What significance can be attached to changes in the level of common stock prices? Ceteris paribus we usually assume that common stock prices are an external reflection of the performance of the firm in comparison with its profitability and growth.¹ This notion is generally referred to as the Baumol Hypothesis.

The fact remains, however, that the usefulness of this hypothesis rests upon its ability to explain and predict stock price changes. In other words, it must be possible to discern a statistically significant relationship between the variables which reflect the activity of the firm (i.e., internal measures of performance) and the price of its stock (i.e., external measure of performance).

This paper reports the results of an extended study of the relationship between stock price and the internal measures of firm performance. It employs annual financial data (over the period 1948-1966) for 99 of the 200 largest manufacturing corporations.

The individual company stock price index used was computed from a monthly company stock price series. This base series contains the market price and the number of shares outstanding of each issue on the last Friday of each month. The other financial data was gathered from Moody's Industrials.

Using this data, a series of simple regressions was computed to test for any significant relationship between stock prices and the selected measures of performance.

The results were analyzed by cross~section analysis and by two- and three-digit industry analysis. It was found that assets, sales, net worth and profits all exhibit consistently significant and high r² values, whereas the profit ratios are much less important in explaining stock price variations.