Daily Gains Letter

Once a Good Investment, Always a Good Investment?

By for Daily Gains Letter |

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One of the main reasons a stock market rally occurs is due to a general consensus among market participants regarding future expectations. Market participants currently believe that companies will be showing better earnings and the overall economic conditions will improve from where they stand now.

Similarly, for certain stocks to go higher, companies should be expected to perform well in the future and grow their business—consistency in sales and profit is expected.

With this said, after profiting significantly from an investment, you might believe that you will be able to profit from it all the time, and that the prices will continue to soar higher, regardless of economic conditions or other factors. Remember the housing market boom in the U.S.? It wasn’t uncommon to hear someone say, “Home prices always go up,” or, “The housing market is always a great place to invest in.” But a few years down the road, we can all see what has happened—home prices in the U.S. economy are still depressed from their highs in 2006.

When it comes to the wider stock market, the situation is very similar—things don’t stay the same forever. A certain stock may be doing great at some point in time, but it may not be the greatest investment to own at another time. Investors must focus on the future outlook of a company and how it will perform, rather than what it has done in past.

Consider Caterpillar Inc. (NYSE/CAT), for example. After the financial crisis and the broad market sell-off in the key stock indices, this company was a great buy. Just take a look at the chart below:

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Chart courtesy of www.StockCharts.com

This company traded below $30.00 during that time. If investors bought then, they would have registered significant gains, as Caterpillar’s stock moved above $100.00. The reason for the rise was very simple: there was a real estate boom in the Chinese economy, and Caterpillar’s equipment would be in great demand.

Fast-forwarding to today, the Chinese economy has been experiencing a slowdown in its gross domestic product (GDP) growth and exports from the country are slowing down. Can Caterpillar be as good a bet now as it was before? Since the beginning of 2012, the company’s share prices have been trending downward.

Time will paint a better picture, but if investors take all the future risks into consideration, they might turn cautious, rather than keeping the same opinion on this stock.

Remember that Caterpillar is just an example of how underlying conditions can change for a company or for a whole stock market. Investors must do their research rather than continue to believe something will go up regardless of changing economic conditions.

Fluctuations in the company’s share prices and the stock market as a whole are very common and prices don’t always go up. For those who are looking to grow their portfolio over a long period of time, making investment decisions based on a “gut feeling” or false belief can severely damage your portfolio.

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