Let me start with quotes by two famous investors –
“If you don’t know what has happened, you’ll never know what is going to happen.”
“People usually expect the future to be like the past and underestimate the potential for change.”
These are exactly opposite statements made by two highly successful investors that complicates the life for mortals like us !
Whom to believe?
The confusion continues to build up as one spends more and more time in the markets.
- You invest into a stock looking at it’s past performance and then it starts underperforming.
- E.g., You invest in Kotak in July 2018 looking at the previous 10 year CAGR of 28%. Then over the next 4 years (2018-2022), the stock generates a paltry return of 6% CAGR.
- You invest into a stock ignoring the past, assuming the future to be revolutionary and then nothing happens and the stock falls off the cliff.
- E.g., Current sentiments around new age start-ups like Zomato and Paytm, wherein the history of losses was ignored for the endless possibilities in the future.
and then there are cases where it actually works –
- Past performance providing a good guidance about the future
- E.g., Stocks like Nestle, Vinati Organics
- Turnarounds working for the companies with a chequered past
- E.g., Tata Motors, Mahindra & Mahindra, Raymond
Result – we as an investor are confused and continue to ask ourselves, what really matters… PAST or FUTURE or BOTH?
This is a question that has bothered me for long. The frustration increases when investment decisions don’t go in my favor and I realise the reason was either I relied too much on the past or decided to become the flag bearer of calling out the future trends.
The purpose of this post is to put my thoughts about where I stand on the issue currently and open it to your scrutiny. So here we go…
“Past is a fact. Future is a hope.”
This is one statement that I am increasingly finding useful to guide me on the subject.
Look closely and you might realise that it is actually quite powerful.
Fact Vs Hope
- Facts are what actually happened. Hope is predicting future that requires a broader outlook, greater research, experience and hence entail more hard work and longevity as an investor;
- Facts have a footprint, Hope has probabilities;
- Facts are difficult to manipulate, Hope gets manipulated all the time.
With this powerful guide, here are my current conclusions on the subject.
1. Past is an excellent indicator of an organisation’s culture and the corporate governance
- Management’s response during difficult business periods
- Treatment of key employees over the years
- Actual delivery vs promises/ predictions
- Efficiency in capital allocation/ deployment
- Business growth trajectory via organic/ inorganic route
Longer the available history, better this analysis becomes…
Every management wants to sell us the future but very few can stand the test of the past.
A pertinent example in the current context – everyone in the auto sector today is jumping onto the EV bandwagon and claims to be the undisputed king in future. However, if one looks at their past track record, most of them have been very poor product innovators and/ or customer service providers.
It doesn’t mean that things can’t change. However, past actual facts help an investor to ask for pointed relevant questions and make a more calculated prediction.
2. Future performance is what generates returns for the investors and not the past
This is a key to keep in mind… always !
Environment and trends change and so do the performances of various businesses.
Old leaders give way to new… and as active investors, we aim to remain with the leaders… don’t we?
We could neither afford to remain in the historical glory of Nokia, Kodak and GE, nor ignore the increasing adaptability of the tech.
Our returns are bound to remain muted if we continue to put unshakeable faith on the old champions and/ or keep shooting down the new emerging trends.
3. Guided by past, predictability of the future improves
This seems to be an obvious conclusion based on the previous two points.
Past allows us to ask the right questions, which in turn improves the predictability of the future events.
- If the management has always followed a hire and fire policy, how then it now plans to attract the top talent?
- When company has never bothered to deliver on it’s past promises, why should I rely on it’s new visions?
- Company has always worked with selective products. Due to heat from the competition, it now plans to launch many new categories. However, won’t managing a larger product portfolio be a drag on it’s efficiency?
- Company’s Return on Capital Employed (ROCE) has been very volatile in the last 10 years. How is it predicting a secular improvement in the next 5 years?
Above are only few examples, but I believe you would have got the point.
I believe where most of us err is by using past and future for wrong inferences.
- Past is more suitable to understand the management quality whereas we mostly use it for the historical financial performance.
- Future is needed to predict the business trajectory where rather than doing our own independent research and hard work, we mostly get influenced by larger than life management talks.
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