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SIMPLYBIZ INVESTMENT SERVICES
Similar trends exist in other markets . In both Japan and the UK , in 11 out of 18 years , the average top-10 performer fell to the bottom half of the performance distribution in the next year . In Germany , it happened in all but four of the last 18 years .
THE LESSONS
As human beings , we love a good story . And what makes a better story than a winner ? Hype is exciting ! That ’ s why value investing is so psychologically hard to do in practice . It involves buying the losers , the unloved stocks .
More generally , the charts above show why investors should be cautious about chasing performance . Strong gains will tend to stretch valuations relative to fundamentals like earnings . Share prices start to bake in ever more optimistic expectations . At one point , Tesla traded on a valuation of more than 200 times consensus forecasts for its next 12-months ’ earnings ( today it is on 77x ). The erstwhile Magnificent-7 ( Apple , Microsoft , Nvidia , Alphabet , Amazon , Meta Platforms and Tesla ) collectively are twice as expensive as the rest of the market , in terms of a multiple of next 12-months ’ earnings . Some companies may be able to deliver on these expectations ( identifying which is the hard part ). Many will not . And it can only take a small miss on earnings or a small change in the external environment – as happened this month – for an outsized share price reaction from the “ hot stocks ”.
The companies that win in the long run are often not the ones that are the best performers in any one year but the ones that can grow sustainably in the long run ( meaning they can keep it up , not a reference to sustainability in an ESG sense , although these concepts can be related ). Several years of good results and performance can easily compound over time to deliver better investment returns , in a less helter-skelter way , than if you are tempted to chase the best performers .
For example , $ 100 invested in a stock that goes up 10 % a year for three years will be worth $ 133 at the end . The ( arithmetic ) average yearly return on a stock that goes up 20 %, down 10 %, up 20 % is also 10 %. But $ 100 invested in this would only be worth $ 130 after three years .
Momentum has been a popular investment strategy in recent years , but naively glory hunting is likely to result in high costs and mediocre returns . To quote hip-hop megastars , Public Enemy : don ’ t believe the hype .
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A version of this article was originally published in FT Alphaville .
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