Saturday, December 31, 2005

New Year's Eve:Past performance is no indication of future return

Past performance is a poor indication of future return. This statement is particularly true in biotechnology stocks. Neopharm (posting 12.27.05) is a good example of a stock that had recently underperformed for a couple of months but then surprised most by opening up 52% in a day. If there is no correlation between past performance and future return, why are we so drawn to looking at charts and looking at past performance? I believe it is because it is in our nature as human beings to relfect, because we don't know what the future holds we look toward the past. Additionally, we are aware of the law of physics that states that an object in motion stays in motion and it takes a catalyst with an incredible amount of energy to change an object's direction. It is this notion that causes the incorrect assumption that a stock's past performance may give us an indication as to the future return. Anyone who has been on the wrong side of a trade when a stock gap's up or down will tell you the past is the past and nothing more.

On New Year's Eve we reflect on the previous year like a stock chart. We look at our past performance and seek to make improvements for the future. We make promises to ourselves that we will improve upon the past. We make New Year's resolutions to join a gym, to work out more, to start a new diet; but somewhere deep down inside we know that in fact we are lying to ourselves and our resolution will likely go on unresolved. We fear that the past momentum is too great to overcome. We know that without an external catalyst we won't loose the weight and developed the six pack we envy.

The catalyst necessary for change can come from multiple directions. A stock's catalyst can be internal or external. Internally a company can make changes that will lead to improved productivity which will improve margins leading toward improved profitability and ultimately this will be reflected in the stock price. The other kind of catalyst are external. We recently saw example of an external catalyst when Hurricane Katrina hit New Orleans devastating that region. Post-Katrina many companies were forced to take charges for losses due to closing and shipping delays. Tenet Healthcare (ticker: THC) is an example of a stock that is arguable one that was hit the hardest with six of their hospitals closing some of which would never reopen.

On New Year's Eve it is good to reflect on the past and look to what internal catalyst we can muster up that will drive positive change in our life. However, internal changes take a great deal of energy and are most likely to disappoint. This New Year's Eve while we reflect on the past and look toward the challenges that lay ahead lets humble ourselves and realize that maybe we don't have the ability to drive the change in our world. Instead of making false promises, that only dissapoint; let the past be the past and nothing more. Don't let your past determine your future return, instead pray that God will act as a supernatural catalyst to drive change in your world.

Jerimiah 33:3 "Call upon me and I will answer you"

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