GuruFocus Research: What worked in the market from 1998-2008? Revisiting Business Predictability

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Apr 01, 2009
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GuruFocus Research: What worked in the market from 1998-2008? Revisiting Business Predictability

In this article we would like to revisit the concept of Business Predictability, a concept we introduced six months ago. The investment returns with Predictable Companies and others are also updated.

On Sept. 30, 2008 we reported that our study on what worked from 1998 to 2008 which led us to an important concept called “Business Predictability”. We found that companies with higher predictablility in revenue and earning growth carry lower investment risk and higher return; the strategy of buying and holding predictable companies rewards investors with returns far above average. Since then the economy has seen its biggest crisis in more than half a century, and the stock market has declined 30%, even after the recent strong rebound.

As a reminder, we rank the predictability of companies based on the consistency of their revenue and EBITDA (earning before interest, tax, depreciation and amortization) per share over the past ten fiscal years. Companies with the highest consistence in revenue and earning growth have the highest predictability rank. Accordingly, we assign a Predictability Rank ranging from 5-Star (highest) to 1-Star (lowest) to each company. A 5-Star rank means that the company has been consistent on the growth trend in its operation. A 1-Star Predictability Rank means that the company either had at least one quarter of negative EBITDA or no growth over the past 10 years. If the 10-year financial history of a company is not available, it is not ranked. The Predictability Ranks of all companies are updated once every week.

The Sustainability of Business Predictability

It has been six months since our original study . The past six-month period has been the most unpredictable period for both the economy and the stock market in many decades. Although we do not like what has happened in the economy and the stock market, but this period serves as a perfect period to test the investment strategy based on Business Predictability. If a business can maintain its predictability over the past six months, it is likely it will sustain future economic distress as well.

Among the 572 companies that were deemed as Predictable Companies in August 2008, 501 remained on the list. 71 companies or 14% of the Predictable companies in August 2008 dropped out. Among the 80 5-star ranked predictable companies, only one company, or Toyota Motors (TM) dropped out. As the car industry experienced its worst year in many decades, Toyota Motors, the most respected auto company, saw its first quarterly loss in 70 years. Among the companies that were ranked 4.5-star or 4-star, 10 out of 160 companies dropped out the list, which is a percentage of 6%. Therefore, we can conclude that the list of the top ranked Predictable Companies is very resilient to economic downturn.

Investment Returns of the Predictable Companies

During the period from Jan. 1998 to March 2009, the S&P500 lost about 1.1% annually, not counting dividends. The performances of all the companies under study are shown in this table:

Total Number of stocks 501 2171 2672
Stocks that lost money 138 1479 1617
Stocks lost more than 50% 58 913 971
Stocks lost more than 90% 11 375 386
% of Stocks that lost money 27.5% 68.1% 60.5%
% of Stocks that lost >50% 11.6% 42.1% 36.3%
% of Stocks that lost >90% 2.2% 17.3% 14.4%
Average gain 155.2% 20.0% 45.4%
Median gain 71.0% -37.0% -24.5%
Maximum Gainer 2408.0% 17834.0% 17834.0%
Annualized Average gain 9.1% 1.7% 3.6%
Annualized Median gain 5.1% -4.2% -2.6%

Similar to what we found out in the our previous study, the Predictable Companies have had much higher investment returns. As a group they have had an annualized median gain of 5.1%, compared to the -2.6% of all companies under study. The unpredictable companies have a loss of -4.2% annually, which is much worse than that for all the companies under study.

The reason we have achieved above average returns by investing in predictable companies is not because we have picked the biggest gainers, but because we have avoided a high percentage of losers. Among the 501 predictable companies, 138 or about 27.5% of them have lost investor’s money if they were bought in January 1998, and held until March 2009. However, investors would have lost money on 60.5% of the 2672 companies if they bought indiscriminately. Obviously the probability is even higher (68.1%) if investors bought the unpredictable companies and held them until now.

Compared with the results in our August 2008 study, because of the market decline since then, the market turned from a 2.7% of annual gain to a 1.1% of annual loss, a decline of 3.8%. The median gain of all the companies under study declined from a 3.1% of annual gain to a 2.6% of annual loss. The median gain of predictable companies declined from 8.9% to 5.1%. The decline of the predictable companies is about the same as with the market, but the unpredictable companies suffered an additional loss of 1.3% annually on average. Therefore, investing in Predictable Companies is safer and more recession-proof than investing in unpredictable companies.

Among the 100 most predictable companies, only 16% have lost money if investors stayed invested with them for 11 years. This group posted an annual gain of 8.3%, more than 10% higher than the whole group of 2672 companies, which returned -2.6%. The second group of 100 predictable companies posted an annualized gain of 6.5%, and the chance of losing money with them is 24%, as shown in the table below.

