Value Investing 101 and Worst Calls of 2011 Part I: S&P 1380

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Tis the time of year where everyone makes their predictions for 2012. Although they make good headlines, they are often totally wrong. I think a strong tenet of value investing is that the future is uncertain. That is one of the reasons why Benjamin Graham used prior year earnings and not forward earnings. I believe there is merit to modeling out a bit, and I do it myself. But to totally rely on the future leads to speculation.

Warren Buffett has some secret formula for modeling, which we are convinced no one knows. As stated on numerous occasions, we have asked people to predict which stock Buffett would buy. Given that he is very limited by the huge amount of cash, there are only a few hundred US companies at most, for a full buyout. Yet no one predicted the purchase of Lubrizol. We will rest the matter here.

Just as a few examples from 2011; no one predicted the Arab Winter, the Japanese earthquake, Tebow phenomenon, The Euro-zone collapse etc. would occur in 2011.

Although we admit that ValueWalk tries to have catchy titles, we think that the audience would be better served by pointing out the mistake of ‘forecasters’, instead of predicting that we know the future. This is not to mock anyone but rather to try to ingrain the reader with the folly of thinking that they can predict with certainty the future. We can run thousands of articles on this topic, but we will limit it to a few just to get the point across.

We will focus on large media, banks, economists etc. instead of bloggers, because the former have much more of an influence on the retail investor (the year is not over, but we will have to use ytd data to write a few articles on this topic).

Worst Call of 2011 Part I: S&P 500 year end target 1379:

Emphasis is my own:

4. No New Normal Next Year Seen by Strategists Predicting 11% Gain in S&P 500

Rising profits and cash balances will push the Standard & Poor´s 500 Index to the biggest three- year advance since the 1990s, surpassing forecasts for below- average returns, strategists at Wall Street´s biggest banks say. The benchmark gauge for American equities will rise 11 percent to 1,379 in 2011, bringing the increase since 2008 to 53 percent, the best return since 1997 to 2000, according to the average of 11 strategists in a Bloomberg News survey. Goldman Sachs Group Inc.´s David Kostin, the most accurate U.S. strategist this year, said sales growth will spur a 17 percent rally in the S&P 500 through the end of 2011. Market analysts say earnings will hit record highs, keeping valuations below historical averages at the same time government spending aids the economy. Reaching their average forecast for 2011 would give the index annualized gains of 15 percent over three years, twice the rate anticipated by Pacific Investment Management Co.´s new normal theory that anticipates deficits and increased regulation will limit returns. “Your new normal may not be quite so new,” said Barry Knapp, the New York-based head of equity strategy for Barclays Plc, who expects the S&P 500 will reach 1,420. “There´s nothing to worry about with earnings. We´ll get some margin expansion, and we´re still at a pretty good stage in the economic cycle. From my perspective, I´ve tried to think about all the risks. I just think the outlook is favorable, so favorable that I struggle to see how the equity market doesn´t perform well.”


Actual result:

While the forecasters were largely right about the EPS target, they were dead wrong about the earnings multiple, which is half of the equation.


The S&P is not at 1214, and is off by ~14%.  If you had bought in early 2011 expecting an 11% gain, you would be severely disappointed by a 1% drop (dividends included). This also assumes that you had the stomach to bear all the volatility which occurred.

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