Forecasting obsessions

This article from the FT, and the research that it refers to to, nicely illustrates what I think is one of the biggest myths of investing:

http://www.ft.com/cms/s/0/21c20d22-effe-11de-833d-00144feab49a.html?nclick_check=1

The article refers to a study by academics claiming that analysts' forecasts have no effect on share prices. The authors analyse a load of share price moves following analyst forecast changes and could find no evidence that such changes had any effect on prices. Therefore, the authors conclude, star analysts and stock pickers add no value to investors.

Unfortunately the authors are completely missing the point. The conclusion that forecasts do not move share prices is not particularly surprising. Indeed value investors have long since largely considered accurate forecasting as not a very relevant input to valuation analysis (sometimes it can be interesting to know which way forecasts are going, but they tell you nothing about the underlying value drivers). It implies a degree of knowledge and accuracy that is simply not there. Furthermore, study after study has shown how pathetic analyst attempts at forecasting earnings actually are (e.g. James Montier's many studies). They are almost as bad as economists' attempts at forecasting GDP. Therefore why should we be surprised that the market takes no notice of forecasts?

The value added part of fundamental stock analysis comes by identifying genuinely undervalued securities, not by forecasting what next year's eps is going to be. To do this requires accurately valuing the company's assets, the earnings power and, where appropriate, any long term growth prospects. Once this process is completed the investor looks to buy at a discount to this value, providing margin of safety. Value investors rarely make any attempt to forecast earnings, expect perhaps for the purpose of scenario analysis.

That said, for all the misconceptions surrounding the forecast obsession, from a value investors perspective I hope the fetish prevails. The more analysts spend their time desperately trying to produce more accurate forecasts to base their valuations off, the more likely they are to miss more obvious value opportunities.