N = New Products, New Management, New Highs; Buying at the Right Time

N = New Products,
New Management,
New Highs:
Buying at the Right Time

It takes something new to produce a startling advance in the price of
a stock.
This something new can be an important new product or service, sell-
ing rapidly and causing earnings to accelerate above previous rates of
increase. It could also be new top management in a company during
the last couple of years. A new broom sweeps clean, or at least may
bring inspiring ideas and vigor to the ball game.

Or the new event could be substantial changes within the company's
industry. Industrywide shortages, price increases, or new technology
could affect almost all members of the industry group in a positive way.

New Products That Created
Super Successes

1. Rexall's new Tupperware division, in 1958, helped push the com-
pany's stock to $50 a share, from $16.
2. Thiokol in 1957-1959 came out with new rocket fuels for missiles,
propelling its stock from $48 to the equivalent of $355.
3. Syntex, in 1963, marketed the oral contraceptive pill. In six months
the stock soared from $100 to $550.
4. McDonald's, in 1967-1971, with low-priced fast food franchising,
snowballed into an 1100% profit for stockholders.
5. Levitz Furniture stock increased 660% in 1970-1971, with the pop-
ularity of their giant warehouse discount furniture centers.
6. Houston Oil & Gas, in 1972-1973, with a major new oil field ran up
968% in 61 weeks and later in 1976 picked up another 367%.
7. Computervision stock advanced 1235% in 1978-1980, with the
introduction of new Cad-Cam factory automation equipment.
8. Wang Labs Class B stock grew 1350% in 1978-1980, due to the cre-
ation of their new word-processing office machines.
9. Price Company stock shot up more than 15 times in 1982-1986
with the opening of a southern California chain of innovative
wholesale warehouse membership stores.
10. Amgen developed two successful new biotech drugs, Epogen and
Neupogen, and the stock raced ahead from 60% in 1990 to the
equivalent of 460% in January 1992.
11. Cisco Systems, another California company, created routers and
networking equipment that allowed company links with geographi-
cally dispersed local area computer networks. The stock advanced
over 2000% in 3V2 years.
12. International Game Technology rose an astounding 1600% in
1991-1993 with new microprocessor-based gaming products.

In our study of greatest stock market winners from 1953 through
1993, we discovered more than 95% of these stunning successes in
American industry either had a major new product or service, new man-
agement, or an important change for the better in the conditions of
their particular industry.

The Stock Market's Great
Paradox

There is another fascinating phenomenon we found in the early stage
of all winning stocks. We call it "the great paradox." Before I tell you
what this last new observation is, I want you to look at three typical
stocks shown on the next page. Which one looks like the best buy to
you? Which stock would you probably avoid?

Among the thousands of individual investors attending my investment
lectures in the 1970s, 1980s, and 1990s, 98% said they do not buy stocks
that are making new highs in price.

The staggering majority of individual investors, whether new or expe-
rienced, feel delightful comfort in buying stocks that are down substan-
tially from their peaks.

I have provided extensive research for over 600 institutional investors
in the United States. It is my experience that most institutional money
managers are also bottom buyers¡Xthey, too, feel safer buying stocks
that look cheap because they're either down a lot in price or selling
near their lows.

The hard-to-accept great paradox in the stock market is that what
seems too high and risky to the majority usually goes higher and what
seems low and cheap usually goes lower. Haven't you seen this happen
before?

In case you find this supposed "high-altitude" method a little difficult
to boldly act upon, let me cite another study we conducted. An analysis
was made of the daily newspapers' new-high and new-low stock lists dur-
ing several good, as well as poor, market periods.

Our findings were simple. Stocks on the new-high list tended to go
higher, and those on the new-low list tended to go lower.
Put another way, a stock listed in the financial section's new-low list of
common stocks is usually a pretty poor prospect, whereas a stock mak-
ing the new-high list the first time during a bull market and accompa-
nied by a big increase in trading volume might be a red-hot prospect
worth checking into. Decisive investors should be out of a stock long
before it appears on the new-low list.

You may have guessed by now what the last intriguing new realization
is that I promised to disclose to you earlier. So here are the three stocks
you had to choose among on the previous page, Stock A, Stock B, and
Stock C. Which one did you pick? Stock A (Syntex Corp, see below) was
the right one to buy. The small arrow pointing down above the weekly
prices in July 1963 shows the same buy point at the end of Stock A in
July on the previous page. Stock B and Stock C both declined.

When to Correctly Begin
Buying a Stock

A stock should be close to or actually making a new high in price after
undergoing a price correction and consolidation. The consolidation
(base-building period) in price could normally last anywhere from seven
or eight weeks up to fifteen months.

