Top 50 Rules of Investing: An Engaging and Thoughtful Guide Down the Path of Successful Investing Practices by Reed Scott;

Author:Reed, Scott; [Scott Reed]
Language: eng
Format: epub
Publisher: Morgan James Publishing
Published: 2024-03-15T00:00:00+00:00

RULE #27

Past Performance Can Be An Indication Of Future Performance

“But many that are first will be last, and the last first.”

—Matthew 19:30

Advertisements in our business are required to say, “Past performance is no indication of future performance.” Everyone sees that, but I don’t think they really believe it. And they are not helped by the fact that a large number of advertisements spend an enormous amount of time talking about their past performance.

I compare that type of advertising to the shell game that magicians and street performers like to play. The shell is never where the people think it is. When investors ask the question, What can I make on this investment, the answer, I have no idea, would be correct. But it isn’t what they want to hear. It is easy to find an investment that has done exactly what investors want, show them past results, and talk them into investing with the hope that it will happen again.

The truth of the matter is that expecting an investment to keep outperforming is not reasonable. But that doesn’t mean you can’t look at past performance and gain some insight into the future. Although it is impossible to know exactly what an investment will do in the future, it is not that hard to determine an expected trend. Let me give you a few hints. “What comes up, must come down.” “Once the pendulum swings far out to one side, it must come back.”

The investment world is a reversion to the mean business. Good investments that do poorly should be expected to do well in the future. And the converse is true. Good businesses that have done exceptionally well recently will probably do poorly in the next cycle.

Now remember, I do not mean that the company itself is doing well or poorly. I mean their stock price is doing well or poorly. The price of a security rarely represents its exact intrinsic value. Investors are constantly loving it too much or hating it too much. Sooner or later, the truth will come out and the price trend will change.

That is the reason why Warren Buffett has often said that he spends a lot of time calculating the intrinsic value of a company. If an investor knows the intrinsic value and can wait until the market price dips significantly under that, he/she can buy a company with much less associated risk.

The truth is that past performance can be a pretty good indicator of future performance. It’s just not what most people think. Many fund companies set their sights on the funds that have done really well and want you to believe that they will continue on that track for a long time. You never see an advertisement that says, “Our fund has been really poor the past few years but you should buy it now because it is going to turn around.” Or, “Our fund has had a great run and it’s probably going to go down for a while because investors are going to be taking some profits.

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