Amazon.Com (AMZN) stock has been en fuego since releasing its third quarter earnings on October 22. Before the announcement, the company’s stock price implied 12.6% sales growth. Then the company reported that in the third quarter it produced 27.8% year-over-year sales growth, easily surpassing this (relatively) low Required Business Performance. This sent the stock soaring from $95 to more than $130. The company also guided analysts to between 21% and 26% for the fourth quarter.

It is really quite remarkable how consistently such a large company has been able to continue to expand. Moreover, it is impressive that it continues to dominate the online retail space and much of retail in general. But it is the company’s experience over the last year that has been the most remarkable. Despite the stock losing 50% of its market value during the market collapse, the company continued to post strong results throughout.

Walgreens (WAG) drugstores have become as ubiquitous as Super Wal-Marts (WMT) throughout most of the United States. Their familiar neighborhood corner locations serve more than five million customers every day, and produced $63 billion in revenue in the fiscal year that ended this past August.

The current price of Walgreen stock implies growth in revenue of 6.9% over the next twelve months. For the fiscal year ending in August of 2008 revenue grew 9.8%, but for the most recent fiscal year revenue grew only 7.3%. But the company’s remarkably consistent history of growth is also relevant—revenues have grown every year for an incredible thirty-four consecutive years. Over the past ten years, this growth has averaged 13.6%, although this rate of growth is slowing. Check out the chart below. Clearly revenue growth is remarkable, but should it be alarming that it has slowed so much over the past ten years? How much of this is already baked into the stock price?

I don’t maintain this blog much anymore, but that doesn’t mean I don’t follow Berkshire Hathaway (BRK.A). And I would be remiss not to comment on the news I awoke to on Tuesday.

This is likely the most historic day in the history of Berkshire. The company is making the largest single acquisition – by a huge margin – in its history by acquiring the 75% of Burlington Northern Santa Fe (BNI) it didn't already own. Additionally, BRK.B is getting split 50-for-1, so no more $3,000 shares. Is this the end of the BRK mystique?

I don’t write for this site much anymore, but that doesn’t mean I don’t follow Berkshire Hathaway (BRK.A). And I would be remiss not to comment on the news I awoke to yesterday morning.

Tuesday was likely the most historic day in the history of Berkshire. The company is making the largest single acquisition – by a huge margin – that it ever has by acquiring the 75% of Burlington Northern Santa Fe (BNI) it doesn't already own. Additionally, BRK.B is getting split 50-for-1. No more $3000 shares. Is this the end of the BRK mystique?

The question I am posing is whether Verizon Communications (VZ) can add 5.4 million new wireless subscribers and whether its likelihood of doing so is greater or lower that of than AT&T’s (T) adding 4.7 million new wireless subscribers.

Verizon looks like a great buy right now. The company has weathered the crisis very well, is adding new subscribers faster than its peers and sports a 6% dividend yield. The important question, however, is can the company deliver results sufficient to justify its current stock price of $30?

Several weeks ago I wrote about the cause of the underperformance of high RBP Probability growth stocks relative to low RBP Probability growth stocks. The conclusion I drew was that an irrational bull market run and unprecedented support for growth stocks from the U.S. government lead to a breakdown in the typical relationship between high and low RBP Probabilities stocks.

The unusually strong performance of low probability growth stocks waned in September, just as stock prices in general reached a plateau. Whereas low RBP Probability growth stocks had actually outperformed high RBP Probability growth stocks earlier this year, this trend is reversing. Government stimulus directed toward growth companies disrupted the typical relationship between low– and high–RBP Probability growth stocks, but with prices now fully reflecting this government support, the historical behavior of stocks with low– versus high–RBP Probabilities has returned. Indeed, while the DJ U.S. Large-Cap Growth Index returned 4.87% in September, the DJ RBP U.S. Large Cap Growth Leading 30 returned 8.18% and the DJ RBP U.S. Large Cap Growth Lagging 30 returned 3.72%

Amazon.Com (AMZN) continues to dominate the online retail space and much of retail in general. Most importantly, its stock price implies a level of business performance that should be easy for the company to produce. (See AMZN’s RBP Snapshot as of October 7)

The company’s experience over the last year has been quite remarkable. Despite the stock losing 50% of its market value during the market collapse, the company continued to post strong results throughout. For the fiscal year that ended in December of 2008, the company posted sales growth of 29% over fiscal 2007. And for the twelve months ending in June of 2009, despite a recession and credit market freeze, the company was still able to report sales growth of nearly 20% over the same period a year earlier. Margins have continued to improve during this growth as well, resulting in operating profit, net income and EPS growth even higher than the growth in sales.

