens of news items about his stocks and makes many seemingly important buy and sell decisions every day. The noise doesn't get filtered out. Everything seems important to some managers.

The thought process is something like this: What will the Federal Reserve do at its next meeting? Will company X beat earnings estimates next quarter or miss them? Which direction will oil go from here, up or down, and how might that affect consumer spending? Is the economy headed into a recession? What will company X's stock price do over the next three months? Will the analysts reduce earnings estimates after I buy the stock, resulting in short-term losses? Are analyst estimates too low, so that there is a short-term profit opportunity? Which will perform better over the next year, foreign stocks or domestic stocks?

These are the thoughts of a typical fund manager on a typical day. Thoughts are scattered across a range of subjects, with questions that can't possibly be answered with any accuracy (like those above) gaining most attention. If you waste much of your time worrying about questions that can't be answered, you are spending less time on the few things you can answer.

Contrast this with the investment process of Warren Buffett and his partner, Charlie Munger. Their record is astounding, yet they have no analysts on staff to crank out spreadsheets or discounted cash flow valuations. How can two people out-research a staff of 100 highly trained financial analysts using the latest and greatest computer technology?

The answer is that Mr Buffett and Mr Munger are able to filter out the noise better than just about anyone else. Based on the shareholder letters Mr Buffett has written, it appears he does not get distracted by unanswerable questions and daily noise, at least to the same degree as everyone else. He and Mr Munger avoid researching companies they can't easily understand. They ignore questions that can't be answered, such as which direction the economy is headed this year. They don't waste time.

Instead, they focus on just a few things: the integrity and talent of a company's management team, the size of its economic moat and whether its valuation seems reasonable in light of the cash flows it is throwing off today. They don't try to predict the future except in a very general way. They stay within their circle of competence and ignore all else. They don't get distracted by shiny objects - or Bloomberg terminals.

Calm in the Storm

The Market has been an roller coaster ride. I believe the anxiety traders are feeling must resemble how the disciples felt in the boat in the middle of the storm. Yet during the storm Jesus was sleeping because he was at perfect peace. The disciples couldn't understand why he was sleeping, because they were being tossed around. As a Christian in the market I believe we have to pray and remember that God gives us peace that surpasses all understanding. The peace he gives us is not as the world give it. The peace of the world requires a good environment, but the peace that God gives us is irregardless of the environment. I have found that when the market is going crazy and my co-workers are screaming, it is best to leave the room for just a minute or two and find a quite place like a conference room to pray. In that time I find that God arrives and restores to us the peace, which gives us the calm in the storm to make the right trade decisions.

Finding God in Market Turmoil

August is typically the time of the year is when Hedge Fund managers go to their homes in the Hamptons for a little rest and relaxation, but this August has been anything but peaceful. The meltdown of the sub-prime mortgage market has caused multi-billion dollar companies like American Home Mortgage (AHM) to go bankrupt, Bear Sterns(BSC) to shut down some of its hedge funds and Goldman Sachs(GS) one of the most prestigious brokerage houses to suffer huge losses to their stock price. Yet in the midst of all this Market in turmoil how is it that we can have a peace that the Bible describes, "surpasses all understanding".

I was playing tennis with a successful executive friend of mine who ran a multi-billion dollar corporation and after the match he started telling me about a certain time in his life during which he found himself in a crisis. I expected him to tell me how God gave him comfort during this time but instead he described how challenging the time was and how he had a hard time understanding "Why" he was being put through this circumstance and "Where" God was hiding during this time?

It got me thinking that while there are many times in the Bible that God chooses to manifest himself in a Big way, but there are other examples where He remains silent. It occurred to me that almost all the great figures in the Bible experience periods in their life when God was "silent" and His presence felt far off. The Psalmist best describes this time in our Christan walk when he says, "though I walk through the valley of the shadow of death you are with me." I believe the psalmist wrote this because he is actually reminding himself that God is still there, even though he doesn't feel His presence. Incredibly even Christ for a moment in time felt separation from God's presence when He was on the cross and said, "my God, my God why have you forsaken me?"

