Introduction

This will be the first in a series of articles where I will cover popular and/or high profile stocks.  The primary objective of this series will be to put a spotlight on the importance of forecasting future growth prior to making an investment decision.  The central idea is to determine whether or not a reasonable forecast of future growth warrants consideration for investment relative to how the market is currently valuing a given stock.

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NVIDIA stock
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Positioning Statement: Forecasting is the Key

One of the most important investment principles is the undeniable relationship between earnings and/or cash flow growth and long-term shareholder returns.  After literally examining thousands of fundamental graphs, I can confidently state that the profit and/or cash flow growth of each respective company are the most critical drivers of returns.  Valuation plays a major role, however, it is the rate of change of earnings and/or cash flow growth that matters most of all.  Therefore, it only logically follows that the key to success is forecasting earnings and/or cash flows.

The good news is that calculating the prospects of a well-run business’ growth potential can be accomplished with enough accuracy to be relied upon.  Guessing how short-term stock prices may behave is an exercise in futility.  Think hard about the implications of this.  Investors everywhere are obsessed with forecasting stock prices, a task that is impossible to accomplish, yet they tirelessly persist.  No matter how often they are proven wrong, they continue on.  Yet ironically, the easier and more rational approach is hiding in plain sight.  Fundamental analysis may seem harder, yet in truth it is not.  The hard part is exercising the patience and trust to allow the results to manifest as they must inevitably do.  Instant gratification is not a promise of sound long-term investing.

Forecasting Future Growth: the Process

One of the best benefits of the F.A.S.T. Graphs fundamentals analyzer software tool that I co-founded is the clear valuation perspectives it shows regarding historical earnings and/or cash flow growth and returns.  The evidence overwhelmingly supports the conclusion that if, in fact, historical business results generate historical returns; then it logically follows that future business growth will be the determinant of future returns.  Of course, this assumes that valuation is in alignment with that growth.  Therefore, the importance of forecasting business prospects and future income streams is undeniable.

Fortunately, forecasting future earnings and/or cash flows needs only to be accomplished within a range of reasonable probabilities and/or possibilities.  In other words, you only need to be essentially correct to achieve desired results.  This article is only offered as an introduction to this important process and the principles behind it.  However, I remind you that forecasting earnings and/or cash flows within a reasonable range is not only possible, it’s also within most people’s competency level as well.

Forecasting future growth within a reasonable range of probability requires more common sense than genius.  So my advice is, don’t be intimidated by a task your common sense is capable of accomplishing.

Forecasting Future Earnings (and/or cash flows) Is Key

Regardless of why, any time I am in the process of making buy, sell or hold decisions on my portfolio, I always start by calculating the relative current valuation of each holding. From there I immediately begin thinking about what the future might hold for each company I own. As an investor, I understand that I can learn a great deal from the past, but I also acknowledge and understand that I can only invest in the future.

Moreover, both common sense and history would clearly indicate that long-term investing success is directly related to the success of the underlying business invested in, adjusted for valuation of course. When valuation is sound, long-term past performance results will be functionally generated by long-term past business results. This makes it obvious; to me at least, that it logically follows that future long-term investing success will be functionally generated by future long-term business results.

This implicitly implies that having a rational forecast of the future prospects of any business I own is imperative. On the other hand, common sense would also dictate that forecasting the future with exact precision is not possible. But, that is not to say that a reasonable forecast of what the future might bring cannot be made. When forecasting the future growth potential of a company, I do not need to be perfectly correct, only reasonably so.

Therefore, instead of perfect precision, I approach forecasting more generally. My goal is to determine and develop confidence that the businesses I own are capable of continuing to grow long-term at preferably an above-average rate. Furthermore, and more pertinent to the theme of this article, my goal would be to keep those stocks capable of generating enough growth to support my future needs, and harvest only from those that may not be.

My Personal Views on Forecasting Future Earnings

To a great extent I base my entire investing rationale upon the undeniable fact that earnings and/or cash flow growth determine market price and dividend income in the long run. Therefore, I believe it only logically follows that reliably forecasting future earnings and/or cash flow growth is crucial – and the key to long-term investing success. I approach forecasting future earnings and/or cash flow growth from both the macro and micro perspective. Importantly, I also utilize both historical data and future expectations as integral parts of my research process.

To forecast future earnings and/or cash flow growth with any degree of accuracy, it seems logical to place great emphasis on recognizing major future investment opportunities. Therefore, I continuously seek to evaluate and analyze major macro-economic trends. First, I study and monitor demographics. The consumption patterns of the various segments of our population are knowable within reason and thus can provide me clues to potentially profitable businesses.

For example, I believe it is important to recognize and understand the economic impact of our population’s current bimodal distribution, namely the “graying of America” and the “baby boomer” generation. Understanding the consumption tendencies of these and other large demographic segments allows me to make reasonably informed but general forecasts as to the potential future health of several industries that will serve these large and growing markets.

Additionally, I am constantly searching for information and knowledge regarding the rapid advances in new technologies, scientific breakthroughs, and creative ideas that portend the advancement and possibly the birth of new industries and their accompanying profit opportunities. Although it is my policy not to invest in new technologies too early (high risk), I feel it is important to recognize them early and develop a knowledge base and assimilate the data to prepare for future investment opportunities. I believe this approach greatly facilitates my forecasting process.

A Fascinating Corroborative Comment from a Reader

The venerable Benjamin Graham, who is considered the undisputed father of value investing, believed that valuing a business should be based on both quantitative and qualitative analysis. Furthermore, he believed, as I do, that the word “investment” should not be applied loosely. Regarding future estimates, Ben Graham reluctantly acknowledged its value. However, to Ben’s point of view, he believed that any assessment of the future was, by nature and definition, speculative. Consequently, when we tackle

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