RBP Probability is the implied probability of sustaining performance. In his 2008 white paper, Professor Bjorn Jorgenson of Columbia Business School tested the sensitivity of RBP Probability to some important variables. First, he confirmed the intuition: RBP Probability declines as a) stock prices rise, b) risk (as proxied by the discount rate) increases and c) operating margin declines.

These is what we'd expect, but the magnitude is not straightforward. By performing experiments in which only one variable was changed at a time, he found that the relationship between the size of the stock price change and change in RBP Probability was generally S-shaped. This implies that changes in RBP Probability are lower for a given change in stock price when RBP Probabilities are either very high or very low.

Since the market bottomed in March the RBP Probabilities of value stocks have been noticeably lower than those of growth stocks or the market in general. For instance, currently the DJ RBP US Large-Cap Growth Leading 30 has a weighted average RBP Probability of 90.21%, while the DJ RBP US Large-Cap Value Leading 30 has a weighted average RBP Probability of only 78.07%. What causes this discrepancy? It is an interesting phenomenon and one that I have thought much about.

Before I get started, let us define value stocks and growth stocks. The components of DJ RBP Growth Indexes are drawn from the Dow Jones U.S. Large-Cap Growth Index, whereas the the components of DJ RBP Value Indexes are drawn from the Dow Jones U.S. Large-Cap Value Index. Half of the stocks in the Dow Jones U.S. Large-Cap Index are designated growth and half value based on a “style” score that is calculated from six variables: Projected PE, projected earnings growth, price-to-book, dividend yield, trailing revenue growth and trailing earnings growth.

I’ve long argued that one of the best applications of RBP Probability is in the comparison of alternative or substitute investments. For example, when making a decision on a single stock, it is helpful to compare that stock’s RBP Probability with the median RBP Probability within its industry. Today I am looking at the classic one-two market: Coca-Cola versus PepsiCo.

In recent years PepsiCo has come to be assumed by many investors to be the better growth company of the pair. Coca-Cola’s stock, despite its endorsement from Warren Buffett as one of his “permanent holdings,” has been stagnant for well over ten years now. Meanwhile PEP is up a respectable 76% in the last ten years leaving some to wonder if Buffett has gotten it all wrong.

Estee Lauder (EL) is a personal products company particularly prone to declines in discretionary spending. Its sales over the previous twelve months have served as strong evidence of this. This fact, coupled with strong stock price performance, gives the company only a 37% probability of producing the performance implied by its stock price. (See EL’s RBP Snapshot as of Sep 4)

For the fiscal year that ended on June 30, revenue declined 7.3% versus FY08. For the fourth quarter, revenue declined 16% versus the same quarter a year earlier. The recent sales declines make the historical sales growth profile of Estee Lauder increasingly dismal, pushing the company’s RBP Probability down by more than 30% during the month of August alone.

Whether all investors realize it or not, stock prices ought reflect the future performance of a company, not the past performance. It is easy to lose sight of this simple notion when the only data we have available is that which describes operations that have already occurred, particularly since we have an enormous amount of such data. But in reality the only reason past performance matters is because it is usually indicative of what will happen in the future. For instance, a PE ratio of 20 times prior twelve month’s earnings might seem far too high for a particular company, but five years down the road, with the benefit of hindsight, we may be able to see that the valuation was actually quite reasonable.

The problem we run in to when trying to value a company based on future performance is that future performance is, simply, unknown. We can make educated guesses, but nobody really knows for sure. The Required Business Performance (RBP) methodology is an excellent way to cope with the truism that the future is always uncertain because it approaches the investment decision in a very different way. Rather than guessing what future performance will be and then assigning an appropriate value, RBP asks “What is the level of future business performance that is required to support the current price of the stock?” Then, after calculating this level, RBP asks “What is the likelihood that management can deliver this level of performance?”

