The Past Predicts the Future

"Past performance is not indicative of future results."

If you've ever read any of the disclaimers or legal statements on just about any investment advice, you've heard this line.

This statement is boilerplate. It's typically used when describing investment strategies and mutual funds.

In theory, this makes a lot of sense: Just because a fund manager or company performed a certain way in the past doesn't necessarily mean they will do so in the future. The world will change, and the results will also change.

But does this idea make much sense?

When companies are in a strong strategic and competitive position—especially if they're in long-term growth industries—good performance is a great predictor of future good performance.

When discussing picking stocks, we often discuss picking "winners."

These are companies that have consistently shown high earnings growth and the ability to outperform investor expectations, which they often continue to do. This may reflect their underlying positioning, industry, or management teams' execution.

Often – and ideally – it's reflective of all these factors.

While it seems prudent to issue a disclaimer that the future may not look like the past, significant trends, at least the ones that can make you the most money, tend to last for a long time.

It's better to say that while past performance is not a guarantee of future performance, it can often be a good predictor. One of the best investment strategies is to go out and discover where this is true.

When examining companies, it's crucial to deconstruct why they have performed so well in the past.

One of the biggest drivers of financial results is economic sensitivity. Most companies have some sensitivity to the economy. A rising tide does raise all ships, and a recession is a challenging environment for most businesses to grow and beat expectations.

When considering a company's track record, you first must examine its sustainability.

Mature industries—like manufacturing and retail—tend to be more economically sensitive. For instance, when steel demand increases, the economy tends to drive it.

These industries can experience great periods of performance, but you're better off buying stocks in this category when they are doing horribly rather than fantastically.

Other companies in growth areas – think of the Internet or pharmaceuticals – have fabulous long-term trends.

One of our favorite examples is e-commerce.

In the second quarter of 2021, e-commerce sales made up 14% of overall retail sales in the U.S. – a big jump from the 11% they made up in 2019.

By comparison, e-commerce sales in China made up 25% of all retail sales in 2020, up from 21% the prior year.

Are there that many fundamental differences between the U.S. and China that make these numbers so different?

The truth is that the Chinese retail sector was much less developed than that of the U.S. However, as new retailers rolled out, they built out in the most efficient manner—online.

Besides this, we don't think there are any fundamental differences between the retail sectors. We also believe that e-commerce in the U.S. will eventually make up a much larger percentage of commerce... perhaps even more than 50%.

This is an example of a long-term trend that will continue for decades... where you can find the kinds of winners that can produce huge returns.

Think of it this way. Even if the U.S. only reaches Chinese levels of e-commerce adoption, it would double the current levels.

If we're right about 50% adoption, that would be 300%-plus growth from current levels. This will take time, but this giant growth wave is akin to the move to electrification or the automobile.

Although we have already seen incredible past performance in this trend – consider that Amazon (AMZN) is up more than 300% over the past five years, tripling the return of the broad S&P 500 Index – it's also a great predictor of future performance.

If you focus on proven winners from an industry and management perspective, you're in a great position to make significant returns.