Why it pays to be long-sighted when investing

The further into the future that risks and rewards lie, the worse markets are at evaluating them accurately.

For those investors with a truly long-term mind-set, this provides an opportunity to profit.

The discounted cash flow model is a popular approach used by analysts to value companies. An important part of this involves forecasting a company’s prospects. More often than not this comes in two (or more) stages.

First, company-specific forecasts about what they think will happen in the near-term. Second, an assumption a company will revert to a constant growth rate, which will then apply for all other years into the future.

Analysts concentrate on the near term

The reality is that the average number of analyst forecasts per company drops precipitously once you get two to three years out (see chart). Hardly anyone bothers forecasting longer-term.

The chart below shows this for US large and small caps but it's the same pattern for other major  markets, such as Europe ex UK, the UK, Japan and emerging markets.


The opportunity for long-term investors

This inability of the market to focus on longer-term prospects can result in companies being significantly mis-priced.

The opportunity for the long-term investor is to identify, ahead of the market, companies and sectors that stand to benefit from supportive developments or that are most exposed to risks.

This applies everywhere, but some specific ways it can play out are:

  • ESG investing / sustainable investing. The biggest risks from climate change will be felt over a much longer timescale, for example.
  • Thematic investing. Many themes are long term in nature, so to assume that earnings will plateau at some trend level from year-three onwards would dramatically underestimate their potential. To stick  with the climate change example, the transition to a less carbon-intensive energy system (the ‘global energy transition’), including all of the infrastructure required to make this happen, is going to take place over the next 20 years. Above-average growth rates are primed to endure for much longer than the next three years. Ignoring this could be costly.