The most important factor affecting the long term performance of a stock is the company’s profits. In the simplest terms: stock growth follows profit growth. Over the long term, as the profits go up, the stock goes up. When profits go down, the stock goes down. Plotting company profits along with the stock’s price can reveal enlightening facts as to the true reason why a stock went up or down.
Above is a ten year chart of Lucent (LU) from 1996 to 2005, along with the profits Lucent made each year to the right of the chart. Notice LU did great when profits were hitting record highs. But when profits went down — in 2000 — the stock went down too. Profits never got back to their old highs, and neither did Lucent stock.
At its heights, and through its downfall, LU was one of the most widely owned stocks in America. People felt comfortable holding Lucent because it was spun-off from AT&T.
Often, we as investors get caught up in a story. We know in our hearts “it’ll be back” yet over the long term, stock growth still follows profit growth. The first rule of When to Sell is sell when profits fall.
