The Only Prediction You Can Trust

Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Sadly, that tedious part of the year is coming again. I´m not talking about having to tolerate those annoying relatives through the holidays, that´s what wine is for. Something even worse is approaching: economic and stock market predictions for 2013.

I don´t even need to hear any of these forecasts to have an opinion about them, history has forecasters wrong over and over again. The truth is that the economy and the stock market are incredibly complex systems, and no one has been able to predict them with consistency over time.

One thing is much more certain though, and more relevant for investors: buying high quality companies at fair prices delivers solid returns in the long term. You don´t need to forecast economic growth, tax policy or the evolution of the S&P 500 to do well in the long term. Making a list of the best companies to buy, and pulling the trigger when the price is right, is a much more effective way to make money.

The Tune of History

History doesn´t repeat itself, but it does rhyme. Companies with strong competitive advantages and smart management teams usually have solid performance track records, and they are more likely to continue delivering strong results in the future too.

Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) looks well positioned from that perspective. This is not just one business, but a compendium of high quality companies selected by Warren Buffett himself over the decades. Berkshire has outperformed the markets by a considerable margin as measured by the evolution of its book value per share, but investors have gotten increasingly pessimistic about the company, to the point that Berkshire is trading at a historically low price to book value ratio.

The company has become much bigger, and Buffett has admitted that we shouldn’t expect in the future the same level of over performance the Berkshire has delivered in the past. But the Oracle of Omaha still believes that Berkshire will do better than the indexes in the long term, and it has done so on a consistent basis, even in recent years.

Buffett considers Berkshire cheap enough to merit a stock buyback, and he understands a thing or two about buying high quality companies at discounted prices, so investors should consider a long position in the company now that the price is so attractive.

The Price of Risk

It´s almost impossible to forecast the economic cycle, but investors can differentiate if they are being properly rewarded for assuming cyclical risk or not. Caterpillar (NYSE: CAT) is one clear example about a high quality company offering an attractive entry price, even if the business is heavily exposed to economic uncertainty.

The company is the market leader in equipment and machinery for construction and mining, two sectors with high sensitivity to economic conditions. But Caterpillar has managed to deliver positive earnings and cash flows during the great recession of 2008-2009, so it should be fine in the long term regardless of short term economic problems.

Besides, at the current P/E ratio around 9, Caterpillar is historically cheap, which leaves plenty of room for upside gains if the company continues delivering strong earnings figures.

A similar case can be made about Ford (NYSE: F) at current levels. The auto industry is quite cyclical, profit margins are thin and competition is really tough, but Ford is trading at a forward P/E below 8 times earnings estimates for the next year, this is materially cheaper than the same ratio for Japanese competitor Toyota (NYSE: TM) which trades at a forward P/E around 15.

Not only is Ford cheaper than Toyota, it has also regained a lot of market share versus the Japanese company over the last years. Ford has been building better and more efficient vehicles, and the company is increasing its productivity while keeping costs under control. Financial strength has also improved notoriously at Ford, the company is reducing its debt and it also resumed its dividends last year.

The business is cyclical, but Ford is a well managed company which is moving in the right direction, and the stock is cheap. Investors in Ford are being well rewarded in terms of upside potential for assuming economic risk, and that´s the kind of investments which usually work out well in the long term.

Bottom Line

Forget about market forecasts and economic predictions, they are mostly a waste of time, and you don´t even need them to do well in the markets. The only prediction worth trusting is that high quality companies bought at attractive prices deliver healthy returns in the long term. Fortunately, investor´s concerns regarding the economy have created some interesting opportunities to choose from.


acardenal owns shares of Berkshire Hathaway, Ford and Caterpillar. The Motley Fool owns shares of Berkshire Hathaway and Ford. Motley Fool newsletter services recommend Berkshire Hathaway and Ford. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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