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Sep 2, 2014

Investing With Incomplete Information

by Dale McIntyre

Many, if not all, of the average investors invest in the stock market with incomplete information on the companies they buy. They do not have investment services with huge amounts of data nor many investment tools. Some can’t afford them and some don’t know where to find them. It is true that a diligent investor can make money with ordinary investment tools but it is also true that an investor with better investment tools can often make higher returns. There is a trade-off between the cost of information and the additional gains it provides.

What Is Available

There are quite a few tools and sources of data that are readily available for a small outlay. Most newspapers have a business section with at least the latest stock prices. There are some reports on the television news and of course now there is the Business News Network. Some investors with laptop computers can get special reports from BNN just by texting in to BNN. But everyone should at least have the information available in The Report on Business in The Globe and Mail. This is not timely information as it only comes out once a week but it is accurate and it is useful. It contains earnings per share (E.P.S) and price earnings ratios (P/E), dividend yields and the movement in price for the week and the year. This information can be enough for many investors to use and make money on. But don’t count on this kind of information alone to bring extraordinary returns.

Data Problems

These sources of data only show how companies have performed in the past. Using them for investment purposes means that you think the company will perform basically the same in the future. That is, a company that had a P/E ratio of 15 last year will be counted on to basically have that ratio next year. The assumption is that earning will increase by 3 to 5% because the economy grows by 2 to 3%. Their earnings will increase by a little more than the growth of the economy. The dividend yield will remain basically the same as in the last year.

The gains obtained by these static measurements will, with a little variation, combined with information on the economy, show your best estimate of future gain. This is an estimate of the gain using the “buy and hold” method. It does not need accurate information nor rely on it. Its gains are obtained over time, assuming little change but positive change. It counts on things remaining almost the same or a little bit better for the next two to three years. The investor has bought a solid performer and expects things to be a bit better. This method relies on a 2 or 2.5% increase in the economy and will earn a solid gain plus a dividend.

More Accurate Data

The kind of information mentioned will not enable investors to predict future changes that well. In order to do that the investor needs information on future revenues and profits and even some engineering information. First one must realize that free information is not that accurate; The Globe and Mail’s weekly Report on Business does have some inaccurate information and some out-of-date information, as does BNN. So relying on this data, even if it is only for “long term” investing, will not guarantee accurate results nor positive returns. I know, as I have used it. So there is a cost to having accurate information. You can get an investment service but it may cost up to $30 a month. If you use a broker for information then the commissions will be higher. Some brokers charge up to $20 a trade for low volume or low asset portfolios. More accurate advice, however, will likely increase returns even for “buy and hold” investors, thus again showing that there is a trade-off between the cost of information and returns.

There are also bare-bones brokers now, such as Questrade and Interactive Brokers. These services offer low cost trading and provide you with average quality data and no advice. This is only for well-educated investors who know how to use investment data.

Predicting Future Stock Prices

Another method of investing is called “momentum” investing. It ignores the company fundamentals such as earnings and growth in earnings plus the price/earnings ratio. The focus is on the movement in stock price and the change in the movement in price usually over the last year. For example, this investor needs to know how much the stock price moved in May and how much in June and is the price increase less or more in June. The investor looks at the momentum in the price changes. Is it accelerating or decelerating? Only in a secondary way do they check statistics such as the change in the price/ earnings ratio especially if the price has moved up well in the last week. The problem is that the price can move downwards quickly in the next month and the momentum can accelerate even more in the month following. Here weekly information such as in The Globe and Mail will not be accurate enough to make buy or sell decisions. “Momentum” investors need more expensive and more accurate information and it costs money.

Two Examples

Here I offer two examples of companies where the detailed data leads to different investment decisions than with the kind of data that is free or relatively free.

I deal with a small broker and his commission rates are not the cheapest rates in the industry but I do get a lot of company information. I get operational updates and quarterly reports sometimes eight or nine pages in length. Here is where I learn the inside information on companies I am interested in.

Connacher Oil And Gas

Two examples of companies that I get good information on are Connacher Oil and Gas and Perpetual Energy. The detailed, accurate information I got was responsible for my decision to invest. In both cases I made a purchase decision instead of just watching the stock. 

Connacher Oil and Gas recently reported Q1 results; it had a loss of $62 million while its revenue increased by 3% to $105 million. Its total assets decreased to $1.23 billion from $1.25 billion. This stock does not seem destined to have a large positive price momentum soon. But Connacher has heavy oil reserves of 450 billion barrels and two SAGD facilities. It is constantly increasing its production processes and its steaming processes which increases production of heavy oil more cheaply. It is increasing its production every month and paying off debt. Its production now is almost 14,000 barrels per day and will be almost 15,000 barrels before the end of 2014. This is the production of $4 and $5 stocks. Connacher has debt problems but it is a blossoming $2.50 stock very soon. Now it trades at $.22 per share. So you have to read the details.

Perpetual Energy

Another stock for which you need accurate data is Perpetual Energy; it must be examined in detail. Its production for the first quarter increased by only 3%. Capital expenditures are down for the year and most of it has already been spent in the first quarter. But Perpetual is very efficient with its capital expenditures. It drilled three wells in its West Edson area and found a pool that increased its natural gas reserves by 60%. It used this new pool to obtain a joint venture (JV) that pumped $120 million into this new property. The net asset value (NAV) of its reserves increased from $3.07 a share to $4.80 per share and the stock trades at only $2.25 a share. Only by reading the operational updates do you see how a small company is performing. Brokers that have this information often charge higher commission rates so the ability to earn higher returns costs more.

Dale McIntyre has a Master's degree in economics and a Diploma in B.A.(both from the University of Ottawa). He also worked 13 years in the federal civil service in various departments.He also had a business selling life insurance, stocks and bonds in Cambridge, Ontario. daleandmac@gmail.com