“Theme investing” can pay off from time to time. Recent investment themes have included renewable energy and emerging markets such as China and India. Today’s most popular investment themes include social media.

However, theme investing can turn out badly for investors, especially those who get in late or forget about investment quality.

The reason why is straightforward. When you indulge in theme investing, you allow a theme or concept to take a central place in your investing decisions. Usually the theme or concept includes some prediction about the future that has some truth in it, and will make noticeable changes in society. You may assume that if you can just get aboard that theme or find an investment whose future is tied up with it, you are bound to make money.

In other words, you are buying what you might call a “Big Idea” without making certain that a particular investment has a workable business concept, or the management strength and financing it needs to overcome competition and profit from it.

Focusing on a theme can cause you to overlook crucial details

A key problem is that if the theme is your overriding investment consideration, it’s all too easy to get sloppy about the details. You may come around to the view that the theme is so powerful that you can safely disregard p/e ratios and other measures of value and risk. You may wind up basing investment decisions on offhand projections or self-serving advice from promoters.

Mind you, facts support most popular investment themes. Keeping those facts in mind can help you spot stocks with extra potential. But if you let the theme make the decision for you, you are sure to overlook risk.

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Analyzing “theme” stocks for investment quality

Before we give any recommendations on stocks that are part of a popular theme, we always look for clear signs of investment quality.

For example, the theme of social media has become very popular as the phenomenon has spread over the past decade. And it doesn’t show any sign of slowing down. Indeed, it has spawned a number of highly-publicized new stock issues from well-known companies in the business (more about that below). However, as with all investment themes, you must choose your social media investments very carefully to profit. That’s because many of these companies have only limited investment appeal.

For instance, two of the biggest names in social media, Facebook (symbol FB on Nasdaq) and Zynga (symbol ZNGA on Nasdaq) announced new stock issues to great fanfare earlier this year. A week before Facebook’s shares became available to the public I stated my reasons for staying away from the stock in a video presentation (View the video here). We recommended neither stock and both have seen their share prices dwindle since they were issued.

To cut your risk, you should focus on social media stocks that already have a sound base of other operations, preferably businesses that provide steady revenue streams. That helps offset the risks that come from having future revenues based almost entirely on success in social media, a highly competitive and rapidly-changing field.

Google goes far beyond social media theme

Google (symbol GOOG on Nasdaq), provides an example. It is one of the companies we analyze in our Wall Street Stock Forecaster newsletter. Google has a large presence in social media which includes Google+ (its social networking answer to Facebook), YouTube (video sharing), Picasa (photo sharing) and Blogger (on which people create their own blogs), among others.

Yet Google does not need to succeed in all of these social media ventures to do well. It derives large profits from its world-leading Internet search business. It also invests in a variety of other money-making projects. Recent ventures like its software for Android devices have become important contributors to Google’s growth.

In May 2012 Google completed its purchase of cellphone maker Motorola Mobility and it is using Motorola’s expertise to launch more new products. Google is also in the process of introducing a new class of non-voting shares (Class C) that will have the effect of a 2-for-1 share split, thus making its shares more affordable.

Google’s shares had a sharp drop last week thanks to a mismanaged release of its earnings report, but the stock has made up a good deal of the ground it lost.

In short, Google has used its dominant position in Internet searches to build a broad base of revenue and earnings. It can generate new growth in a variety of ways. It does not need one “theme” to be successful, yet it is a lower-risk way for investors to profit from the growth of social media.

COMMENTS PLEASE—Share your investment experience and opinions with fellow TSINetwork.ca members

Have you had notable success with stocks you invested in because they were riding a popular theme, or trend? Have you had any disappointments with theme stocks? Let us know what you think.