Late last month, we asked if you can get a real edge on individual equities in general. This week we ask if you can get an edge on large cap stocks in particular. We think yes. We think there are lots of ways to get an edge on large cap stocks—more ways than we can fit in here. So we’ll discuss just one of our favorites: Looking beyond the next handful of quarters in earnings estimates.
One of the toughest parts of an analyst’s job is deciding whether to use a short-term or long-term outlook as he or she develops an investment thesis. Often—perhaps too often—the shorter view wins out for less-than-the-best reasons. Because analysts usually are judged on quarterly performance, for example. Or because there are so many voices chattering about the same issues concerning a particular security.
Those short term perceptions are often what drive a stock, but in our experience, short term noise and thinking can create biases in analysts’ financial models—particularly in forecasting next year’s earnings estimates.
For instance, if an analyst is convinced that shorter-term factors are going to have a negative influence on a particular stock, chances are that perception will bias his-or-her longer-term estimates. Such a bias can keep estimates artificially low, as the analyst may have a difficult time explaining to clients a negative thesis on a stock with accelerating longer-term forecasts.
Simply being aware of the potential for such a bias can be a powerful tool, especially when an analyst believes the longer term potential of a stock outweighs the short-term risks.
So when we hear that most investors are waiting for that “one last negative factor” to subside before getting more constructive with a security, we get interested. Usually, with well-known products and names, the negative factors are already well-known and anticipated—and factored into short-term forecasts.
But longer-term recoveries from those negative factors in subsequent year’s numbers are often overlooked. The result is a potential edge for the investor willing to cultivate the long term perspective.
There is, of course, the risk that those shorter term factors will drive down the price after one purchases a security. But if your long term investment thesis is unchanged after those events such a price dip often is a great time to add to a position.