Far better to base investment decisions on hard facts rather than stock market predictions.

Most successful investors agree that it’s a good idea to base investment decisions on facts rather than stock market predictions. You can make mistakes with facts, of course, but predictions have a much higher failure rate. However, one obstacle to investment success is that it’s easy to mix the two up.

Perhaps the best example of how stock market predictions can turn out differently is with the tobacco industry. Starting a few decades ago, cigarette makers came under relentless attack from government, health authorities and lawsuits. Many investors took it for granted that the industry was doomed.

Lots of smokers quit, and this hurt cigarette demand. But the obvious negatives stopped new competitors from entering the industry. Laws against cigarette advertising limited advertising expense for the industry, so profitability rose. Cigarette makers were able to pass the costs of litigation and regulation onto their customers. Meanwhile, tobacco use grew quickly in emerging markets.

The anti-tobacco movement was a fact, and a good thing. It helped many people avoid lung cancer, COPD and other health scourges. But investors were wrong to accept the widespread prediction that cigarette stocks were bound to be terrible investments. In fact, the reverse turned out to be true. Despite the anti-tobacco campaign, cigarette stocks turned out to huge winners. A number of tobacco companies have generated steady capital gains and rising dividends over the past five to 10 years. We happily follow the instructions of portfolio management clients who insist that we refrain from investing their funds in tobacco stocks. We share their distaste with smoking. I haven’t recommended a tobacco stock in decades. However, I wouldn’t support, for instance, government bans on tobacco. That would simply create a new type of black market for criminals to exploit, just as they now exploit demand for illegal drugs.

This is not an isolated occurrence, of course. Movies were expected to put live theatre out of business. Television (invented in the 1930s) was expected to put radio broadcasting out of business. The Internet was supposed to put all sorts of industries out of business.

It’s also hard to predict what effect changes will have on an industry. It’s even harder to predict how long those changes will take to appear. Mixing up facts and predictions can also lead you to buy stocks that are way over-priced due to bloated expectations for growth. The best example of this occurred during the Internet mania of the late 1990s. Many investors paid extraordinary prices for stocks that barely qualified as start-ups.

However, many of the outlandish Internet predictions of the late 1990s have already come to pass, or will do so in the future. It’s just that they’ll take years if not decades to reach the market, much less make any money. That’s why we prefer stocks with big plans that are making money right now from their current operations.

You see this again and again in investing. Stock market predictions are terrible at determining what effect changes will have on an industry. It’s even harder to predict how long those changes will take to appear. Of course, adverse changes are hardest on companies with bad financing, poor products, weak management or other drawbacks. Meanwhile, successful companies figure out ways to adapt and even profit from change.

Have stock market predictions been profitable to you in the past? Or did the information prove pointless or even costly? Share your experience with us in the comments.