To invest effectively in the markets, you don't need to be able to predict the future

 To invest effectively in the markets, you don't need to be able to predict the future

Instead, knowing a company's basic development might help you identify potential investments that may outperform the index itself.

Although it is difficult to forecast future index or stock price levels, it is feasible to have a considerably more accurate assessment of a company's future fundamentals.

Making forecasts, particularly regarding the future, is challenging.

-Physicist Neils Bohr or baseball player Yogi Berra

Unknown author is cited in the above quotation. It is unclear who said it—if one of the aforementioned two people or possibly someone else. If this is the case for a recent occurrence in the information age, then forecasting the future is undoubtedly a difficult task. The holy grail of the stock market for many investors is to attempt to forecast future market levels or stock prices. There is another, more sane approach to market investment, however.

Know what you already know and what you don't

Although it is difficult to forecast future index or stock price levels, it is feasible to have a considerably more accurate assessment of a company's future fundamentals. The book value or net worth of a business, with the exception of financial enterprises, may be determined with a better degree of certainty than its sales, even within the fundamentals. Furthermore, it is simpler to predict that the company's net worth will most likely exceed a certain minimal level in the next year or a number of years; we may refer to this as the conservative future book value.

Calculating the company's Return on Equity (RoE) is necessary to determine a conservative future book value. For businesses that are firmly rooted in their ecosystem, RoEs may be rather tenacious. These businesses are able to protect their margins because they consistently and significantly outperform their competitors.

Additionally, the demand for their products is steady and maybe even increasing. These businesses have predictable revenues and profitability. Their RoEs are predictable as a result. The majority of growth is within the current markets for the current goods, new products that are complementary to or supplemental to the existing products, or markets in new regions for the present products. These firms manage their capex in accordance with their predicted growth rates. Because of all of this, the RoE is relatively predictable. The management of such businesses is very aware of the necessity to retain their high RoEs and will only grow if it is viable to do so, even when entering whole new goods or markets.

One may anticipate the conservative future book value with ease using the RoE, long-term growth rates, and dividend policy. One may determine the potential future worth of the firm using an anticipated price-to-book-value (PBV) multiple of the future book value. Of course, the anticipated future value of the firm should also be rather cautious if conservative growth rates and RoEs are employed with generous dividend distributions.

Although cautious, there is a chance that the aforementioned estimations will be off. Numerous rivals may enter the market in the future. Alternately, there can be internal difficulties, changes in regulations, a rise in the negotiating power of suppliers and consumers, etc.

Additionally, the corporation could engage in M&A, buybacks, rights problems, or other corporate activities, among other things, which might cause the forecasts to diverge from actual outcomes.

One may think about adding it to the portfolio if the current multiple is less than what is warranted for a firm with the projected RoE and growth rates. Additionally, keep in mind that a good equity portfolio should normally include 20 to 50 companies. Institutional investors may have up to 50 portfolios, whereas aggressive individual investors can have 20 to 25 in a targeted portfolio. If one remembers to add companies from at least three to four various industries/sectors and avoid having an excessive allocation to one sector, this should offer enough diversity.

How to evaluate a good RoE, growth rate, and PBV multiples will be the following issue. It's an excellent place to start if the RoEs and growth rates are greater than the median or average. In order to investigate firms with PBV lower than the medians or averages of these companies, one may first look at all the businesses with comparable RoEs and growth rates. Simply compare it to the RoEs of the Nifty 50 or Nifty 500 if that is too challenging. The PBV (also known as PB), price-earnings ratio (PE ratio), and dividend yields are all published by Nifty. The RoE is obtained by dividing PBV by PE. Compare their growth rates to the nominal GDP growth rates or the Nifty 50's profits growth rates.

Of course, the optimum method is to estimate a company's conservative intrinsic value using various valuation methodologies, such as DCF, assuming one has exact data on all of the firms for the aforementioned factors. However, the aforementioned should usually be sufficient to give one a sizable advantage.

In conclusion, avoid putting too much emphasis on macroeconomic projections. These often don't work out as planned. Nobody is able to foresee the future. In reality, it has been shown by mathematicians that it is impossible to forecast non-linear dynamic systems.

The underlying development of a corporation may be forecast more accurately, yet still not completely. One might concentrate on it and attempt to determine which firm would represent a superior investment than the index itself.