Uncertainty and Forecasting in the Marketplace

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No one knows what the earnings of a company (except perhaps an electric or gas company or, to a lesser degree, a bank) will be several years hence.

Even if the investor knew the earnings results several years off, he would not even then know at what price the stock would sell because: common stock valuation almost always can differ by between 12 to 15 percent; much larger differences in valuation result from changes in the market valuation of a dollar of earnings.

If large and small investors were persuaded of the foregoing, much disappointment would be eliminated and less confidence would be expressed in the future price movements of stocks. Instead of the assurance that X Manufacturing stock will sell at $65 per share, it would be more frequently said that the stock of X Manufacturing should sell at $65 per share.

Economic, financial, and industrial conditions change too rapidly to permit accurate forecasting of earnings three to five years hence. As the professionals say, there are too many "imponderables." This is merely a way of saying there are too many uncertainties. Phases of the business cycle may not recur in the way that had been anticipated. The commodity price level may be lower or higher than had been projected. Demand may have been accelerated by new uses for a product or cut down by the substitution of competitive products. Higher labor costs could not, perhaps, be passed on in prices.

New supplies may come on the market from domestic or foreign competitors. One striking example must suffice: In 1956, Aluminum Company of America earned $89.6 million. Almost every forecast of the trend of sales and profits was more glowing than the last. One did not need to be an expert to observe how the use of aluminum was growing. Here was a splendid company in every respect. Five years later, in 1960, Alcoa earned $40.0 million!

The more distressing fact is that if the investor was provided with the fabled "crystal ball" and guessed earnings correctly, he might still be way off concerning the price of the stock at the end of a three-or five-year period.

Given all the facts concerning a company, there will still be a difference of at least 12 to 15 percent in the value placed on the stock by various analysts. Value measures a flow of future earnings and dividends, and the very same set of facts will lead different analysts and investors to different conclusions about the future. Proof of this is always present during a reorganization of a company and the working out of a recapitalization plan.

One would need to work through the testimony of witnesses in proceedings before the Securities and Exchange Commission, in its reports to courts in reorganization proceedings, or in proceedings before the Interstate Commerce Commission in order to understand why 12 to 15 percent is actually a very modest difference of opinion. Valuation proceedings growing out of tax litigation involving stock of closed corporations tell the same story. And the competitive bidding of investment banking firms for the stock of companies like Schering Corporation, whose stock was wholly owned by the Alien Property Custodian, underlines the wide spread in opinions about stock valuation when no market has heretofore existed.

For these reasons, playing the stock market is often thought of as just another form of gambling. Yes, there are some who have been in the game long enough to decipher patterns, but even they lose often enough. The best bet, then, is to study the history of the companies, mutual funds or variable annuities in which you wish to invest, consult a broker, and then hope for the best.

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