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Three Key Forces That Drive up Stock Prices
Posted by: Matthew Indyke and Brian Zen (IP Logged)
Date: March 25, 2013 05:30PM

Last year, we analyzed selected companies on what factors could increase or decrease its future stock prices. Three of those companies, Boston Scientific (BSX), Walgreen’s (WAG), and Kayak (KYAK), have experiences serious price appreciation after our analysis. Kayak made the biggest move, going from $26 on August 16 to $40 this March. Walgreen’s made an equally significant advance from $37 on December 16 to $46 recently. And Boston Scientific has just begun getting out of the woods with a very low price of $5.50 on December 31 that has now risen by $2 to $7.50. What do all of these stocks have in common? Here are three things that could be key forces driving up the prices:

· Lowering Costs and Prices: The company is built around a low-cost structure that limits overhead and operating expenses, and in return, provides cheap, affordable prices for customers.

· New Strategies Showing Results: The company is adjusting its business model and marketing tactics to reflect changing demographic trends and macroeconomic conditions, while new management strategies seem to be working well in the current market.

· Increasing Cash Flow: The company generates increasing operating cash flow on an annual basis, giving the company sufficient cash to keep its operations running and to reinvest in new products and services that help its business grow for the future.

Low-Cost Structure Combined with Discount Offers

Building a business on the lowest cost possible has proved challenging in an ever-changing environment demanding the use of more resources to perfect the product or service the company provides. When costs like overhead run high, the business has no choice but to charge a higher price in order to turn a profit, or in some cases, break even. One place where we commonly find companies with a low-cost structure would be an Internet-based business. Or for a business offering attractive prices for its consumers, look no further than necessity-based businesses.

Companies that produce pharmaceuticals, food, and other necessary consumer products tend to have steady demand, given that people can’t live without it. The average consumer cannot cut out expenditures on necessary goods when they have less money but rather cut things they do not need from their budget. Demand for these types of products are always high enough that these types of businesses can afford to regularly offer reduced products or discounts to create the business they need to stick around. Boston Scientific and Walgreen’s are two such businesses that have both thrived in the last few months as a result of great prices combined with low cost.

These companies show that it all starts with limiting your expenses and not spending too much on something that may fail to turn a profit. In our article, Why Cooperman And Price Are Betting On Boston Scientific’s Turnaround, a point of emphasis was on Boston Scientific’s attempt to “develop a more cost-efficient arrangement by merging the cardiovascular group and cardiac rhythmic management (CRM) group into one product group, a transaction designed to deliver more affordable and regularly available care to patients”. This transaction had helped increase sales of CRM products by 27% and Boston Scientific’s cardiology products, altogether, had made up 56% of all product sales. The attractive prices slowly increased demand and sales and eventually was one factor that led to the company’s gradual stock price increase. Analysts continue to predict Boston Scientific has further to go.

In our article Why Are Cooperman And Soros Shopping In Walgreens?, one of the company’s advantages in the area of low-cost structure referenced was its development of in-store health clinics. It was lauded as a smart investment in that article because of the fact that pharmacies can afford to provide care more cheaply than traditional doctors’ offices and hospitals. Pharmacies, unlike doctors and hospitals, use less overhead to provide clinical services. They are able to provide cheaper care because unlike hospitals, health clinics are not a pharmacy’s primary source of revenue. At the time of the Walgreen’s article, the company had increased 28% from its 52-week low of $28.53 to $36.10. Since then, the stock has risen even further to $46.50. Aside from the development of in-store clinics, Walgreen’s has always sold its products at a price cheaper than competitors, making it one of the best discount pharmacies around.

New Management Strategies that Works

Without a quality management, very few companies can succeed over the long term. When a CEO steps down or is let go, this often initiates a negative reaction that initially causes the stock price to fall. On the other hand, when a new full-time CEO gets hired, it can be viewed as a sign of change for the company, with the restructuring being enough to lead some value investors to believe the company is now better off for the long term.

However, new management alone isn’t the only basis to measure where a stock’s price will go. The new management should understand how to properly handle the company on not just an internal level but on an external level. The best companies that thrive into the long-term are those with an adept management team that recognize and evaluate economic factors and work from the outside in. They are focused on how to do what is best for the customers and not overly focused on internal issues concerning how to sell products and services or even changing the compensation of its staff. Some questions strategy-focused managers ask are: Does market growth mesh with your business growth cycle? Are economic trends and business conditions favorable? And do you follow the demographics of your target markets, like age and wealth trends?

Successful companies focus on what the market wants. Kayak has won over lots of customers thanks to an experienced management team that had a defined mission and set up the company based on what customers would want. The company’s cofounders had previous experience managing similar companies and took that knowledge to a new venture that would improve features like pricing comparison and an easy-to-navigate website. And the business model would work to perfection. Kayak’s stock price has risen by $14 since last August and one of the reasons is because Kayak’s business model is focused on understanding demographic preferences and macroeconomic conditions, two things that drive a company’s marketability. Our article, Online Travel Industry Getting Squeezed: Kayak Vs. Priceline featured the following information that was a sign of things to come:

Kayak does not provide online bookings directly but gives consumers a one-stop research solution to best fares along with other value-added services like flight status updates and pricing alerts. By providing an easy comparison of fares across various websites, Kayak makes the travel search easier for its users. People who use Kayak find they never need to leave the site to check if they are getting the best deal on their bookings.”

When your managers are succeeding and your customers are satisfied, more people will gravitate towards your company. Consumers will be interested in checking you out and using your services. When investors become aware of this, they will be attracted by what you offer and consider you as an investment. Then the flywheel starts to push the stock prices up.

Increasing Cash Flow Lifted by Increasing Demand

The most important factor that affects the value of a company is cash flow. In the long run no company can survive without enough cash. Because if a company doesn’t make money, is it going to stay in business? Most companies don’t. When a company not only increases cash flow but increases it faster than it did in a prior point in time, it is often a good sign that the company will be able to continue growing exponentially rather than linearly. Companies that create growth and accelerate growth sell for a premium for this reason. Moreover, most companies need the additional cash flow to support growth, seasonal demands, business opportunities, or short-term cash needs.

What Boston Scientific, Walgreen’s, and Kayak all have in common are that they have experienced increasing cash flow on either a quarterly or annual basis in the last year. During 2012, Kayak’s operating cash flow made a dramatic turnaround from the 2nd to the 3rd quarter, recording operating cash flow of $23 million in the 3rd quarter after running negative at $2.5 million the previous quarter.

Boston Scientific also experienced a modestly increasing operating cash flow on both an annual and quarterly basis in 2012. While investing and financing cash flows were suffering at the same time, it supposedly led to the company’s increasing operating cash flow. The company’s investments, for the time being, are paying off, putting Boston Scientific in a better position for the long term.

And as highlighted in the Walgreen’s article a few months ago, consistently rising cash flow was always one of its strengths. At the time of our analysis, their cash flow increased by 112% from the same quarter in the prior year. The lesson learned here is that investors tend to jump into a company when they see increasing cash flows.

Disclosure: Brian Zen has a position in BSX.

Stocks Discussed: KYAK, WAG, BSX,
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