One of the hardest concepts for individual investors to grasp is the idea that the stock does not represent the company.  In fact, the stock represents investors’ PERCEPTIONS of the company.  If investors think a company’s future is bright, even though it is not yet a big success, they’ll pay a premium for their expectations–pushing the stock up in the process.  Contrarily, if investors perceive that a company is becoming less successful, or simply growing less rapidly, its premium will shrink.  In the worst cases, the stock will decline, even though the company is still growing!

For example, Intuitive Surgical (ISRG) is a company that makes million-dollar remote-controlled surgical systems that do minimally invasive surgery better than humans.  It was a marvelous growth stock from 2004 to 2007, appearing in Cabot Top Ten Report 17 times.  Its first appearance was August 2004 when it was trading at 23, and its last was December 2007 when it was trading at 328.  At the peak, its P/E ratio (its premium) was 98!  But then the company’s growth began to slow . . . and it’s still slowing.  The growth rate of revenues in the past five quarters has slowed from 68% to 22%, while the growth rate of earnings has slowed in the past six quarters from 111% to (ready?) just 2%!  Looking forward, analysts are projecting that earnings will grow just 2% in 2009.

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In short, the perception of the company’s growth prospects has diminished dramatically.  So the P/E (the premium) has shrunk to just 21.  The stock has fallen from 328 to 103.  And the trend is still down.  How low it will go, no one knows, but I guarantee that when it bottoms it will be selling at a great discount . . . at which point bargain-hunters hunting for value will appear.  But it’s not there yet.

What growth investors want to own are companies where perception is improving.

Last week, on January 22, Mike Cintolo, editor of Cabot Market Letter and Cabot Top Ten Report, wrote here about ITT Technical Institute (ESI), a stock that’s performing very well because investors are flooding into for-profit education stocks.  The reason, of course, is that students young and old are taking courses to boost their employment prospects, so earnings expectations are being ratcheted up.

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In the past four quarters, revenue growth rates at the school have increased from 12% to 15%, 14%, 17% and 21%.  Analysts now project that earnings will grow 23% in 2009–and they’re usually conservative.  We still like the stock (in fact we like several in the group), but note that a pullback toward 105 is not unlikely.