Why Precision can Fail You in Investing

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Over the weekend, I came across an interesting story from the 1980s that was recounted by investor Bill Gurley.

Back then, American cable and telecommunications operator AT&T was a dominant monopoly so strong that the US Justice Department had to force the corporation to break up into smaller pieces. Despite its monopoly, the company made its fair share of kerfuffles along the way. The following was written by Prof. Angel Lozano and shared by Gurley:

“In 1980, McKinsey & Company was commissioned by AT&T (whose Bell Labs had invented cellular telephony) to forecast cell phone penetration in the U.S. by 2000. The consultant’s prediction, 900,000 subscribers, was less than 1% of the actual figure, 109 Million. Based on this legendary mistake, AT&T decided there was not much future to these toys. A decade later, to rejoin the cellular market, AT&T had to acquire McCaw Cellular for $12.6 Billion. By 2011, the number of subscribers worldwide had surpassed 5 Billion and cellular communication had become an unprecedented technological revolution.”

It would be an understatement to say that this was quite the monumental miss. Perhaps, one of the errors made by AT&T was the act of confusing precision with accuracy. It turns out that precise numbers might not always be accurate. There is a difference between the two.

Accuracy vs. precision in the SGX

Food catering group Neo Group Ltd (SGX:5UJ) runs its umisushi Japanese food outlets in Singapore and Indonesia under its Food Retail Segment. Based on its financial year ended 31 January 2014 (FY2014), the segment reported annual sales of $12.7 million based on 23 umisushi outlets (22 in Singapore, one in Indonesia).

The focus of this article, though, is the company’s target of 30 outlets that it plans to build or franchise by 2016. More explicitly, can it meet this precise target? Let’s think of suitable comparisons to figure out whether this precise target can turn out to be accurate.

Of the 22 sushi outlets currently in operation, 10 outlets are located within MRT stations while at least five other outlets are in close proximity to the stations. To test the accuracy of the target, finding out the total number of MRT stations in Singapore may make sense.

Similarly, we can use the number of comparable outlets from companies such as Sakae Holdings Ltd (SGX: 5DO), Mr. Bean Group Limited (private) and Old Chang Kee Ltd (SGX:5ML) as a basis for comparison –  Sakae Holdings runs slightly more upscale Japanese restaurants as compared to umisushi‘s low-priced Japanese fare, Mr. Bean’s an outlet for soy-based drinks and snacks, while Old Chang Kee is well-known in Singapore for its curry puffs and other deep-fried snacks like fish balls and chicken wings.

Here are the basis for comparisons:

Comparison basis Number of units in Singapore
MRT stations 108
Old Chang Kee 80
Mr. Bean Group 60
Sakae Sushi 49

Source: wikipedia, company reports or websites, FLA Singapore

From the table above, it would be fair to say that we have a large margin of safety in this 30 outlet target from Neo Group. With the food purveyor coming out with new food concepts and looking for further expansion in Indonesia, a case can be made that the target of 30 outlets would likely be exceeded. Sakae Holdings Ltd also runs more than 100 outlets internationally, which adds to this case.

Foolish take away

Investors might be better served if they focused on improving accuracy instead of precision. Although no one is infallible and is able to predict the future with 100% accuracy, with a little common sense, we may come closer in predicting the probability of a future outcome.

So, if you can keep on grounding your estimates with fair accuracy, it stands to reason that you increase your chances of being right in the future business outcomes of any company.

And as you might know, a company’s share price would likely follow its eventual business performance. In other words, we might just to stand to improve our own investing success from our simple observations and insight about the future of a company’s business.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong doesn’t own shares in any companies mentioned.