The chart above shows the outperformance of the DJ RBP US Large-Cap Leading 30 Index over the DJ RBP US Large-Cap Lagging 30 Index. The Leading 30 Index is composed of the thirty stocks in the Dow Jones US Large-Cap Index with the highest RBP Probabilities, while the the Lagging 30 Index is composed of the thirty stocks in the Dow Jones US Large-Cap Index with the lowest RBP Probabilities. It is remarkable how well RBP Probability has been able to differentiate among stocks that subsequently perform good or bad. Year to date, the Leading 30 Index has returned +18.09%, while the Lagging 30 Index has fallen 2.03%.

Express Scripts (ESRX) seems to bucking the trend today, a day in which the market is off 2%. Perhaps this is due to Obama’s announcement that the public plan need not be a part of his health care overhaul. If this happens, then Express Scripts might be among those companies relied upon should cost controls be mandated but also left to insurers to sort out for themselves.

Nevertheless, until the health care reform issue is completely resolved – that is, until we know for certain what exactly will occur – Express Scripts seems like a very overvalued stock that will have trouble meeting its Required Business Performance unless something drastic and unforeseen occurs soon.

To me, this is proof the mainstream media has absolutely no clue about economic reality.

CNN proudly boasts that Cash For Clunkers program is “Real Stimulus,” claiming that “the boost to auto sales caused by the government trade-in program should lead to increased production from Detroit. That could have a big ripple effect.”

RBP Probability tells us the likelihood, based on historical rates of sales growth, that a company will be able to generate sufficient sales to justify the current price of its stock. So how do we use this?

The best way is to use it to assess the riskiness of a stock at its current price. Investors have always had a hard time quantifying the risk inherent in investing in stocks. (For that matter, people have had a hard time quantifying any type of risk.) We used to have beta, the relative volatility of a stock relative to the volatility of the market. This made some amount of sense for the short-term trader who may have to liquidate at a moment’s notice. If the stock is very volatile, and the trader happens to be forced to sell when the stock is down, well, that is bad. And thus volatility makes the purchase of the stock risky.

Whole Foods Market, Inc. (WFMI) began 2009 trading at $9.44/share. At $24.20, the stock has climbed more than 160% in the first seven months of the year. With any gain as large as this, an important question is whether the gain is justified or the result of overly optimistic investors trading on their own momentum.

At its current stock price, the company’s Required Business Performance implies revenue growth of at least 5.2% in the upcoming twelve months and even higher levels of growth beyond that time. (See WFMI’s RBP Snapshot) While this may seem attainable given the company’s historical growth rates, with current market conditions it is relatively unlikely that the company will meet this Required Business Performance.

After its runup on last week’s earnings announcement, I think eBay (EBAY) stock is overpriced. But then again, it was overpriced before the runup too. Please let me explain.

I do not think eBay is a bad company. Much the opposite, in fact. After all, it has a retail business model that requires no inventory! It is the only legitimate player in its market niche, merchants often depend on its services for their very survival and eBay has found a way to charge fees at every level of the transaction. It is a beautiful arrangement, really. And this is likely what carried it through the dot com crash that destroyed just about every other meaningful peer company.

Second Quarter earnings season will get in to full swing this week with reports from the biggest technology names as well as a couple of big financials. I thought I would briefly look at each one to assess what we should expect to hear from them when they report.

Johnson & Johnson (JNJ):
J&J’s Required Business Performance implies a revenue decline of 1.9% over the next twelve months. This is the level of performance the company’s management must produce to support the current stock price of $56.93. This works out to a RBP Probability of 65.5%, indicating that it has a 65.5% chance of meeting this Required Business Performance. This is on par with that of the Pharma & Biotech sector and slightly higher than the Pharmaceuticals subsector median RBP Probability of 62%. In other words, it is basically a flip of the coin as to whether J&J will deliver on its Required Business performance when it reports quarterly results on Tuesday.

In this recession, investors seem to be looking for “comfort stocks.” The Hershey Company (HSY) is one stock that could benefit from consumers focusing on the simple pleasures.

For the twelve months that ended in March, Hershey reported sales growth of 5.1%, quarterly sales growth in the first quarter of FY 2009 of more than 6.5%. This was the first substantial gain in several years and seemingly got many investors re-energized on the stock. Unfortunately, I think this new-found energy was just a sugar high.