Regular readers will know that I’m always skeptical of forward projections whilst buying shares. This is due to a very important lesson I learnt from a previous investing mistake.
Whilst it’s important that you view a company’s market going forward, and take clues as to future performance one should never focus too heavily on forward projections.
Let’s take a case study as to why: My purchase of EasyJet shares.
I bought EasyJet shares at around £16 a share in May 2015. My stake today is worth 35% less. Although, I always say that “my shares could drop 50% for all I care”, EasyJet is different because I didn’t do my homework.
This investment turned sour due to an investing mistake on my part.
The peril of forward projections
It’s important to understand the range of projections that exist for a share, and just taking the consensus recommendation isn’t good enough.
As you can see from the graph below, some analysts give a price target of £20 to EasyJet whilst others place it closer to £5. Who know’s who’s right?
The problem with many investors (and myself in May 2015) is that people buy shares expecting analysts to be correct about future earnings. At Least by taking the consensus estimates one could feel fairly comfortable right?
WRONG – these are estimates. Estimates change depending on continually evolving circumstances. Just look at the target price consensus revisions for Easyjet shares.
It’s so easy to feel secure because the price you’re paying is below the consensus price target.
It’s easy to feel secure because even the lowest target is not far off the price you’re paying.
But, like any projection. Things are subject to change, and Easyjet is a perfect example.
In July this year Easyjet shares tanked after the company issued a profit warning. Nobody, even the mystical analysts and their abundance of tools and resources saw it coming.
With any other share I’d be delighted at a drop in price but with Easyjet I wasn’t. I wasn’t comfortable in owning the shares at that price. Why? Because I was banking on projected earnings to pay lofted projected dividends. Big mistake.
Blinded by dividend.
When I stumbled across dividend growth investing, I got so obsessed with my own skewed version of the theory that I was blinded by dividend.
When buying EasyJet shares, I didn’t do my homework and betrayed most dividend investing principles.
The rationale for buying EasyJet shares pretty much lied solely on the dividend.
I saw this graph, took the forward dividends and EPS as gospel and plunged in head first. Look at that juicy 66p dividend in 2018. I thought, that would give me a yield of 24%. GENIUS…..More like idiot!
Another problem with projections and estimates, aside from the range of differing estimates is that projections can only be made with information available at the time.
As things change, so do projections.
But one thing that can’t be changed is the fundamentals of the company for the previous year or latest set of quarterly results.
This is why investors should never base their investments on the factual results at hand.
Management blames the following for Easyjet’s journey off course;
- EgyptAir tragedy
- Increasing market capacity (i.e more supply)
- An expensive euro due to brexit
- A very high level of cancellations during 3rd quarter 2016 with 1,221 compared to 726 in the third quarter 2015”
What I should’ve looked at – avoid this mistake!
What I should have looked at before buying EasyJet shares were the company’s fundamentals, and the environment in which it operates.
Doing so would have clearly shown me that an airline stock is not the steady growing, reliable dividend payer that dividend growth investors should buy.
Indeed, any intelligent investor, not blinded by yield and greed would have seen that the airline industry is;
- fiercely competitive – Increased capacity mean lower fares for all operators
- Extremely sensitive to external factors – Think terrorism and weather
- Very unpredictable – Think delayed flights + compensation claims
How on earth could such a stock be a steady, predictable dividend payer?
Just knowing these facts about the airline industry would have been enough to keep a conservative investor (as I now consider myself) far away.
Warren Buffett has notably said the following on airline shares;
“The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers”
— Warren Buffett, annual letter to Berkshire Hathaway shareholders, February 2008
Who would doubt the oracle of Omaha?
As for the future of Easyjet, who knows.
My interest in the stock has declined rapidly since I awakened as to the perils of the airline industry and continually revised revisions.
One thing EasyJet did teach me was
- Never trust forward projections for any metric. Be it dividend, earnings, revenue e.t.c
- Always thoroughly check the industry in which a stock operates (duh!), you may have some serious misconceptions
- Don’t be greedy. Predictability is far more important than projections of dividend growth.
Warren Buffet famously made a $353mn investing mistake in the airline sector. Thankfully my investing mistake only cost me £500.