Can This Stock Go Any Higher?

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

That phrase runs through my head every time I see a chart of some high-flying stock that's gone up three-, five-, or tenfold. I remember thinking it with Starbucks in 1997, and over the past year with commodity stocks like agriculture chemical provider Mosaic (NYSE: MOS  ) and steel maker Nucor (NYSE: NUE  ) . I'd often watch in disbelief as the stock I had doubted surged even higher.

Certainly, virtually every stock has been knocked lower recently. But watching stock prices gyrate during the recent volatility in the market won't help you determine which ones will keep plummeting, or bounce back eventually. Thankfully, there's a better way to look 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.

The same holds true for stocks that have really lousy-looking charts -- a nose-diving share price doesn't tell you anything about a company's future. In fact, stocks that have suffered protracted falls may be the best opportunities out there, if the fundamentals say so.

For instance, looking at the chart of soup-to-nuts maker Campbell Soup would make you queasy: The stock lost about one-quarter of its value in early 2003. PepsiCo looked much better -- it topped the S&P 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 early 2003, each had the fundamental drivers in place for future growth, and both have since returned more than 60%.

Great stocks, great companies
A company's stock may be volatile even over extended periods, meaning that 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

Past 5-Year
Performance

AK Steel (NYSE: AKS  )

514%

Apple

819 %

Gilead Sciences (Nasdaq: GILD  )

169%

Transocean (NYSE: RIG  )

299%

Arcelor Mittal (NYSE: MT  )

570%

Data from Google Finance.

The stock gains of many of these companies can be tied to fundamental business improvements. For instance, Apple's smash-hit line of iPods has fueled the demand for high-margin iTunes that has cemented the Apple brand in the mind of consumers. In 2007, sales across the company rose to a level 4.5 times of that reported five years ago, and net income came in higher than the two previous years combined.

Regardless of past gains, these companies had the right stuff to go higher. Some of these names may continue to outperform the market, but their past charts won't help you pick the best investment today. Fundamentals will.

The fundamental conclusion
With the turbulence in the market, many stocks are tumbling from their highs. But this actually makes it a great time to invest, particularly in fundamentally sound businesses -- not just those with impressive charts for who knows what reason? There's no guarantee how long a company's stock will keep rising, but 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 by 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 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 Campbell Soup and Starbucks. Starbucks is a Motley Fool Inside Value selection. Starbucks and Apple are Stock Advisor recommendations. The Fool owns shares of Starbucks. The Fool's disclosure policy knits one, purls two.


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