What Makes Trend Investing Difficult? by Sui Chuan Yeo – ValueEdge

It’s no secret that we are bottom up investors. That is because we find trend investing to be a difficult endeavour, and we would like to share why.

What is trend investing?

Some people prefer to invest based on what they think the next big thing will be. For example, if they conclude that the future lies in big data analytics, they will invest in a company that does big data analytics. However, we believe there are numerous intricacies which tend to be overlooked.

Demand-centric conclusion

More often than not, the premise of one’s conclusion that a product will be the next big thing is often demand-centric. That is, they assume just because everyone will be using that product 10 years for now, the company/industry will be a definite investing homerun. There are certainly instances when that is true, just look at Microsoft and Coca-Cola. However, the same logic applied to many other industries will yield a different outcome.

The airline industry, for one, is known to be a notoriously unprofitable and highly challenging business. Yet, everyone knows that air travel is an essential mode of transport with no close substitutes at the moment.

The same goes for the solar industry. Solar electricity generation has increased every year since 2004.

Trend Investing

From 2011 to 2014, solar electricity generation more than doubled. For the same period, the NYSE Bloomberg Global Solar Energy Index declined by half. Clearly, having a judgement of the demand side is insufficient for an investment thesis.

Remember to look at supply

Ex-CLSA Chief Strategist Russell Napier once spoke in one of my classes. I cannot recall most of what was said that day. But what I do remember was his advice to always to look at supply, not just demand – an aspect that is often overlooked.  High demand and profitability often attracts new competition which may drastically change the equation. In both the solar and airline cases, supply outstripped demand. The only winner is the consumers and this brings me to my final point.

Value chain analysis

Even if the high demand for a certain product materialises as predicted, additional analysis has to be made to determine which segment of the value chain actually benefits from the said demand. This is what makes trend investing so difficult. Economics teaches us that only players with monopoly power will be able to continue earning supernormal profits. Unfortunately, retail investors like us often do not have the required access to information, making it very difficult to discern the players in the value chain, much less the ones with monopoly power. Let’s not forget that consumers are also part of the value chain, and they seem to be the ones who are winning most of the time.