Why Earnings Growth is Important to a Stock's Performance

If you go back through the history of the stock market there is a recurring theme among those stocks which have had some of the strongest price appreciation and it's related to their Earnings Growth.  If you plot a chart of Earnings Growth versus a companies Stock Price there is a usually a strong relationship between the two.

Here are a few examples over the past few years.  First lets look at ELNT and its associated table of Earnings Growth and Stock Price over the past two years.

ELNT	3/99	6/99	9/99	12/99	3/00	6/00	9/00	12/00	3/01	6/01	9/01
% Earnings Growth	-29%	+17%	-58%	+130%	+180%	+243%	+313%	+184%	+43%	-67%	-73%
Stock Price	2.40	5.53	8.91	14.13	39.25	44.25	91.25	39.25	21.50	33.00	33.00

Meanwhile if we take the table above and make a graphical plot of ELNT's Earnings Growth versus its Stock Price show a very strong relationship.  Notice how ELNT's stock price (blue line) began to rise significantly as its Earnings Growth (red line) started to accelerate beginning in December of 1999 (point A) and continued through September of 2000 (point B).   From September of 1999 until September of 2000 ELNT saw its stock price rise from $9 to over $90 a share for a return of nearly 900%.

Next look what happened as ELNT's Earnings Growth peaked in September of 2000 and began to decelerate over the next several months.  As you can see ELNT's stock price dropped in unison with its Earnings Growth (points B to C) and eventually gave back much of its gains that had occurred in 2000.     

Now lets look at another example which proves that even in a Bear Market stocks can do well if they have strong Earnings Growth.   BEL was a company that had major problems with its Earnings Growth in 2000 as shown by the table below.  BEL didn't start to see any positive Earnings Growth until 2001 but when it did finally occur BEL's Earnings Growth accelerated strongly in the latter half of 2001 into early 2002.  

BEL	3/00	6/00	9/00	12/00	3/01	6/01	9/01	12/01	3/02
% Earnings Growth	-33%	-120%	-112%	-155%	+125%	+175%	+500%	+355%	+3100%
Stock Price	7.00	4.00	4.00	3.00	4.00	6.00	4.00	6.00	20.00

As shown by the graphical chart of the table above BEL's stock price went nowhere in 2000 (points D to E) as their Earnings Growth remained negative.  However as BEL's Earnings Growth accelerated in 2001 into early 2002 investors took notice as BEL's stock price exploded in early 2002 (point F to G).   Since the Fall of 2001 BEL's stock price has risen from around $4 to over $20 a share for a return of 375% even in a negative market environment. 

As these examples show regardless of market conditions companies which have strong accelerating Earnings Growth have the potential to perform very well until their Earnings Growth begins to decelerate.  If you don't believe this go back and research some of the best performing stocks of all time and a majority of them will exhibit similar characteristics.

The key is to recognize those companies which are starting to establish a trend of accelerating Earnings Growth before everyone else does which takes a lot of time and research.   This is what I do every week as I spend over 20 hours a week looking for companies that are starting to show signs of accelerating Earnings Growth.  This is how I found BEL and ELNT well before their stock prices took off.

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