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Don’t Be Tricked by the Past When Investing

Warren Buffett once opined that in the business world, the rearview mirror is always clearer than the windshield.

Numerous investors believe that the future is too difficult to predict. Hence, it is easier to simply focus on a company’s past performances. However, in investing, focusing purely on the past is extremely dangerous.

Peter Lynch, legendary investor and author of the book “One up on Wall Street”, wrote that investors should not be so attached to a winner that complacency sets in and we stop monitoring the story.

What we, as investors, need to realise is that the past may give us good information about the overview of the company. Yet, the future may not always mirror the past. This is because there can be fundamental changes to a company.

In light of this, I have highlighted three key business changes to look out for that can affect our investments.

A change of consumer behaviour

As well all know, consumer behaviour changes frequently. A good example of this would be consumers’ shift towards spending their spare cash on “memorable experiences” over “material things”.

This phenomenon has been seen all over the world, as rich millennials spend more on dining, travelling and concerts while cutting back on spending on luxury items like branded watches and clothes.

Consumers are also going digital and are using e-commerce more often while doing less physical shopping.

These two changing consumer patterns can have a negative effect on a variety of businesses. Companies that are unable to adapt to move sales online may suffer as a result. Furthermore, luxury watches and clothes retailers may face future headwinds as the mindset towards “meaningful experiences” shift matures.

Tarnished reputation

“We can afford to lose money — even a lot of money. But we can’t afford to lose reputation — even a shred of reputation.” – Warren Buffett

Brand recognition and reputation are key intangibles that can drive consumers to a business. Likewise, if a brand has been tarnished due to bad press or poor management, it can have a huge impact on the overall health of the business.

Two years ago, I bought a restaurant share that had performed admirably in the past. It was reporting same store sales growth of mid-single digits and overall profit growth of mid-twenties range for the last five years.

Unfortunately, the very next month, the company suffered a major setback. An E-coli virus outbreak hit one of its 2,000 stores. 40 people were hospitalised. Even though all victims recovered, the same could not be said about the company’s reputation.

Previous loyal customers now avoided the company like a plaque. Its same store sales declined nearly 30% the next full quarter, and the company reported its first operating loss. Up till today, it has yet to recover from that incident, and its share price is trading at 50% below its peak.

Through this example, it is easy to see how a tarnished reputation can have an extremely adverse effect on a company’s future profitability.

A change of management

A strong management team that puts shareholders interest at heart is vital for any investment.

It is, therefore, paramount that we are familiar with any management changes in our investments. If an experienced manager is not replaced adequately, the company may falter in the future.

This is especially so for companies that have enjoyed a long tenure with a successful manager who finally retires. Replacing that departing manager is usually extremely difficult, and investors need to do their due diligence on the incoming management team.

The Foolish bottom line

The past may sometimes be a good indicator of a company’s future. However, there may sometimes be changes to a company’s fundamentals or business outlook that can negatively affect its profitability. Investors who focus only on the past to make investment decisions may sometimes miss out crucial information about the future.

Meanwhile, for more (free!) investing insights, sign up here for your FREE subscription to The Motley Fool's investing newsletter, Take Stock Singapore. It will teach you how you can grow your wealth in the years ahead.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Jeremy Chia doesn't own shares in any companies mentioned.