Hindsight is 2020. While it’s easy to look back on a great trade that you passed up, investors make a much more common mistake. They tend to use recent trends and extrapolate them out forever.
The problem with that strategy is that an investment looks like the best opportunity after it’s already had a great run. Early investors already made their money. And no company can always be on the growth path. There will be times to change course and even restructure, sell, or close a business.
Investing is about looking forward. While looking at recent financial data can give some clues about likely near-term performance, it doesn’t tell you anything about how the market will value a company in the future.
For instance, in the 1990’s, tobacco stocks were facing billions of dollars in litigation over the health problems caused by cigarettes. After agreeing to one of the largest fines in history, the sector was able to retrench and head higher.
For starters, the government outlawed advertising by the industry—saving the big tobacco companies billions of dollars that could go back to shareholders. And secondly, the government taxed cigarettes just high enough to collect revenues while being just low enough to discourage folks from quitting.
But in the early 1990’s, that outcome was far from certain, and investors using a rear-view mirror approach wouldn’t have found the big opportunity there.
Many of today’s attractive companies will go out of favor. Or we’ll learn that they weren’t all they were cracked up to be in terms of sales or profits. Likewise, many companies out of favor today may post surprisingly good returns in the future now that current expectations are so low.
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