I recently read the book "Superperformance stocks: An investment strategy for the individual investor based on the 4-year political cycle," by Richard S. Love. Although the book was written in 1977, much of the principles remain the same. The book title speaks for itself, and the author suggests using the 4-year political cycle as an investment strategy. And subsequently, he writes about the superperformance stocks of the time, and the common denominators of those stocks.
I will focus on the latter part of the process, and that is the superperformance stocks. What traits do they have in common, how to find them? And I will review some of the winners in recent years.
Definition of a superperformance stock: "One that at least tripled in price and increased at a minimum rate of three times during a two-year period. A move was considered ended if the price failed to reach a new high in less than six months, or if there was a price reaction of 25 percent or more."
Stocks that have a chance to become superperformance stocks share some of these characteristics:
- Large increases of earnings, especially if the large increase comes as a surprise.
- Mergers and acquisitions.
- New management.
- New products.
Large increases of earnings and sales are the main reason for a stock to rise substantially. Other reasons come into play as well, as mergers and acquisitions, new management and new products are all in service of providing higher earning power for a company. The market discounts the future, and that might be enough to push the price higher significantly, even though the increase in earnings is not still visible. However, if those expectations are not realized in the future, the price of the stock may drop severely, as the move would inflate the valuation.
The best results come after the market has experienced a severe correction or a bear market, because that is the time when most stocks are at deflated levels, and there would be many bargain opportunities in that environment. The environment is dependent on the fiscal and monetary situation, as the lowering of interest rates and fiscal stimulation lead to higher stock prices, as we have seen with massive Quantitative Easing in recent years. And that is the environment where superperformance stocks are abundant and have the most potential. Rising interest rates and fiscal tightening are negative for stocks in general, and in that kind of environment it is much harder to find a stock with potential to have a large increase in price.
So, that is the theory. Now let us take a look at some examples.
Apple Inc. (AAPL)
Apple is one of the most popular examples of a superperformance stock, and one that shows that a stock can have several superperformance moves, and lead in several market cycles. It had a dynamic management led by Steve Jobs, new and innovative products that enabled the company to increase earnings and sales substantially since 2004, and the market was moving higher when those three superperformance moves occured. The S&P 500 (NYSEARCA:SPY) moved higher in all three superperformance cycles, and it was the case in all the other examples that are shown later.
3D Systems Corp. (DDD)
3D Systems is a recent example of great investor enthusiasm. 3D printing is regarded as an exciting technology with vast potential, from industrial application to individual use. 3D Systems' earnings grew 135% and 64% in 2011 and 2012 respectively. It also introduced a wide variety of new products, and was very aggressive on the acquisition front. Those results brought two superperformance moves, as the stock increased almost four times in 2010-2011, and tripled from January to September 2012.
Netflix, Inc. (NFLX)
Netflix is the most recent example. It rose 250% in less than six months. The move came after several positive developments: the company announced that the "House Of Cards" program will be exclusively available on its streaming service; it signed a deal with Disney, which gives Netflix the right to receive first-run content from the media giant for several years; the company announced an upbeat earnings report with a 200% EPS surprise. Netflix had a prior massive run of 1,500% in the 2009-2011 period. The company had substantial earnings and sales growth prior and during the run.
Baidu Inc. (BIDU)
Baidu was one of the most impressive superperformance stocks. It increased more than 1,300% since the bear market lows of 2009, in a move that lasted a little over two years. Earnings growth in the period was in 40% to 150% range. The company was enjoying the leading position in the Chinese search market, and the rapid growth of internet use in the fast-growing economy.
After the superperformance phase is over, there will often be a severe correction, depending on how much the valuation has been inflated in the superperformance period and depending on the general market environment when the run is over. These stocks lose steam when the growth phase is over, and many times they will end their move before the end of the growth phase, as many investors anticipate the slowing down of growth, many take their profits, and eventually, the blown up valuation becomes a concern, and causes a correction.
It is useful to look at past behavior of stocks in order to learn from them. History often repeats itself in the stock market. The names of the stocks change, but the overall situation is always similar. Acceleration of earning power is the most important thing to look for when examining the potential of a stock to become a superperformance stock. And the superperformance move will most often coincide with the bull market cycle of the general market.