The Worst Way to Pick Stocks

A little more than three years ago, I moved to Las Vegas. I knew full well that it is a city of flashing lights, the electronic whirring of slots, and the kind of easy-come-easy-go attitude toward money that only casinos can engender. What I didn't realize at the time was that it's also the home of one of the top college basketball programs in Division I history: the UNLV Runnin' Rebels.

I could probably be forgiven for not knowing that, since the Rebs had a long stretch of being pretty mediocre after coach Jerry Tarkanian was ousted in 1992. But the Rebs have a tremendous history behind them, with a 0.712 all-time winning percentage -- which ranks them fourth among Division I programs. And it was right around the time that I arrived in Las Vegas that new head coach Lon Kruger started to get the team back into top form, and it's made appearances in the NCAA tourney in three of the past four years.

This year, the Rebs are off to a heckuva start -- they're 7-0, ranked 23rd in the nation, and are just coming off a win over Virginia Tech in the finals of the 76 Classic.

As for me, I've found myself in a funny situation. I'm not much of a college basketball fan, let alone a longtime Runnin' Rebels follower, and yet I've been attending games, checking scores on ESPN, reading up on Rebel players, and even sporting UNLV apparel. And yet even though I'm generally much more of a football fan, I couldn't care less about the craptastic 2-10 Rebel football team.

Am I a fair-weather fan?

It's not unusual
Thanks to renowned psychologist Robert Cialdini, I know that my newfound love for Runnin' Rebels basketball isn't all that strange. In his classic text on influence -- conveniently titled Influence -- Cialdini writes the following:

... we want our affiliated sports teams to win to prove our own superiority. ... According to the association principle, if we can surround ourselves with success that we are connected with in even a superficial way (for example, place of residence), our public prestige will rise.

In other words, I'm doing what many other sports fans do all the time -- rooting for a winning sports team so I can associate myself with its success. Of course, I don't have any special insight into whether the Rebs will keep performing well, but I've been drawn like a magnet to the fact that they have been winning recently.

Let's talk stocks
OK, so maybe you don't watch college basketball, and you definitely couldn't care less about the UNLV Runnin' Rebels. But investors get caught up in the same sort of success-chasing behavior that led me to buy a Rebels basketball jersey.

Encouraged by big profits that a stock has already created, investors chase after the market's best-performing stocks, hoping to cash in on future returns and -- likely, at least unconsciously -- trying to associate themselves with the stock's success. You can almost hear the excited cocktail chatter, "It's a real screamer! It's up 300% since last year, and there's only more to come!"

There's even a name for this kind of investing -- momentum investing -- and there are many investors who think chasing big returns like this is the only way to go.

But while being a fair-weather fan doesn't have too many serious downsides (apart from the risk of being made fun of), fair-weather stock pickers may find themselves holding a lot of underperforming stocks. I gathered data going back to 2000 and tracked how the 20 top-performing stocks of every year performed the following year. For those chasing returns, the data don't look promising.

Source: Capital IQ, a Standard & Poor's company. Returns measured on Jan. 1 of years shown.

As you can see, only two years out of those nine did the top-performing stocks manage to outperform the market the year after they dominated it. I'm not sure I like those odds. In fact, it would seem that momentum investors who are chasing the hottest stocks are lying down on the train tracks right as the train is coming through.

Are you a fair-weather investor?
So, what stocks should investors be looking out for right now? Here are the 10 best-performing stocks over the past year among all companies worth $500 million or more last year.

Source: Capital IQ, a Standard & Poor's company.

Certainly, if you've owned these stocks over the past year, you're feeling pretty darn good right now. And you should -- those are some huge one-year returns. And there are plenty of investors that are still really excited about these companies now. Netflix has soundly vanquished Blockbuster and is streaming its way to the stratosphere, Las Vegas Sands will ride the Asian gaming scene to untold profits, and Chipotle Mexican Grill will continue to charm fast-casual diners with high-quality burritos.

But will these stocks really deliver over the next year? Or will investors be drawn to the stocks' success until that success tarnishes the least little bit, causing them to jump ship and look for a bigger winner?

I'm not going to make any guarantees that any individual stock in this group is going to underperform over the next year, but if you own one of these or find one of them blinking on your buy radar, be sure to think long and hard about why that particular stock is going to be the exception of this group and not lag the market over the next year.

I don't think it's the time to be buying any of the stocks above. But my fellow Fools have put together a free report detailing five stocks that The Motley Fool owns, and they think you should own, too.