Some investors spend a lot of time staring at charts. Can you really tell what a stock will do by charts alone?
In the short term, stocks do move based on little more than popular opinion. Ask any politician, popular opinion can be fickle.
In the long term, quality companies producing significant cash flow will outperform stocks that get 15-minutes of fame.
Are you losing your mind, trying to chase the market back and forth? There is a better way.
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Victoria Gnatiuk/iStock via Getty Images Co-produced with Beyond Saving Driving In The Rearview Mirror
Investors love their charts. Give them a new idea, and the first thing they will do is go look at the charts. How has it performed over X years? Often, they will come to a conclusive determination about whether it is a “good” or “bad” investment.
Let’s play a game: Which stock would you buy? Here are two 3-year charts with the stock’s name redacted:
Stock 1: YCharts Clearly, over the past 3 years, the investment in stock 1 was an unmitigated disaster. You read an article on SA arguing that the company is very innovative and that it shouldn’t have sold off, the author is claiming that it is poised to come back to prior highs and even beyond! Here are some of the comments you see:
Comment 1: Great article! This company is innovative and will produce massive gains!
Comment 2: Don’t listen to this joker, I bought this stock 3 years ago, and now I’m sitting on a 90% loss. This company is a loser that is headed for bankruptcy.
Comment 3: You’re still pumping this loser? Don’t you ever learn? Investing in an index fund would be better. What were your results last year?
Or Stock 2: YCharts What about Stock 2? Over the past 3 years, it’s done really well. More than doubled! You read an article from an author pointing out the success of the company and suggesting there is a lot of upside to come. You read the comments and see things like:
Comment 1: Wow, you are really late. The stock has doubled and is trading at all-time highs. It is too late to buy now, I’m waiting for a pullback. Only an idiot would buy at these prices.
Comment 2: Hey, thanks for writing about this stock! I’m up 200% and am loading up on more!
Comment 3: You should take your gains before they disappear, this company is WAY overvalued.
Which stock do you buy? There is a right answer. The Right Answer
The right answer is neither because you don’t have nearly enough information to make an educated decision! The chart isn’t going to tell you which is the “better” investment, nor does it tell you which to avoid. You have no way of knowing which of the commenters are right, and which are wrong because you haven’t taken the time to even know what the company does, how it makes money or project how much it might make in the future. With just the chart, any decision to buy or sell is a gamble.As it turns out, the company in both examples is the exact same company! One of the best-performing stocks of the 21st Century, Amazon ( AMZN ). Data by YCharts Data by YCharts The reality is that there are a lot of companies that had charts looking a lot like AMZN from 1999-2002 that never recovered. There are a lot of companies that have had charts that look like AMZN from 2010-2013 that weren’t able to sustain that growth. The difference? It’s all about the fundamentals. What is the company doing, and how will that translate to earnings per share?Without context, you can’t interpret price movements. Investors who are driving looking in the rear-view mirror are destined to crash. What Is Your Investment Horizon? When talking about a stock’s performance, we love to talk about 1-year, 3-year, or 5-year charts. Occasionally, someone might look back 10 years. Then arbitrarily draw a conclusion that the investment is “good” or “bad” based on its price today compared to the price at a prior point in time.How long are you investing for? Well, if you started investing at say 45 years old, you will be investing for 20 years before you reach the traditional retirement age of 65. Then, […]