As the stock emerges from its price adjustment phase, slowly resumes
an uptrend, and is approaching new high ground, this is, believe it or
not, the correct time to consider buying. The stock should be bought
just as it's starting to break out of its price base.

You must avoid buying once the stock is extended more than 5% or
10% from the exact buy point off the base. Here is an example of the
proper time to have bought Reebok, at $29, in February 1986 before it
zoomed 260%. The second graph shows the correct time to have bought
Amgen at $60¡Xin March 1990¡Xbefore it jumped more than sixfold.

How Does a Stock Go from
$50 to $100?

As a final appeal to your trusty common sense and judgment, it should
be stated that if a security has traded between $40 and $50 a share over
many months and is now selling at $50 and is going to double in price,
it positively must first go through $51, $52, $53, $54, $55, and the like,
before it can reach $100.

Therefore, your job is to buy when a stock looks high to the majority
of conventional investors and to sell after it moves substantially higher
and finally begins to look attractive to some of those same investors.
In conclusion: Search for corporations that have a key new product
or service, new management, or changes in conditions in their industry.
And most importantly, companies whose stocks are emerging from
price consolidation patterns and are close to, or actually touching, new
highs in price are usually your best buy candidates. There will always be
something new occurring in America every year. In 1993 alone, there
were nearly 1,000 initial public offerings. Dynamic, innovative new com-
panies¡ bundle of future, potential big winners.

(Excerpt from 'How To Make Money in Stocks')

A = Annual Earnings Increases; Look for Meaningful Growth

If you want to own part of a business in your home town, do you
choose a steadily growing, successful concern or one that is unsuccess-
ful, not growing and highly cyclical?

Most of you would prefer a business that is showing profitable growth.
That's exactly what you should look for in common stocks. Each
year's annual earnings per share for the last five years should show an
increase over the prior year's earnings. You might accept one year
being down in the last five as long as the following year's earnings
quickly recover and move back to new high ground.

It is possible that a stock could earn $4 a share one year, $5 the next
year, $6 the next, and the following year¡X$2. If the next annual earn-
ings statement were $2.50 versus the prior year's $2 (+ 25%), that would
not be a good report. The only reason it may seem attractive is that the
previous year ($2) was so depressed any improvement would look good.
In any case, the profit recovery is slow and is still substantially below the
company's peak earnings of $6:

Select Stocks with 25% to
50% Annual Growth Rates

Owning common stock is just the same as being a part owner in a busi-
ness. And who wants to own part of an establishment showing no growth?
The annual compounded growth rate of earnings in the superior firms
you hand pick for purchasing stock in should be from 25% to 50%, or
even 100% or more, per year over the last 4 or 5 years.

Between 1970 and 1982, the average annual compounded earnings
growth rate of all outstanding performing stocks at their early emerging
stage was 24%. The median, or most common, growth rate was 21% per
year, and three out of four of the prominent winners revealed at least
some positive annual growth rate over the five years preceding the giant
increase in the value of the stock. One out of four were turnarounds.
A typical successful yearly earnings per share growth progression for a
company's latest five-year period might look something like $.70, $1.15,
$1.85, $2.80, $4.

The earnings estimate for the next year should also be up a healthy
percentage; the greater the percentage, the better. However, remember
estimates are opinions. Opinions may be wrong whereas actual reported
earnings are facts that are ordinarily more dependable.

What Is a Normal Stock
Market Cycle?

Most bull (up) market cycles last two to four years and are followed by a
recession or bear (down) market and eventually another bull market in
common stocks.

In the beginning phase of a new bull market, growth stocks are usual-
ly the first sector to lead the market and make new price highs. Heavy
basic industry groups such as steel, chemical, paper, rubber, and
machinery are commonly more laggard followers.

Young growth stocks will usually dominate for at least two bull market
cycles. Then the emphasis may change for the next cycle, or a short
period, to turnaround or cyclical stocks or newly improved sectors of
the market, such as consumer growth stocks, over-the-counter growth
issues, or defense stocks that sat on the sidelines in the previous cycle.
Last year's bloody bums become next year's heroes. Chrysler and
Ford were two such spirited turnaround plays in 1982. Cyclical and
turnaround opportunities led in the market waves of 1953¡X1955,
1963-1965, arid 1974-1975. Papers, aluminums, autos, chemicals, and
plastics returned to the fore in 1987. Yet, even in these periods, there
were some pretty dramatic young growth stocks available. Basic industry
stocks in the United States frequently represent older, more inefficient
industries, some of which are no longer internationally competitive and
growing. This is perhaps not the area of America's future excellence.
Cyclical stocks' price moves tend to be more short-lived when they do
occur, and these stocks are much more apt to suddenly falter and
encounter disappointing quarterly earnings reports. Even in the stretch
where you decide to buy strong turnaround situations, the annual com-
pounded growth rate could, in many cases, be 5% to 10%.

