In my previous article about Superperformance stocks, I wrote about what it is needed for a stock to have an outstanding run, meaning a rise of more than 200% in less than two years, by the definition of Richard S. Love, the author of "Superperformance stocks: An investment strategy for the individual investor based on the 4-year political cycle."
The emphasis of this article is the performance of those stocks after their upside run is over. Most of stocks will be grossly overvalued at the end of their superperformance run, since the momentum drove the price substantially higher in a long term burst of investor optimism. If a company achieves high earnings and sales growth, and if the growth is in approximate vicinity of the price rise, the correction does not have to be severe, but in most cases, the stock underperforms the overall market for several months, and even years.
As the substantial rise of the stock is most often associated with accelerating earnings and sales, new management, new products, mergers and acquisitions, the end of one or all of these optimism and growth drivers often brings the end of the stock's rise. The company might report disappointing earnings, weak guidance, new (now old) products saturate the market, become obsolete, or there are better new products by the competition. Those are some of the reasons that are company specific. Others are the general market environment and the overall economy. A fierce selloff or a brutal bear market would probably have a strong negative effect on the price performance of the stock, regardless of the growth levels and investor optimism. In the 2008-2009 bear market we have seen that in all of the superperformance stocks that were mentioned in the previous article, as the S&P 500 (SPY) dropped more than 50% bringing the superperformance stocks down.
Now let us take a look at specific stocks that were covered as superperformance stocks in the previous article, and the corrections they had that were not associated with the severe 2008-2009 bear market. Earnings surprises and data were collected from Earnings.com. Source for charts below is Stockcharts.
Apple Inc. (AAPL)
Apple is an example of the more reasonable valuation at the end of the superperformance run. One of the causes for the end of the run was a substantial slowdown in earnings. Apple reported 20%, 23% and flat earnings growth respectively in the last three quarters. Earnings growth 14 quarters before was in 42% to 122% range. Earnings surprise was another feature Apple had all the time during its high growth phase. Average earnings surprise since 2009, up until Q2 2012 was 41%. Since Q2 2012, Apple posted two negative earnings surprises and a slight beat in the latest quarter. Weak guidance was another feature, and analyst estimate revisions were coming down very quickly. Although the PE at the top was 16.5, that did not stop the stock from falling 40% in the next six months.
3D Systems Corp. (DDD)
3D Systems suffered a correction in a degree similar to Apple's, falling 42%, but in just two months this year. Trailing PE was very high, almost approaching 100, which was out of sync with reality, as future growth rates were not justifying such a high ratio, but the momentum caught the stock, and it rose almost 400% in one year's time. Then concerns emerged, such as the aggressive acquisition policy and a possible inability of the company to grow organically, the co-founder/CTO Charles Hull sold more than half of his shares, and the earnings report disappointed investors. And 3D Systems corrected 55% in 2011, after a strong 350% rise.
Netflix, Inc. (NFLX)
Netflix is a great example of price momentum on both sides, up and down. After the massive 1,500% run in 2009-2011 period, the stock plummeted 80% in just four months. The steep selloff came after a service pricing fiasco, and a substantial fall in earnings followed.
Baidu Inc. (BIDU)
Baidu is in a slow, transformational process from growth to a value stock. It peaked in summer of 2011, after a 1,300% run in two years. The PE at the peak was above 100, it is 18 now. The growth peaked roughly at the same time as the price did, and had slowed significantly since. You can read more about Baidu's growth process in my article, explaining the earnings maturation cycle.
While it is great to catch a great stock performer in its early stages of growth, the position must be closely watched. The fundamentals driving the stock price must be monitored, especially in companies with high earnings and sales growth rate. When the growth slows down or becomes negative, the stock price might drop precipitously in a very short time frame.