Briefing.com - Escaping Earnings Season Unharmed
10-Jan-01 06:11 ET
[BRIEFING.COM - Robert Walberg] Today marks the official beginning of earnings season -- Yahoo! (YHOO) and Motorola (MOT) report after the close -- so it's time for a refresher course on how to avoid seeing your portfolio blown up by an earnings miss. Given the market's volatile mood, those companies that disappoint the street in any way will most likely see their stocks punished, and punished severely. In fact, it's not uncommon for a stock to lose a third of its value in response to a disappointing report. Consequently, one goal going into earnings season is to avoid these situations at all cost. Fortunately, the cost isn't very high - just a little extra work on your part. Listed below are several items in a company's financials worth investigating.
Profit-Margins
Profit margins reveal how much a company makes for every dollar of sales. While margins can be stated in different ways (such as gross or net), it is never good to see a declining trend. It should be noted that gross and net margins will occasionally move in opposite directions. Don't be too alarmed if gross margins are rising while net margins are falling, as the company could be expanding its sales force - a move which should help bolster profitability in the future. However, if net margins are rising while gross margins are falling take note, as the former number can be massaged to look good.
Inventories
This is a tough one, as a rise in inventories can be interpreted differently. On the one hand, it could signal that demand for a company's product is growing. On the other hand, it could signal that a company isn't selling its products as fast as expected. The latter is a big concern in the retail sector at the moment, as investors fear that excess inventories will lead to bigger than expected mark-downs.
How to tell the difference? One way is to look at the inventory to sales ratio. Then compare that figure to the same period the prior year (or two or three). Though the percentage itself means different things from industry to industry, a rising trend spells trouble anywhere. If you're willing to spend a little more time it can be very insightful to compare the I/S ratio of the company you're interested in with the I/S ratios of its industry peers
Cash Flow
In this instance we are concerned with whether the company has sufficient cash flows to fund the ongoing business and finance growth. Steer clear of those companies in which net income has been rising over time while operating cash flows have been falling. Eventually, the firm will have trouble growing its business. Operating cash flow appears on the statement of cash flows in a company 10-Q & 10-K.
Accounts Receivable
Accounts receivable, found on the balance sheet, represent monies owed to the company for products/services sold. When a company's accounts receivables are rising faster than sales there is often trouble ahead. Why? Well, it could signal that a company is recording sales prematurely or that the company is so eager to move merchandise that it has extended the deadline for receiving payments. In addition, a customer that buys too much now will take a long time before buying again. In which case future comparisons won't be favorable.
Consensus Earnings Trend
In addition to the financial tests noted above, investors might also find it helpful to keep track of the trend in forecasted earnings. If the consensus earnings estimates have been trending lower over the past 7 to 30 days, there is a good chance that when the company issues its numbers the street will find reason for further concern, thereby resulting in additional cuts to future earnings estimates. Basically, bad news (downward trend in forecasted earnings) often precedes more bad news.
Devil Is In The Details
Taking the time to ferret out this information may not be exciting, but it could keep you from experiencing the heart racing anxiety that occurs from watching one of your stocks drop off a cliff after it "surprised" the street with disappointing numbers. Remember, these are warning signs and not guarantees of future trouble. Then again, where there is smoke...
Robert Walberg
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