Requiring a company to show two consecutive quarters of sharp earn-
ings recovery should put the earnings for the latest twelve months into,
or very near, new high ground. If the 12 months earnings line is shown
on a chart, the sharper the upswing the better. This will make it possi-
ble in many cases for even the "old dog" about-face stock to show some
annual growth rate for the prior five-year time period. Sometimes one
quarter of earnings turnaround will suffice if the earnings upswing is so
dramatic that it puts the 12 months ended earnings line into new highs.

Check the Stability of a
Company's Five-Year
Earnings Record

While the percentage rate of increase in earnings is most important, an
additional factor of value, which we helped pioneer in the measure-
ment and use of, is the stability and consistency of the past five years'
earnings. We display the number differently than most statisticians do.
Our stability measurements are expressed on a scale from 1 to 99.
The lower the figure, the more stable the past earnings record. The fig-
ures are ca^ulated by plotting quarterly earnings for the last five years
and fitting a trend line around the plot points to determine the degree
of deviation from the basic earnings trend.

Growth stocks with good stability of earnings tend to show a stability
figure below 20 or 25. Equities with a stability rating over 30 are more
cyclical and a little less dependable in their growth. All other things
being equal, you may want to choose the security showing a greater
degree of consistency and stability in past earnings growth.
Earnings stability numbers are usually shown immediately after a
company's five-year growth rate, although most analysts and investment
services do not bother to make the calculation.

If you primarily restrict your selections to ventures with proven
growth records, you avoid the hundreds of investments having erratic
earnings histories or a cyclical recovery in profits that may top out as
they approach earnings peaks of the prior cycle.

How to Weed Out the Losers
in a Group

When you investigate a specific industry group, using the five-year
growth criteria will also help you weed out 80% of the stocks in an
industry. This is because the majority of companies in an industry have
lackluster growth rates or no growth.

When Xerox was having its super performance of 700% growth from
March 1963 to June 1966, its earnings growth rate averaged 32% per
year. Wal-Mart Stores, a discount retailer, sported an annual growth
rate from 1977 to 1990 of 43% and boomed in price an incredible
11,200%. Cisco Systems growth rate in October 1990 was an enormous
257% per year and Microsoft's was 99% in October 1986, both before
their long advances.

The fact that an investment possesses a good five-year growth record
doesn't necessarily cause it to be labeled a growth stock. Ironically, in
fact, some companies called growth stocks are producing a substantially
slower rate of growth than they did in several earlier market eras. These
should usually be. avoided. Their record is more like a fully matured or
nearly senile growth stock. Older and larger organizations frequently
show slow growth.

New Cycles Create New
Leaders

Each soaring new cycle in the stock market will catapult fresh leader-
ship stocks to the attention of the market, some of which will begin to
be called growth stocks. The growth record in itself, however, is only a
starting point for would-be victorious investors, and it should be the
first of many earnings measurements you should check.
For example, companies with outstanding five-year growth records of
30% per year but whose current earnings in the last two quarters have
slowed significantly to + 15% and + 10% should be avoided in most
instances.

Insist on Both Annual and
Current Quarterly Earnings
Being Excellent

We prefer to see current quarterly earnings accelerating or at least main-
taining the trend of several past quarters. A standout stock needs a
sound growth record during recent years but also needs a strong current
earnings record in the last few quarters. It is the unique combination of
these two critical factors, rather than one or the other being outstanding,
that creates a superb stock, or at least one that has a higher chance of
true success.

Investor's Business Daily provides a relative earnings ranking (based
on the latest five-year annual earnings record and recent quarterly earn-
ings reports) for all common stocks shown in the daily NYSE, AMEX,
and OTC stock price quotation tables.

More than 6000 stocks are compared against each other and ranked on
a scale from 1 to 99. An 80 earnings per share rank means a company's
current and five-year historical earnings record outclassed 80% of all
other companies.

The earnings record of a corporation is the most critical, fundamental
factor available for selecting potential winning stocks.

Are Price-Earning Ratios
Important?

Now that we've discussed the indispensable importance of a stock's cur-
rent quarterly earnings record and annual earnings increases in the last
five years, you may be wondering about a stock's price-to-earnings
(P/E) ratio. How important is it in selecting stocks? Prepare yourself for
a bubble-bursting surprise.

