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How to avoid one simple investing mistake that could cost you thousands

Credit: Domiriel

Are you a ‘tailwind’ investor? Tailwinds are a sexy story like an ageing population, high electricity prices, automation and so on. The idea is that tailwinds will lead to constantly rising demand and a windfall for companies in a certain industry. Right now the buzzwords are ‘cloud migration’ and ‘Software-as-a-Service’ (SaaS) which many readers will recognise.

A can’t-lose proposition

One mistake that many investors make is to think that tailwinds = a good investing opportunity. My second ever investment was in Origin Energy Ltd (ASX: ORG) a number of years ago, because I’d read in a popular finance magazine that the natural gas boom was coming, electricity prices were obscene, and consumer demand for cheap gas was going to lead to rising gas prices and make Origin’s assets very valuable.

I sold out a couple of years later at $15, a minor profit, because I felt the company hadn’t achieved anything. The reasons for Origin’s unspectacular performance are many, but my primary investment error was thinking that the company was in a very good position because of this attractive tailwind gusting along behind.

It doesn’t work that way in real life.

What’s the actual benefit?

Tailwinds are not the be all and end all. One popular play over the past decade has been the ‘ageing population’ which is supposed to benefit Australian healthcare companies like Japara Healthcare Ltd (ASX: JHC), Sonic Healthcare Limited (ASX: SHL), Ramsay Health Care Limited (ASX: RHC) and so on. Many companies in the sector have performed well, but that’s primarily because they’ve operated consistently well and used high levels of debt to build or buy new facilities – not because of a stampede of older people needing brain scans and hip replacements.

How much does an ageing population really benefit a healthcare company each year? People continue to age 1 year for every 12 months of life, just like they always have, with the only difference being a fairly modest rise in the probability of severe illness.

‘Organic’ (i.e., not by acquisition) revenue growth has been limited to middle single digits at many established healthcare providers in recent times, and even if old people account for a majority of this, the ageing population might only be worth ~3% revenue growth per year. Great to have over the long term, but not the kind of growth to get you up in the morning.

How it goes wrong:

Good tailwind and poor company or strategy. That’s the simplest explanation, and an ageing population or government subsidies can’t help businesses like Estia Health Ltd (ASX: EHE) that expand aggressively, pay high prices for acquisitions, and collect a lot of debt.

How it goes right:

Find a good company and then it’s like getting the tailwinds for free. Class Ltd (ASX: CL1) is a very interesting way to play both the switch to cloud computing as well as the growing demand for Self-Managed Super Funds (SMSFs). Class has been growing market share in recent times and can stand on its own merits – with its 68% cloud market share likely to prove a boon if the cloud migration tailwind blows as expected.

Foolish takeaway

Don’t get me wrong, I love a good tailwind. In truth, lest you think I’m being unfairly negative, sometimes the tailwind is so massive that it floats all boats equally – just look at the growth in funds under management in companies like AMP Limited (ASX: AMP).

Compare AMP to something like Magellan Financial Group Ltd (ASX: MFG) over the past 10 years though, and you’ll see why tailwinds on their own aren’t always worth writing home about.

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Motley Fool contributor Sean O'Neill has no position in any stocks mentioned. The Motley Fool Australia owns shares of Class Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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