As an investor, when you hear that ‘commodities are running’ and ‘property is booming’, do you rush to buy shares? Or do you worry that you’ll ‘miss out’ on the commodities run or the retail revolution? Allowing these macro-economic terms to significantly influence your investment decision is risky and ineffectual.

Once you have decided to invest based on fundamentals instead of sentiment (see Planning to be a successful investor: Feb 2010), the next step is to decide which research and news to follow – micro-economic or macro-economic.

• Micro includes everything that is specific to the company, like its financial information (sales, margins, history and prospects), the strength of management, the business strategy and competitive position.

• Macro includes general metrics like GDP growth, exchange rates, interest rates, retail sales growth, building plans approved and the oil price.
  

The successful investor should, for the most part, ignore macro research and spend more time on micro research.  This view is shared by Peter Lynch, one of the world’s most successful investors. In his book, ‘Money Masters of our Time’, author John Train quotes Lynch, “I spend about fifteen minutes a year on economic analysis. The way you lose money in the stock market is to start off with an economic picture. I also spend fifteen minutes a year on where the stock market is going. All these heavy-thinking deals kill you.”

Train goes on to say, “Lynch notices that people always ask him about the outlook for the economy and the stock market and other such large and general questions. But nobody can give these answers. And even if anyone could, companies like Proctor and Gamble and Colgate should be little affected by such fluctuations.”

Focus on what’s important

The point is this: it is significantly more valuable to focus on the micro over the macro. The investor doesn’t have enough time to pay sufficient attention to both. Also, the conclusions reached through micro research often clash with the macro and it is important to know where one’s allegiance lies when there is a decision to make about which data to follow.

Last year I attended an investor relations meeting with the CEO of a South African building supplies retailer. An analyst in the room asked the CEO which data he follows to determine how much stock to hold in his retail outlets. The analyst asked whether he paid attention to building plans passed or GDP growth or possibly another macro metric. The CEO laughed and said he doesn’t follow any of that data. When he decides how much stock to hold he walks around the stores and sees how many customers are buying building supplies.

The point he made is an important one – CEOs do not base their business decisions on where the rand is going or what South Africa’s GDP forecast is for next year. Yes, these factors do play a part, but their importance is minimal compared to micro details like sales strategy, new store openings and buying power of customers. Good CEOs spend much more time focusing on the company- and industry-specific information, and it is wise for investors to follow suit.

For example, it is unlikely that a CEO will rely on a report of South Africa’s nationwide building plans passed in deciding whether to open a new store in a developing rural area. Instead, a team will travel to that area and count how many new houses are being built. They will find out where builders are currently buying their supplies and after doing the profit calculations, they will decide whether it is viable to open a store. Decisions are made on the ground with real, specific data.

All companies operate in the macro environment and each company is, to a greater or lesser degree, exposed to the same interest rate and GDP growth rate. The major differentiating factor, therefore, is the specific company’s ability to deliver returns irrespective of the environment in which it finds itself.

Put more simply, if we had to pick a winner for a horse race from ten entrants it would be unwise to spend our time evaluating the weather conditions and the length of the grass on the track (these conditions affect all the horses and knowing or forecasting them helps little in deciding which horse will be fastest). It would be better to find out what condition the horses are in and which horses have historically been faster over the race distance, and which horse has the best jockey on its back – these would be the differentiating factors in picking a winner.  

How Hyundai defied gravity

In 2008 the international motor car industry experienced a catastrophic blowout. Who can forget the images of thousands of cars standing in fields and lots near shipping ports, without any prospect of being sold? Sales plummeted, so did profits and investors pulled their money, causing share prices to crash. But one company defied the world and its industry.

Hyundai Motor Corporation experienced no decline in sales (In fact, their total units sold grew throughout 2008 and 2009) and in the 9 months ended September 2009 they grew EPS from 372cps to 624cps (in USD). During the same period, the other motor manufacturers were not doing as well:

• GM and Chrysler made unthinkable losses and burned through billions of dollars of government bailout money, before finally declaring bankruptcy.
• Ford saw its EPS crash from 455cps to 61cps (in USD).
• VW became entangled in a hostile takeover attempt with Porsche while their EPS plummeted from 950cps to 178cps (in Euro).
• Even the venerable Toyota Motor Corporation saw its EPS decline from YEN104 to YEN31. And more recently they were hit with a recall of over 8 million cars worldwide for faulty accelerator pedals, causing their stock price to crash in a matter of weeks.

Why, despite operating in the same ailing industry, did Hyundai outperform the other manufacturers so resoundingly?

1. Speed – Hyundai streamlined and revolutionised its production process so that it can deliver new models to market before its competitors.
2. An ambitious, energetic management team – Management have instilled a very strong work ethic in the company and they are serious about growth and excellence.
3. Quality – Since 1999 Hyundai has improved the quality of its cars so much that Toyota ranks them as their most dangerous competitor.
4. Innovative advertising campaigns – At the height of the recession Hyundai allowed US customers to return their cars if they lost their jobs. Naturally then, many people concerned about job losses looked to Hyundai when purchasing their new car.  
   

The points listed above are what made the difference in Hyundai. Notice that all the points are company specific and have nothing to do with macro-economic statistics. While most investors fled from stocks in the car manufacturers, investors who stuck with Hyundai were rewarded as they watched the share price more than double in the last year.

Picking the correct research material

Becoming a great investor is largely reliant on picking the best companies – companies that outperform irrespective of their operating environment. The best way to start is to spend less time reading up on world growth and to spend more time learning everything one can about companies from annual reports, independent research and company websites.

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Sources:
1.    Train, John. Money Masters of our Time. 2000. Harper Business.
2.    Taylor III, Alex. Hyundai Smokes the Competition. Fortune Magazine, Vol. 161, No. 1, January 18, 2010.