“Past performance is not indicative of future returns”

Ryan M Jan 14, 2015

There is a common agreement across the financial landscape that investors should not look at past performance of a company and extrapolate this performance into the future. At first glance, this makes sense. Things change at companies and in a more macro sense, economies and politics change and they can change quickly. Also, it would simply be downright detrimental to your financial well-being to blindly invest in a company because they put up a few good quarters or even years. But it is curious that a term such as ‘past performance is not indicative of future returns’ seems to negate any and all merit that past results could have for an investment.

The term in the title could be interpreted in two different ways. The first interpretation could be solely based on stock price performance. In the broadest sense, yes, the old adage works because of the fact that (as we all know, hopefully), just because a stock goes up today, does not mean it will go up tomorrow.  But for believers in momentum strategies there is some data to back up the notion that past performance does at least have SOME ability to predict future returns. The Millenial Invest blog covers the topic and some data points quite well. This obviously does not assume a blanket approach of buying whatever the hot stock is at the time and like everything in investing, no strategy works 100% of the time. With the first interpretation, one could argue that the common disclaimer is actually a little misleading, as there is some statistical evidence that past performance can be used as a successful investing strategy.

The second interpretation is where I really think the disclaimer can be quite misleading for investors. This is when it is used in conjunction with a company’s performance and operations. Quite simply, historical performance is all we can rely on! Looking forward, no matter how well researched or thought out the forecasts and estimates are, they are still estimates and involve some level of speculation. Looking at past performance is an absolute truth (barring misstatements and fraudulent reporting) and a disclaimer that seems to disregard the performance and accomplishments of companies that continually execute and generate returns for shareholders doesn’t seem to benefit anyone and undermines the notion that a company that continues to operate successfully is more likely to operate successfully going forward. Lets take it back to high school with an example: 

We have two students, an ‘A’ average student who diligently studies and invests their time in learning and we have a ‘D’ average student who is not academically motivated or maybe just doesn’t have the appropriate skillset that allows them to ace tests. If you were a betting individual, who are you going to put your money on? The answer is pretty simple that it is the ‘A’ student. Betting otherwise simply would make no sense. Even if the ‘A’ student gets strep throat, misses and fails one test, you can be fairly confident that the student will bounce back from the sickness and achieve ‘A’ results once again.  Yes, an enterprising individual could have done the due diligence and ascertained that the ‘A’ student was showing signs of strep throat and therefore would miss and fail the test but this is besides the point. Anyone who would not look at the past results of the ‘A’ student to determine the likelihood of them getting an ‘A’ on the next test is excluding some very important data from the analysis.    

I do not want to undermine the importance of not reading too much into past performance, especially when dealing with mutual funds because it is a sure way to end up chasing returns. I also can appreciate the need for a disclaimer to ensure investors perform their own due diligence before making an investment decision. Finally, if anyone is promising you a return of any kind, run the other way. The value of the disclaimer is not lost on me. Sometimes, however, history should be heeded as it is some of the only ‘real’ data that we can rely on. While I would tend to agree more with the caution that past stock price movements are not indicative of future returns, I would be much more reluctant to extend this disclaimer to that of company operational performance. I would imagine that in nine out of ten cases I would side with the company that has continually performed and met targets over the long term opposed to the company with a ‘good’ valuation that fails to execute time and again. Please do not forget to direct your attention to the disclaimer after reading. 

Past performance is not indicative of future returns ;)

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