God obviously loves his only son Christ, but at that moment even Jesus felt forsaken when probably needed God the most. If God allowed even Jesus to feel forsaken at the time when he needed Him the most it is likely that we too may feel alone in our greatest challenges. Why does He sometimes seems to disappear? The poem "Footprints" is very beautiful and speaks to the artist in me, but when I'm in trouble the more practical business person side of me emerges and I want to know where God is?

I believe that during our darkest moments when a trial is unbearable the reason God seems to intentionally hide is so we will do three things 1) recall our previous victories, 2) seek his presence even more fervently and 3) rely on His promise that "he will never leave us nor forsake us" and that He will never "give us any burden to difficult for us to carry."

So when everything is falling apart and the Market is crashing, my only hope is to follow Christ's example and cry out to God. It gives me comfort to know that on the cross He too felt forsaken and even though I don't understand "why", or don't feel Him there, He is in fact walking with me in the valley of the shadow of death.

I have come to accept that the "Why" is not necessarily for me to comprehend. The outcome is simply an increased faith and fortitude for the next battle.

Fellowship of the Unashamed -Commitment Statement

I am part of the "Fellowship of the Unashamed". The die has been cast, the decision has been made, I have stepped over the line. I won't look back let up, slow down, back away or be still. My past is redeemed, my present makes sense and my future is secure. I'm finish and done with lone living, sight walking, small planning, smooth knees, colorless dreams, tame vision, mundane talking, cheap giving and dwarfed goals. I no longer need pre-eminence, prosperity, position, promotion, plaudits, or popularity. I don't have to be right first, tops recognized, praised, regarded or rewarded. I now live by faith, lean on his presence, love with patience, live by prayer, and labor by power. My pace is set, my gait is fast, my goal is heaven, my road is narrow, my way is rough, my companions are few, my guide is reliable and my mission is clear. I can not be bought, compromised, detoured, loured away, turned back, diluted or delayed. I will not flinch in the face of sacrifice, hesitate in the presence of adversity, negotiate at the table of the enemy, and ponder at the pool of popularity or meander in the maze of mediocrity. I won't give up, shut up, let up or slow up until I have stayed up, stored up, prayed up and paid up and spoken up for the cause of Christ. I am a disciple of Jesus. I must go till He comes, give till I drop, preach till all know and work till he stops me and when Jesus comes for his own, He will have no problem recognizing me, my banner is clear, I am part of the fellowship of the unashamed.

Tossed Out of the Boat

Sometimes you are out of the boat because you feel like God has called you to something great and feel the faith to walk on water, but other times you are just tossed out of the boat and don't know what has hit you.

The latter is what happened to me recently. I was working for a Hedge fund where my manager and I were not seeing eye to eye and we parted ways. This is an amazing challenge for me, I had only started the job four months ago and my wife and I are only days away from closing on a house and it scares me to think about how we are going to cover the mortgage on only one salary, but I know that even when I'm tossed out of the boat, it is in God's plan.

I recently heard a sermon that really spoke to me, it was by a minister that was trying to explain why even things we think are mistakes or errors might actually be God. The minister explained that the reason he was a minister today was because a door was left open. He explained, that he was inspireed to enter into the full time ministry because of a lecturer he hear in his college. However, the lecturer almost never spoke at this college because he was having visa problems. A classmate of the minister talked to the dean of the college because he believed that he could help the guest lecturer with his visa issues, the classmate happened to be the son of then sitting President Gerald Ford.

The son of President Ford contacted the right people and was able to help the guest lecturer get his visa. Well how did President Ford come into office, it was because Nixon left that White House because of Watergate and why was Watergate revealed? Because one of the buglers left a door ajar and the night watchman on duty noticed it. So leaving a door ajar was the reason this Minister entered into the full time ministry. So if you are enjoying this blog right now you can thank Watergate.

Jeremiah 29:11 says, "For I know the plans I have for you," declares the LORD, "plans to prosper you and not to harm you, plans to give you hope and a future."

Even things I perceive as mistakes are in God's control and a part of his greater plan and that gives me peace.