• Skip to primary navigation
  • Skip to main content
  • Skip to primary sidebar
  • Skip to footer

Fat Tail Daily

Investment Ideas From the Edge of the Bell Curve

  • Menu
    • Commodities
      • Resources and Mining
      • Copper
      • Gold
      • Iron Ore
      • Lithium
      • Silver
      • Graphite
      • Rare Earths
    • Technology
      • AI
      • Bitcoin
      • Cryptocurrency
      • Energy
      • Financial Technology
      • Bio Technology
    • Market Analysis
      • Latest ASX News
      • Dividend Shares
      • ETFs
      • Stocks and Bonds
    • Macro
      • Australian Economy
      • Central Banks
      • World Markets
    • Small Caps
    • More
      • Investment Guides
      • Premium Research
      • Editors
      • About
      • Contact Us
  • Latest
  • Fat Tail Series
  • About Us
Latest

Investors as Superforecasters

Like 0

By Kiryll Prakapenka, Tuesday, 18 October 2022

In today’s Money Morning, what is a necessary skill great investors possess? I believe it’s forecasting. Great investors must be able to appraise the future well. Even the world’s most sophisticated model is useless if fed by bad forecasts. Great forecasts are crucial inputs to any great model or investment thesis.

What is a skill great investors must possess? What quality is necessary, if not sufficient, to elevate one’s investing?

I think forecasting is one.

Great investors are often great forecasters. The giants of the game are able to parse possibilities as a chef parses produce in the market.

They clutch a possibility, inspect it, prod at it, test it…and discard it if need be. All in the pursuit of best aligning their investment theses with the future.

Investing, the past, and seeing the future

We are told ad nauseam that past performance is no guarantee of future performance.

But future performance is where the gains lie.

So if you can’t turn to the past to see the future, forecasting becomes even more important.

To keenly assess what’s coming — to glimpse a stock’s prospects — is what sets the best practitioners apart.

You can be an Excel wizard, spinning webs of financial analysis, and still possess a mediocre track record.

Or you can be a CFO’s worst nightmare, poring over financial statements with an adept eye and performing poorly with your investments.

Take the discounted cash flow (DCF) method of valuing a stock.

The DCF method is one of the most dominant ways to appraise a stock’s worth — taught in business and finance schools all over.

But even DCF’s biggest exponents warn the method has a glaring issue: input.

Consider McKinsey’s respected Valuation textbook on the matter:

‘A valuation based on discounted cash flow is only as good as the model’s forecasts.’

Garbage in, garbage out.

Some think the work lies in executing and running complex valuation calculations.

But the real work comes before: the work to generate sound assumptions and reasonable forecasts.

A model is useless without sound data.

But how do you get sound data about the future? How do you come to reasonable assumptions about matters one, three, or five years down the line?

Superforecasting: a skill in its own right

What does it take to make a good forecast?

A great place to start is by consulting the work of political science professor Philip Tetlock.

Tetlock is the author of the seminal Expert Political Judgment: How Good Is It? and the popular Superforecasting: The Art and Science of Prediction.

Tetlock’s research revealed that good forecasts are rare and often illude the very experts we think would be best placed to make them.

Subject matter expertise does not by necessity lend itself to superior estimates of the future.

In fact, Tetlock found it could hinder them. Experts can double down on bad forecasts by using their wide knowledge of a given field to continue arguing for lousy estimates.

Forecasting, Tetlock found, was a skill in its own right, not a by-product of expertise:

‘What my research had shown was that the average expert had done little better than guessing on many of the political and economic questions I had posed…

‘The average expert was roughly as accurate as a dart-throwing chimpanzee.’

What sets good forecasters apart is not necessarily their knowledge but their thinking. How they think matters more than what they know.

Investment strategist Michael Mauboussin reiterated that point by noting that superforecasters are ‘actively open-minded, intellectually humble, numerate, thoughtful updaters, and hard working’.

They are not defined by encyclopaedic knowledge in X or a PhD in Y. They excel in their pattern of thought, not in its content.

Tetlock distilled the characteristics of a superforecaster to the following bumper sticker:

‘Beliefs are hypotheses to be tested, not treasures to be guarded.’

Superforecasting example: inside view versus outside view

One way to improve your forecasts is to toggle between what Daniel Kahneman — author of Thinking, Fast and Slow — dubbed the inside and outside views.

The inside view is a perspective on the particulars of a case.

Most of us only ever consider the inside view when judging a situation.

The outside view places the particulars among the general trend and considers the base rate.

Kahneman had a neat illustration of this in Thinking, Fast and Slow (emphasis added):

‘An individual has been described by a neighbor as follows: “Steve is very shy and withdrawn, invariably helpful but with little interest in people or in the world of reality. A meek and tidy soul, he has a need for order and structure and a passion for detail.”