Top 100Second 100Third 100Fourth 100Rest Predictables
Total Number of stocks 100 100 100 100 101
Total lost money 16 24 24 31 43
total lost more than 50% 7 9 11 12 19
total lost more than 90% 0 1 4 2 4
% of Stocks that Lost Money 16.0% 24.0% 24.0% 31.0% 42.6%
% of Stocks that Lost >50% 7.0% 9.0% 11.0% 12.0% 18.8%
% of Stocks that Lost >90% 0.0% 4.0% 2.0% 4.0%
Average gain 243.7% 185.4% 104.1% 169.7% 73.8%
Median gain 134.0% 97.0% 70.5% 52.5% 23.0%
Maximum Gainer 1943.0% 2408.0% 1187.0% 1841.0% 2182.0%
S&P500 gained an annualized average of -1.1% from Jan. 1, 1998 to March. 25, 2009
Annualized Average gain 12.2% 10.3% 6.9% 9.7% 5.3%
Annualized Median gain 8.3% 6.5% 5.1% 4.0% 2.0%

Talking about the recession-proof companies, if you are a Premium Member, and checked the List of Predictable Companies, you would notice that the No. 1 most predictable company in the list is ITT Educational Services, Inc. ( ESI). ESI stock has gained about 50% since the inception of the list in October of 2008, while the market declined more than 30%.

Undervalued Predictable Companies and Buffett-Munger Screener

In the Part II of our study of Predictable Companies, we concluded that the group of Undervalued Predictable Companies has the better performances. This is still the case with the recent market crash. This group posted an annualized median gain of 12.2%, about 15% a year better than the median gain of the 2673 companies under study.

As a reminder, the Undervalued Predictable Companies are defined as the Predictable Companies that have a lower P/E ratio in January 1998 than its 11-year average EBITDA growth rate. Premium Members, you can always find the current list at Buffett-Munger Screener. Also please check the current List of Undervalued Predictable Companies for best ideas. In this page, we list the estimated fair values of Predictable Companies using our discounted cashflow model (DCF) calculator. These companies appear to be undervalued, and relatively safe due to their business predictability.

If you are not Premium Member, you are invited for a 7-day Free Trial of Premium Membership.

Update of the Back-testing

As discussed in Part II of the previous study, financial information is not known until the period has passed. In order to further test the idea of business predictability, we can only use the financial information that had become available before the beginning of the test period.

For example, to test the performances of stocks in 2005, we can only use the financial data that was available before December 31, 2004. We use the same algorithm to rank the predictability of business, and observe the stock performances of a portfolio equally invested in the top 25 most undervalued stocks among the top 100 most predictable companies at that time. The portfolio is rebalanced after 12 months. Likewise, for year 2006 , we use the financial information before December 31, 2005 to determine the predictability of business, and invest in the top 25 most undervalued ones among the top 100 most predictable companies, and so on. We repeated the steps for 2007 and 2008. The updated results are shown in table below:

S&P500 3.8% 12.3% 4.4% -37.6% -24.1%
Top 25 Ranked 36.8% 13.6% 18.2% -22.6% 42.2%

As we can see, from January 2005 to December 2008, the S&P500 lost more than 24%, but the portfolio consisted of 25 undervalued predictable companies, balanced each year, has gained a total of 42%.

We would also like to point out that between August and December 2008, one of the most volatile periods in the history of the stock market and the economy, the market lost 27%, whereas the portfolio of the 25 undervalued predictable companies lost 25%, slightly better than the market. Despite the high quality of the companies, they still could not avoid losses when the market was sold off indiscriminately.

For 2009 and the future, we do not need to backtest the performances, as we have set up a model portfolio in the beginning of 2009, it is called Buffett-Munger Model Portfolio. The performance of the portfolio is updated daily so you can check its performances. As of the end of the first quarter, the portfolio is down 6.99% and the market is down 11.67%. The portfolio outperformed the market by more than 4% in the first 3 months of 2009.


The recent economic crisis and stock market crash provide a perfect time for further testing the concept of Business Predictability and Undervalued Predictable Companies. The revisit of our previous study supports the conclusions that companies with more consistent revenue and earning growth reward the investors with much higher gains. The chance of losing money with predictable companies is much smaller if investors buy and hold these companies for long period of time. Investors can achieve returns well above the market average if they stay with the companies that meet Warren Buffett ’s rules of investing, which is: “buying good companies at fair prices”.

Related Articles:

What worked in the market from 1998-2008?

Part I: Business Predictability andPredictability Rank

Part II:Role of Valuations

Part III: Intrinsic Value, Discounted Cash Flow and Margin of Safety


1. Predictable Companies

2. Buffett-Munger Screener

3. Undervalued Predictable Companies

4. DCF Calculator

5. Buffett-Munger Model Portfolio.

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