Can This Stock Go Any Higher?

"This stock has already gone up so far, it can't possibly go any higher."

This 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 in 1997, and with eBay in 1999, and I hear it now with China Mobile (NYSE: CHL). 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, that 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 in early 2003 would have you tossing cookies as the stock lost 50% of its value. PepsiCo looked much better, topping the S&P by 20% during that time. PepsiCo's spinoff 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.

The stock gains of many of these companies can be tied back to fundamental business improvements. For instance, America Movil has averaged 40% annual revenue growth over the past five years -- and profits have grown even more rapidly. What has fueled this growth is a solid track record of developing or acquiring top wireless operators in emerging Latin American markets ahead of competitor Telefonica (NYSE: TEF).

Monster stock
Research In Motion continues to defy analyst expectations as consumers and business users snap up more and more BlackBerry devices. The stock had gone up more than 1,000% in the two years following 2003 as revenue doubled each year before languishing as it fought a patent infringement suit with NTP. Settling litigation early in 2006 cleared away uncertainty for the company and let the rapid growth in earnings shine through, leading to another double in the stock. Some of these companies may continue to outperform the market going forward -- and some may nose over and flop. Their past charts won't help you discern between the two; however, fundamentals will.

In addition to revenues, 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 with 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.

If you're interested in stocks driven off fundamentals -- and not just hype -- have a look at the Motley Fool Stock Advisor service. David and Tom Gardner watch the fundamentals of hundreds of companies and recommend them to readers when shares are priced for big gains. A free 30-day tour of the full service, stock picks and all, is just a click away.

This article was originally published on May 23, 2007. It has been updated.

Fool contributor Dave Mock thought his electric bill couldn't go any higher, either. He owns shares of Starbucks and Campbell Soup. eBay and Starbucks are Stock Advisor recommendations. China Mobile is a Global Gains recommendation. The longtime Fool is the author ofThe Qualcomm Equation. The Fool's disclosure policy knits one, purls two.