‘Is Steve more likely to be a librarian or a farmer?

‘The resemblance of Steve’s personality to that of a stereotypical librarian strikes everyone immediately, but equally relevant statistical considerations are almost always ignored. Did it occur to you that there are more than 20 male farmers for each male librarian in the United States? Because there are so many more farmers, it is almost certain that more “meek and tidy” souls will be found on tractors than at library information desks. However, we found that participants in our experiments ignored the relevant statistical facts and relied exclusively on resemblance [inside view].’

Considering base rates is a great way to improve your forecasts.

Tetlock has a nice demonstration of taking the outside view in Superforecasting (emphasis added):

‘If Bill Flack were asked whether, in the next twelve months, there would be an armed clash between China and Vietnam over some border dispute, he wouldn’t immediately delve into the particulars of that border dispute and the current state of China-Vietnam relations. He would instead look at how often there have been armed clashes in the past. “Say we get hostile conduct between China and Vietnam every five years,” Bill says. “I’ll use a five-year recurrence model to predict the future.” In any given year, then, the outside view would suggest to Bill there is a 20% chance of a clash. Having established that, Bill would look at the situation today and adjust that number up or down.’

Interestingly, McKinsey’s Valuation book hints at the importance of taking the outside view in the following passage (emphasis added):

‘Yet, all too often, we get caught up in the details of a company’s financial statements and forget the economic fundamentals: A company’s valuation is driven by ROIC and growth. Thus, when you perform a valuation, it is critical to evaluate how your forecasts of ROIC and growth relate to the economics of the industry and how your results compare with the historical performance of companies that came before.’

It is not sufficient to focus on the details of your watchlist stock alone.

You must also consider the base rates: the historical performance of similar firms and the mean economics of the stock’s industry.

The inside view may show you a business with great management, solid growth, effective marketing, and happy customers.

But the outside view may show an industry with slim margins, high exit rates, low barriers to entry, and dwindling ROE.

Remember farmer Steve: he was more likely to be a ‘meek and tidy’ soul driving a tractor than a librarian.

So ask yourself whether a stock you’re interested in is more likely to be a statistical anomaly or another affirmation of the mean.

Until next week,


Kiryll Prakapenka Signature

Kiryll Prakapenka,
For Money Morning

All advice is general advice and has not taken into account your personal circumstances.

Please seek independent financial advice regarding your own situation, or if in doubt about the suitability of an investment.

Kiryll Prakapenka

Kiryll’s Premium Subscriptions

Publication logo
Fat Tail Investment Research

Latest Articles

  • Don’t Get Swept Up By the Herd: Bulls & Bears in an Age of Social Media
    By Charlie Ormond

    Markets have always reflected this chaotic behaviour, but today’s markets operate in an environment fundamentally transformed by social media.

  • The latest Closing Bell is available now
    By Callum Newman

    Tune in today to watch the latest Closing Bell podcast with Murray Dawes. We discuss gold, oil, real estate…plus a stock to watch. Tune in now!

  • Thorium: One Step Closer to China’s Energy Fortress
    By James Cooper

    Forget AI, the biggest breakthrough of this century will revolve around ENERGY. And the commercialisation of Thorium reactors could be at the heart. Read on to find out why China could be about to make history.

Primary Sidebar

Latest Articles

  • Don’t Get Swept Up By the Herd: Bulls & Bears in an Age of Social Media
  • The latest Closing Bell is available now
  • Thorium: One Step Closer to China’s Energy Fortress
  • The famous yield curve: buy or sell signal? You decide…
  • How Australians voted for a great wealth redistribution

Footer

Fat Tail Daily Logo
YouTube
Facebook
x (formally twitter)
LinkedIn

About

Investment ideas from the edge of the bell curve.

Go beyond conventional investing strategies with unique ideas and actionable opportunities. Our expert editors deliver conviction-led insights to guide your financial journey.

Quick Links

Subscribe

About

FAQ

Terms and Conditions

Financial Services Guide

Privacy Policy

Get in Touch

Contact Us

Email: support@fattail.com.au

Phone: 1300 667 481

All advice is general in nature and has not taken into account your personal circumstances. Please seek independent financial advice regarding your own situation, or if in doubt about the suitability of an investment.

The value of any investment and the income derived from it can go down as well as up. Never invest more than you can afford to lose and keep in mind the ultimate risk is that you can lose whatever you’ve invested. While useful for detecting patterns, the past is not a guide to future performance. Some figures contained in our reports are forecasts and may not be a reliable indicator of future results. Any actual or potential gains in these reports may not include taxes, brokerage commissions, or associated fees.

Fat Tail Logo

Fat Tail Daily is brought to you by the team at Fat Tail Investment Research

Copyright © 2025 Fat Tail Daily | ACN: 117 765 009 / ABN: 33 117 765 009 / ASFL: 323 988