That phrase runs through my head every single time I see a chart of some highflying stock that's gone up three-, five-, or 10-fold. I remember thinking it with Starbucks (Nasdaq: SBUX) in 1997, with eBay in 1999, and I hear it now with Google. Often, I'd then watch in disbelief as the stock surged even higher.
Although I bought Starbucks, I missed out on those other two -- and countless more. Thankfully, I've figured out a new way of looking at stocks.
Don't vote by chart
The problem I share with many other investors is this: It's too easy to draw a conclusion from a chart and too time-consuming to take a deep look at the fundamental business behind any stock. Yet a stock's past performance can't tell you anything about where it's going in the future. The same holds true for stocks that have really lousy-looking charts -- just because shares are in a nosedive doesn't tell you anything about the future for a company. Stocks that have suffered protracted falls may be the best opportunities out there, if the fundamentals say so.
For instance, looking at the five-year chart of soup-to-nuts maker Campbell Soup (NYSE: CPB) in early 2003 would have you tossing cookies -- the stock lost 50% of its value. PepsiCo (NYSE: PEP) looked much better, topping the S&P during that time. PepsiCo's spin-off of its low-margin bottling group in 1999 helped maintain growth to keep it in the black. But reforms at Campbell had already reversed the trend of declining net income in 2003 as the company refocused operations. These companies had very different historical charts, but by 2003, each had the fundamental drivers in place for future growth, and both have since returned more than 50%.
Great stocks, great companies
While a company's stock may be volatile over even extended periods, business fundamentals are a better gauge of future results than past stock performance. Take a gander at some companies with charts beating the pants off the market in the past five years:
|
Company |
Five-Year Performance |
|---|---|
|
American Eagle Outfitters |
367% |
|
Goldman Sachs (NYSE: GS) |
192% |
|
j2 Global (Nasdaq: JCOM) |
441% |
|
Southern Copper (NYSE: PCU) |
1,396% |
|
Hansen Natural |
8,943% |
|
Celgene |
744% |
The stock gains of many of these companies can be tied back to fundamental business improvements. For instance, j2 Global has continued to grow revenue at a nearly 25% annual clip, and Celgene's operating income has shot up nearly 160% in the past 12 months. Regardless of past gains, these companies had the right stuff to go higher. Even the granddaddy of all growth stocks, Hansen Natural, has kept revenue and earnings growing dramatically to drive a stock return of more than 120% in the past two years. This comes even after a more than 1,970% gain over the two years prior.
In addition to revenue, earnings, or other financial measures, there are other underlying fundamentals in companies worth evaluating. With retailers, investors should look closely at inventory management. With telecoms, they'll want to look at trends in churn and customer additions. And with all businesses, investors should look beyond just the numbers and feel confident in the quality of management decisions. These may be critical in identifying a stock at its peak versus one ready to vault even higher.
The fundamental conclusion
Sure, the market has been strong for many years, and we may see stocks come down in the future. But that's even more reason to be invested in fundamentally sound businesses, not just those with impressive charts for who-knows-what reason. While there's no guarantee how long a company's stock will keep rising, investors can dramatically improve their chances of picking long-term winners -- and avoiding overpriced companies -- by basing decisions on business fundamentals, not just charts.
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