Past Performance as an Indication of the Future

When looking at whether we should invest in something, it may be convenient to look at the past trends for the investment or company and make our decision solely on that, believing that the company will continue to perform as it has in the past. Of course, looking at the past is better than looking at nothing at all, but choosing an investment solely on the past performance of a company (such as investing in a blue chip when it is cheap and just believing that it will continue to deliver the results of a blue chip) is probably not the best investment decision that you or I can make.

(Image source: flickr.com, fosco lucarelli)

Let's look at Creative Technologies. At one point, it look very promising and had delivered good returns from its soundcard business and its share price peaked at over $50 (this was at quite a high P/E ratio though). If we looked at past trends, the company would appear to be a very good investment. But then, the company had a few missteps along the way and now the share price is a fraction of its previous price (even lower than its per-share earnings in some of those earlier years)

Other companies have also gone downhill from their earlier peaks, especially those that are in industries that are being/have been shaken up by new technologies. Eastman Kodak, Polaroid, Nokia are just some examples that I can think of. If we look solely at their past performances, we would have been badly burnt as these companies could not stave off the inevitable decline of their industry with the onslaught of new technology attacking them.

So, if we can't take past performances and trends as the only yardstick for measuring investment potential of investments, what other factors should be take into account? I think that we should focus on the growth potential of the company as well as factors that will influence the company's future performance. The balance sheet, the industry that the company is in are some of the important factors we should be looking at. This is also where some elements of the past can come in. Using the past performance, we can see the company's market share in its industry as well as the presence of competitive advantages (does it have an above average return on equity, profit margin, etc?)

We have to look at the full picture of the company in the present and not be stuck in the past and believing that investments that have done well in the past will continue to do so in the future. Only by looking at the different factors and how they will relate to the future growth of the investment are we able to more accurately determine the investment potential of the company.

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