P/E ratios have been used for years by analysts as their basic measure-
ment tool in deciding if a stock is undervalued (has a low P/E) and
should be bought or is overvalued (has a high P/E) and should be sold.
Factual analysis of each cycle's winning stocks shows that P/E ratios
have very little to do with whether a stock should be bought or not. A
stock's P/E ratio is not normally an important cause of the most suc-
cessful stock moves.

Our model book studies proved the percentage increase in earnings
per share was substantially more crucial than the P/E ratio as a cause of
impressive stock performance.

During the 33 years from 1953 through 1985 the average P/E for the
best performing stocks at their early emerging stage was 20 (the Dow
Jones Industrial's P/E at the same time averaged 15). While advancing,
these stocks expanded their P/Es to approximately 45 (125% expansion
of P/E ratio).

..to be continued..

(Excerpt from 'How To Make Money from Stocks')

C = Current Quarterly Earnings Per Share: How Much Is Enough?

M/A-Com Inc.
Humana Inc.
Kirby Exploration Co.

What did shares of the above-mentioned microwave component man-
ufacturer, hospital operator, and oil Service Company have in common?
From 1977 to 1981, they all posted price run-ups surpassing 900%.
In scrutinizing these and other past stock market superstars, I've
found a number of other similarities as well.

For example, tradiiig volume in these sensational winners swelled
substantially before their giant price moves began. The winning Stocks
also tended to shuffle around in price consolidation periods for a few
months before they broke out and soared. But one key variable stood
out from all the rest in importance: the profits of nearly every outstand-
ing stock were booming.

The common Stocks you select for purchase should show a major per-
centage increase in the current quarterly earnings per share (the most
recently reported quarter) when compared to the prior year's same
quarter.

Earnings per share are calculated by dividing a company's total after-
tax profits by the company's number of common shares outstanding.
The percentage increase in earnings per share is the single most impor-
tant element in stock selection today.

The greater the percentage of increase, the better, as long as you
aren't misled by comparing current earnings to nearly nonexistent
earnings for the year earlier quarter, like 1 cent a share.

Ten cents per share versus one cent may be a 900% increase, but it is
definitely distorted and not as meaningful as $1 versus $.50. The 100%
increase of $1 versus $.50 is not overstated by comparison to an unusu-
ally low number in the year ago quarter.

I am continually amazed at how many professional pension fund
managers, as well as individual investors, buy common stocks with the
current reported quarter's earnings flat (no change), or even worse,
down. There is absolutely no reason for a stock to go anywhere if the
current earnings are poor.

Even if the present quarter's earnings are up 5% to 10%, that is sim-
ply not enough of an improvement to fuel any significant upward price
movement in a stock. It is also easier for a corporation currently show-
ing a mere increase of 7% or 8% to suddenly report lower earnings the
next quarter.

Seek Stocks Showing Big
Current Earnings Incrcascs

In our models of the 500 best performing Stocks in the 40 years from
1953 through 1993, three out of four of these securities showed earn-
ings iricreases averaging rnore than 70% in the latest publicly reported
quarter before the Stocks began their major price advance. The one out
of four that didn't show solid current quarter increases did so in the
very next quarter, and those increases averaged 90%!

If the best Stocks had profit increases of this magnitude before they
advanced rapidly in price, why should you settle for mediocre or down
earnings?

Our study showed that among all big gainers between 1970 and 1982,
86% reported higher earnings in their most recently published quarter,
and 76% were up over 10%. The median earnings increase was 34%
and the rnean (average) was up 90%.

You may find that only about 2% of all Stocks listed for trading on the
New York or American stock exchanges will, at any one time, show
increases of this proportion in current quarterly net iiicome.
But, remember you want to find the exceptional Stocks rather than
the lackluster ones, so set your sights high and Start looking for the
superior Stocks, the small number of real leaders. They are there.
Success is built on dreanis and ideas; however, it helps to know exact-
ly what you're looking for. Before you Start your search for tomorrow's
super stock market leader, let nie teil you about a few of the traps and
pit falls.

Watch Out for Misleading
Reports of Earnings

Have you ever read a corporation's quarterly earnings report that stated,
"We had a terrible first three months. Prospects for our Company are turn-
ing down due to inefficiencies in the home office. Our competition just
came out with a better product, which will adversely affect our sales.
Furthermore, we are losing our shirt on the new midwestern Operation,
which was a real blunder on management's part."

