Idea farm: faith in free money

  • Long-term forecasts should be more wobbly
  • Short-term estimates can also waver
  • Lots of idea-generating content

In theory, making an accurate prediction about an event should be easier the closer we get to it. The more imminent something is, the more information we tend to have – while the window for chance, chaos and unknown factors to assert itself shrinks.

This is generally the case with financial markets. An accurate estimate for Apple (US: AAPL) sales in any given quarter are always unlikely. But with only a few weeks left in the current period and facts about global currency fluctuations and consumer appetite now well established, the margin for error should be smaller than it was a month ago. .

This presents a paradox for investors. Longer-term price, earnings and market estimates should matter much more for today’s decision-making and capital allocation decisions. But the more advanced these predictions are, the more flawed they become.

Again, the margin of error can be wide over a period as short as a year.

Take the consensus forecast for a big index like the FTSE All-Share. You might think that the aggregated predictions of each analyst covering 600 companies would amount to the wisdom of the crowds. And sometimes that’s true: in 2018, for example, the index’s free cash flow per share estimates were never exceeded by more than 5% in either direction in that calendar year ( See table).

FTSE All-Share FCF estimates vs reality*
Year High Down Real Interval
2017 235.69 206.03 214.45 +10% to -4%
2018 249.31 224.21 236.85 +5% to -5%
2019 264.24 220.34 213.4 +24% to 3%
2020 262.2 127.42 147.07 +78% to -13%
2021 223.69 192.57 240.12 -7% to -20%
2022 302.36 257.66
Source: Fact Set. *Per share (£), estimated range during the year.

However, each year since, the range of estimates has been wider, even adjusting for time. The highest consensus in-year forecast for 2021 – made in mid-December – was 7% lower than the actual figure.

Either way, investors are doomed to make short- and long-term guesses.

Usually, the insights, results, and stock screens on these pages focus on forecasts for the next two years. Overall, this seems reasonable, given general market and investor expectations. But it also has its downsides, especially when it comes to expensive stocks: the value of a stock priced at 25 times projected 2023 earnings is not usually attributed to a 4% yield the next year, but what profits will the company make afterwards? years.

One of the ways analysts typically account for this is by using discounted cash flow models, which incorporate many forecasts to arrive at a net present value.

A cruder method is to take analysts’ longer-term forecasts at face value.

Given the reluctance of many City and Wall Street residents to release estimates more than three years in advance, this is often not possible. But some do, and the numbers shouldn’t be entirely ignored.

Using free cash flow per share as an indicator of actual earnings, FactSet shows up to seven years of forecasts for select All-Share and S&P stocks. Adding those numbers up and excluding stocks worth less than five times this year’s expected earnings, we find a handful of companies that are expected to generate at least 75% of their current cash value, in six years or less.

Some of the British names – such as Cineworld (CINE) and DFS Furniture (DFS) – have large debts and operate in fragile sectors where consumption trends are difficult to predict. Others – like Glencore (GLEN) and Hull (SHEL) – will likely face high price volatility and a rapidly changing regulatory environment.

Yes, this type of screening has its limits. But it’s not limited to value stocks: Google-parent Alphabet (US: GOOGL), which trades at 19 times forward earnings, is expected to generate half its market value in cash in six years. The long term always matters.

FTSE All Share
Company ITLOS Price (£) Before NTM PE Year of recovery
cineworld CINE 0.26 5 2
Quick rental SDY 0.48 9 2
quilter QLT 1.18 15 3
bridge stitch BPT 3.37 22 3
DFS Furniture DFS 1.94 seven 3
glencore GLEN 5.42 6 4
TUI-AG TUI 1.89 ten 4
Marston’s MARCH 0.55 8 4
Shell SHEL 23.95 seven 5
BP BP 4.40 5 6
Endeavor Mining VDE 18.75 13 6
Source: Investor Chronicle, FactSet
Company ITLOS Price ($) Before NTM PE Year of recovery
NRG Energy NRG 46.23 9 4
Tapestry TRP 34.62 9 5
Discovery of Warner Bros. WBD 16.85 ten 5
Modern mRNA 140.00 seven 6
Comcast Company CMCSA 42.28 11 6
Source: Investor Chronicle, FactSet

About Myra R.

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