[ Radica: RADAF ]
Let's take a look at the historical stock price activity as fundamental developments from the financial statements developed:
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The stock price collapsed at a Technically recognized reversal point, the Bull Trap. The failure to sustain the breakout to new highs triggered a sell signal among traders.
(June 27th: "...See RADAF for a good example of a Failed Signal called a "Bull Trap...")
But what fundamental factors at this particular point caused the buyers (fundamentalist and momentum alike) to sell en masse?
Well, according to the chart, the price took a turn for the worse upon the release of the Second Quarter earnings report. With sales up 160% and earnings continuing to break records, it baffled some when the stock sold off and failed to recover.
Upon examining the last ten quarterly reports (annual reports included), and plotting various income statement and balance sheet items, I came up with the following:
RADAF, from 1997, looked unstoppable as a result of continually increasing revenue growth, gross margins, and inventory turnover on a sequential basis, quarter after quarter (except for a tiny dip on Q2 '97). 1997 was the year of RADAF, with a gain of 818%.
So what happened in Q2? The only thing I could find from the key ratios I put together was a reversal in trend in inventory turnover, on a sequential basis, from Q1's value of 1.81 to Q2's turnover rate of 1.53. In the third quarter, this figure had edged down again, to 1.28 (Remember, up until then, turnover had been rising steadily from Q1 to Q4 of '97. And from Q1 of 1998 to Q2, we would have expected it to continue rising, but it didn't; instead, it fell).
From Financial Accounting (Harrison & Horngren):
Owners and managers strive to sell inventory as quickly as possible because it generates no profit until it is sold. The faster sales occur, the higher the company's income. The slower the sales, the lower the company's income. A high rate of turnover is preferable to a low rate because an increase in turnover usually means higher profits.
Whatever the case may be, momentum investors took the cue and sold their holdings at the first sign of the potential profitability warning. Cockroach number one (ever heard of the Cockroach Theory?).
The third quarter was a little bit more revealing. As mentioned earlier, the company's inventory turnover continued to decline, from 1.53 in Q2 to 1.28 in Q3. Add to that inventory and receivables growth outstripping sales growth (see previous post on the subject), and the first sequential decline in gross margins.
In 1997, from Q1 to Q4, margins expanded aggressively in conjunction with the increase in inventory turnover. In 1998, Q1 and Q2 both saw sequential increases as well, but faltered in Q3 as inventory turnover edged down. A coincidence? Hmmm.
To elaborate on the importance of gross margins, let me provide an excerpt from Financial Warnings (Mulford and Comiskey):
Declining gross margin as a percentage of sales revenue...was cited by 36 of the survey participants [out of a survey collected from 191 experienced bank lenders] as a useful early warning. With the exception of references to changes in the range of days-type statistics (e.g. inventory days, receivables days, and payables days), a current decline in margins was the most frequently cited of the profitability and liquidity related early warnings.
Many of the participants pointed to the changes in underlying conditions that are reflected in the gross margin...[such as] possible price cutting to hold market share, suggesting a change in competitive conditions in the market. [Other examples] identify underlying increases in material costs that cannot be passed on to consumers as sources of current margin reductions and future earnings decreases. The survey participants clearly see declining margins as something to be investigated closely and as a phenomenon that has proved to be a useful early warning.
Note on the chart how the price reacted upon the release of the third quarter report. Interesting stuff, isn't it.
RT |