No! Here's what you see. "Greatshakes Corporation reports record sales
of $7.2 million versus $6 million (+ 20%) for the quarter ended March
31." If you own their stock, this is wonderful news. You certainly are not
going to be disappointed. You think this is a fine Company (otherwise you
wouldn't own its stock), and the report confirms your thinking.
Is this record-breaking sales armouncement a good report? Let's sup-
pose the Company also had record earnings of $2.10 per share of stock for
the quarter. Is it even better now?

What if the $2.10 was versus $2 (+ 5%) per share in the same quarter
the previous year? Why were sales up 20% and earnings ahead only 5%?
Something might be wrong¡Xrnaybe the company's profit margins are
crumbling. At any rate, if you own the stock, you should be concerned and
evaluate the Situation closely to see why the earnings increased only 5%.
Most investors are impressed with what they read, and companies love
to put their best foot forward. Even though this corporation may have had
all-time record sales, up 20%, it didn't mean much. You must be able to
see through slanted published presentations if you want the vital facts.
The key factor for the winning investor must always be how much the
current quarter's earnings are up in percentage terms from the same quar-
ter the year before!

Let's say your Company discloses that sales climbed 10% and net income
advanced 12%. This sounds good, but you shouldn't be concerned with
the company's total net income. You don't own the whole organization.
You own shares of stock in the corporation. Perhaps the Company issued
additional shares or there was other dilution of the common stock. Just
because sales and total net income for the Company were up, the report
still may not be favorable. Maybe earnings per share of common stock
inched up only 2% or 3%.

The Debate on Overemphasis
of Current Earnings

Recently it has been noted that Japanese firms concentrate more on
longer-term profits rather than on trying to maximize current earnings
per share.

This is a sound concept and one the better-managed organizations in
the United States (a minority of companies) also follow. That is how
well-managed entities create colossal quarterly earnings increases, by
spending several years on research, developing superior new products,
and cutting costs.

But don't be confused. You as an individual Investor can afford to wait
until the point in time when a Company positively proves to you its
efforts have been successful and are starting to actually show real earn-
insrs increases.

Requiring that current quarterly earnings be up a hefty amount is just
another smart way the intelligent Investor can reduce the risk of exces-
sive mistakes in stock selection.

Many corporations have mediocre management that continually pro-
duces second-rate earnings results. I call them the "entrenched main-
tainers." These are the companies you want to avoid until someone has
the courage to change top management. Ironically, these are generally
the companies that strain to pump up their current earnings a dull 8%
or 10%. True growth companies with outstanding new products do not
have to maximize current results.

Look for Accelerating
Quarterly Earnings Growth

My studies of thousands of the most successful concerns in America
proved that virtually every corporate stock with an outstanding upward
price move showed accelerated quarterly earnings increases some time
in the previous ten quarters before the towering price advance began.
Therefore, what is crucial is not just that earnings are up or that a
certain price-to-earnings ratio (a stock's price divided by its last twelve
months' earnings per share) exists; it is the change and improvement
from the stock's prior percentage rate of earning increases that causes a
supreme price surge. Wall Street now calls these earnings surprises.
I once mentioned this concept of earnings acceleration to Peter
Vermilye, the former head of Citicorp's Trust Investment Division in
New York City. He liked the term and feit it was much more accurate
and relevant than the phrase "earnings momentum" sometimes used by
Investment professionals.

If a Company's earnings are up 15% a year and suddenly begin spurt-
ing 40% to 50% a year, it usually creates the basic conditions for impor-
tant stock price improvement.

Check Other Key Stocks in
the Group

For added safety, it is wise to check the industry group of your stock.
You should be able to find at least one other noteworthy stock in the
industry also showing good current earnings. This acts as a confirming
factor. If you cannot find any other impressive stock in the group dis-
playing strong earnings, the chances are greater that you have selected
the wrong investment.

Note the date when a company expects to report its next quarterly
earnings. One to four weeks prior to the report's release, a stock fre-
quently displays unusual price strength or weakness, or simply "hesitates"
while the market and other equities in the same group advance. This
could give you an early clue of an approaching good or bad report. You
may also want to be aware and suspicious of stocks that have gone several
weeks beyond estimated reporting time without the release of an earn-
ings announcement.

One last point to clarify: You should always compare a stock's per-
centage increase in earnings for the quarter ended December, to the
December quarter a year earlier. Never compare the December quarter
to the immediately prior September quarter.

You now have the first critical rule for improving your stock selection:
Current quarterly earnings per share should be up a major percentage
(at least 20% to 50% or more) over the same quarter last year. The best ones
might show earnings up 100% to 500%! A mediocre 8% or 10% isn't
enough! In picking winning stocks, it's the bottom line that counts.

-Excerpt from William O'Neal's How To Make Money in Stocks.