Guiding Higher or Guiding Nowhere?

We've said that stock analysts have as much chance of being right as fortune-tellers do, and that business consultant William A. Sherden is correct when he notes in his book The Fortune Sellers that weather forecasters have at least a scientific basis for their predictions, even if they seem more wrong than right.

Stock analysts don't have such foundations for their predictions, despite all the fancy mathematical models they build. While they might be making so-called educated guesses about a business's direction, it still comes down to a guess. Money manager David Dreman has found that analysts over a 30-year period were wrong by an average 41% when guessing a company's results.

Guideposts to follow
Yet we also noted that State Street Global Advisors has found that because companies are becoming "more explicit" in their guidance in hopes of minimizing stock volatility, analysts have become more negative. If companies were providing more and better information, we ought to use that to our advantage. I began noting which companies were guiding investors higher in their own forecasts. I thought it would be instructive to see just how they have fared in the intervening months.

Six months ago, on March 13, these were the five companies we highlighted, along with their total returns since then.

On the face of it, it might not seem that the survey was of much value since the cumulative return of the five companies was 1.17% for the six-month period. However, I think there are some very telling results that should be meaningful for investors wanting to boost their portfolio's returns.

In that original article, we had two five-star stocks, Korn/Ferry and Brown Forman. While I had found Korn/Ferry to be the more compelling of the investments listed, in retrospect I see that I should perhaps have focused instead on Brown-Forman, but not because it did better than any other company. It's why I believe Brown-Forman did so well.

Turning a deeper shade of Brown
First, Korn/Ferry's guidance had been for just the quarter ahead, which was in line with analyst expectations. The executive search firm actually did well that quarter, and its stock rose from $22.60 on the day we ran our screen up to $26.89 in the weeks after its earnings report for a 19% gain. Subsequent events have caused the stock to crater.

Yet when we look at Brown-Forman, we see that the liquor distributor was upgrading its guidance for the full fiscal year, and it raised the guidance significantly higher than what the analysts were thinking: They were forecasting $3.09 a share for the Jack Daniels distributor and Brown-Forman raised its estimates almost 7% above that, to as much as $3.30 a share. That was signaling significant confidence in what was happening in its business.

At the time, CAPS investor Cheekybloke figured the low valuation being assigned to Brown-Forman had more to do with its recent acquisition of the Herradura brand of tequila than with anything that might subvert the business:

Recently beat down by quarterly earnings report that was impacted by Herradura acquisition. Premium brand who's P/E is trading below industry yet growing faster than its peers. Good steady performer in case of recession makes this a good hedge stock in a portfolio.

In fact, while several dozen CAPS investors have weighed in on the distributor, only two players believe the company will underperform the market.

A guiding light
It's also important to note that there was lots of time available to profit from Brown-Forman's announcement. The liquor magnate had announced this increased guidance the week before we highlighted it, and the stock traded a very tight, flat range for months.

So we might conclude that it pays to investigate companies that are looking more than just a few weeks or months ahead and concentrate on those with a longer time frame. Moreover, zeroing in on businesses that are significantly upping the ante over what the analysts predict could be a sign that can guide us to good times ahead.