-- Investors struggling to make money in the rocky stock market are finding another strategy that's not working: piling on.
Given the difficult market, some investors might be tempted to find the few stocks that have been hot and jump in. But lately that once seemingly sure-fire strategy isn't working, and in fact is costing investors dearly.
Take Netflix, which rents videos to consumers. It was the No.1 stock in 2010 among current members of the Standard & Poor's 500, rocketing 219%. Jumping on to ride that momentum would have meant a bruising 28% loss this year. The stock is down nearly 60% from its 52-week high.
"If you're just buying stocks because they're popular, you're going to get your head handed to you," says Alan Skrainka, chief investment officer at Cornerstone Wealth Management.
Investors chasing past winners have had an especially bad year. Eight of the 10 best current S&P 500 stocks in 2010 are down this year, and seven are doing even worse than the S&P 500's 8.5% 2011 loss.
Investors are torn on why last year's winners are struggling so much, with theories such as:
•Randomness of future stock prices. Stock prices in the future are unpredictable because they reflect the news events that are random and unknowable, says Mark Hebner of Index Funds Advisors. With individual stocks, "Just about anything can happen," Hebner says. Data illustrate the point. Over the past four years, the top S&P 500 stock each year lagged the market the following year.
•Valuations and fundamentals matter, eventually. When stocks have positive buzz, fanned by solid earnings growth, word of mouth and growth, investors like to pile on, says Michelle Clayman of New Amsterdam Partners. But eventually, the valuation gets "stretched," as she says happened with Netflix this year. When Netflix peaked at more than $300 a share, it was trading at more than 70 times its expected 2012 earnings, says Robert Maltbie of Singular Research, when the company's expected growth rate is just 40%.
•Gravitational force and human nature. Investors take comfort following the crowd and tend to push stocks too far up or down, says Charles Carlson of Horizon Investment Services. Eventually, all the investors who are bullish on a stock already own it, leaving only downside from there, Carlson says.
While investors differ on why last year's winners are such losers this year, the caution for investors is consistent. "That's why the saying 'Past performance is not indicative of future returns' isn't just a disclaimer, but should be an investment philosophy," Skrainka says.