When looking for a stock to buy, many people think about which businesses are doing well. “Apple is coming out with a new product that everyone is excited about, so I should buy Apple.” “Healthcare use is going up. It’s time to buy stock in medical services companies.”
The trouble with this idea is that all of these factors are already included in the price of these stocks. Everyone else knows about the new product launch. Everyone knows about healthcare use. The secret to finding stocks isn’t to look for those that are doing well now. It is to look for stocks that will be doing well in the future.
Of course, there are stocks that are doing well now that will also be doing well in the future. Some stocks grow and become more profitable for many years. But many companies do well for a period of time, peak, and then decline. If you purchase shares of these companies at the peak of their growth, all of the profits they are making will already be priced into their stock. This will only lead to declines in the future.
For example, a few years back I bought shares of Harley Davidson Motorcycles, right around the time they changed their ticker from HDI to HOG. They had been growing for years and their share price had risen steadily. The company was seeing record profits and all looked to be going very well. The company warned, however, that the past year was a banner year and growth was likely to slow after that. Indeed, growth did slow and I took a loss on the position as the share price fell.
What I had missed was a change in the demographics. The Baby Boomers had been buying bikes and Harley Davidson apparel as they had become more affluent. As they aged, their focus went from motorcycles to things like retirement and healthcare. This meant that the number of new motorcycles dropped dramatically. The 2008 recession didn’t help either.
So, when picking stocks, don’t choose companies just because they are having a great year. Look at future prospects and choose the companies that have room to grow in the future.
Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.