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It’s common financial wisdom that stocks are the best investment over the long term. While true on the face of it; that may not mean that stocks are always the best investment for the bulk of your retirement savings. Stocks have had a historically excellent record; however there have been extended periods where the stock market as a whole has experienced little or no overall growth. If you were unfortunate enough to have the bulk of your investment in stocks that roughly paralleled the market as a whole during this time period, you’d have lost ground when the effects of inflation were considered (and how can you avoid inflation?). 

Between October 1^st 1965, and April 1^st of 1982, the Dow actually lost ground with closing values on those dates going from 969 to 784. Considering inflation, you’d have been hating life had your retirement savings been in an instrument that roughly tracked the Dow. Obviously, there were individual stocks that outperformed the broader market by a considerable margin.

The Boeing Company for example, buoyed by the expansion of commercial air travel and aerospace applications, saw its shares climb from $2.15 on that same October 1^st date, to $2.29, a trivial climb it would seem, but the aerospace giant was on the way up and had more than doubled it’s stock price by the end of 1982, to $5.92. Seems like a great buy now, no?

Some stocks have done much better over short time intervals. What is the prime determining factor in spotting these equities that outperform the overall market, especially at times when the market is doing poorly? There are a few factors that seem to precipitate large gains in stock price, and thankfully, these are relatively easy to spot. It should be noted however, that these factors definitely do not guarantee the stock price will rise.

Here are some of those factors that appear to directly precipitate a strong performance in stock price:

Strong Growth in Stock Prices Factor #1 – Earnings
Investors are looking for a great company that makes money, and this factor demonstrates it. Stocks that have showed earnings increasing more than 25% over the prior quarter have historically done well. The other very important earnings factor is annual earning per share. Those that had an EPS increase greater than 50% over the prior year did very well too. Look at Exxon-Mobil, who has reported record earnings recently and showed a solid increase each quarter. Their stock has advanced from $40 in Jan of 2004, to almost $80 today.

 

Strong Growth in Stock Prices Factor #2 – Product Introductions
Many times a new product introduction will pump up a company’s stock price. As the product succeeds in the marketplace, investors respond favorably. In addition, a successful new product usually serves to initiate an earnings increase. Note that the new product launch must be successful in order to positively affect stock price, which many are not. Only about half of new commercial products introduced actually succeed in the marketplace. Of those that succeed, only about 20% are true, long term successes. The Marketing Science Institute reported in 1989 that the average gain precipitated by the introduction was .75% in the three days immediately following the product’s announcement. They also found that: “Financial markets positively and quickly recognize the value of marketing decisions. This is both a long- and short-term effect. In addition to the 3-day stock return effect, the 14-year price/earnings ratio of introducing firms is twice that of a matched sample of non-introducing firms.”

Another key finding of the MSI study was that original new products have a positive affect on the firm’s stock price while the market fails to recognize product updates. Another interesting point was that the frequency used by the firm for the product introductions has an affect as well. Companies that announced multiple products experienced almost twice the long term stock price increase as those that introduced a single new product.

Strong Growth in Stock Prices Factor #3 – Institutional Buying
Buy what the big boys are buying. This is true at the beginning of the large funds purchase cycle. Initially interest by large funds will drive the price up, due to the demand itself, and the investor perception that such interest reflects positively on the company. In time that may lead to an excessive ownership stake in the firm by institutional, which does not help the stock price.

 

Strong Growth in Stock Prices Factor #4 – Demand
Weather it’s toothpaste or stocks, if the demand outstrips supply, the price will rise. You probably learned that if you weren’t sleeping that day in Econ 101. So it is with stocks. This axiom more readily affects smaller cap stocks. The demand for something with a smaller quantity is easier to get to a level where it will increase the price. William J. O’Neil, who founded Investors Business Daily, did a comprehensive study of stock prices with respect to demand factors. One of his key findings was that, over the 38 year term of the study, 95% of companies that experienced a strong move upward in stock price had fewer than 25 million shares outstanding when they started their upward climb.

There you go. These 4 factors have been shown to foreshadow a nice increase in a firm’s stock price and overall market value.