Long Term Value, Less Noise: F and GLW
Charlie is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Nate Silver implies our worst wounds are self-inflicted, because we fail to cut through the noise. Just recognizing that fact is helpful. Some kind of noise reduction system for investing might be better for the long term investor. A good look at Ford (NYSE: F) and Corning (NYSE: GLW) may peer through the noise, sharpen your thinking and start building your own system. Examining shorter term heroes and villains like 3D Systems (NYSE: DDD) or Facebook (NASDAQ: FB) is instructive because of the sheer volume of short term noise and lack of long term data--Beware!
Even well trained, educated individuals misunderstand statistics, misapply them, and mistake the import of "data." We mistake random recorded observations for information, and even worse, mistake those for high quality measurements. We go on to presume a relationship between those observations. Then we compound our mistakes by applying statistical analysis to those random events, "discovering" relationships that dont exist, and enshrine them with statistical terms like mean, R-squared and standard deviation. This is why Nate Silver's book The Signal and The Noise is such a good read and well worth a long term investor's careful attention.
For the long term investor, the deception of "noisy" short term price increases has to be the most tempting and damaging of "head fakes." Which are fundamental? Which are the madness of crowds? Thus you have wild swings of opinion and price on DDD and FB (or as I prefer to call them "Faceplant") and few ways to judge their long term prospects as enterprises--the noise level is high. Among the many gems from Nate Silver's book is a segment on Wall Street in which he details his search for some, ANY, correlation of so-called "data" to long term results and finds NONE! As in zero. The closest he can come is the price to earningsratio, or P/E, with (by his calculation) correlation based on R squared of 0.4 (1.0 would be perfect, generally .6 to to .8 would be considered pretty good). So, P/E is not very good but its better than totally random.
If we look at long term established business like F, and GLW, their P/E looks investable, single digits, and if we look at DDD or FB they look astronomical, (DDD at 80 + P/E, note as of 1/11). So what can we tell from this better than nothing, but not so great "metric"? Maybe that with F and GLW, investors have a rational expectation to recover their initial investments in earnings inside of 10 years. Investors get to evaluate what it means from a much less confusing picture that has real history. The clarity of the message, or "signal," is just a little sharper than with DDD or FB, which tell us next to nothing useful. What can a P/E of 80+ mean (DDD)? Or 100+ (FB)? That their business will accelerate to dramatic profits in just a year or two? That speculation is driving their price? That the madness of crowds prevails in these stocks? That their prospects are moonshot-like?
Maybe inclusions of enterprises like DDD and FB in "Data Analysis" is what drives P/E correlations into "poor" territory like 0.4. One thing that long term investors learn repeatedly is to run for the hills when psychology overshadows basics.
SkepikI owns shares in F and GLW. The Motley Fool recommends 3D Systems, Corning, Facebook, and Ford. The Motley Fool owns shares of 3D Systems, Corning, Facebook, and Ford and has the following options: Short Jan 2014 $55 Calls on 3D Systems and Short Jan 2014 $30 Puts on 3D Systems. 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!