For those of us who hold shares or mutual funds, you must be
laughing right now after today's rally due to positive US employment data.
Stock is a great way to make large returns but it comes with great risk. You see, companies like to equivocate a lot
and be vague in their reports and claims (typically biased to their favour, no
surprise there). Since it is quarterly earnings release season right now, this
is the perfect time for me to write this!
"We are happy to
report that revenue exceeded analyst expectations and grew 10% from last
fiscal."
Nice! This is great news right??!! Depends, in most cases it
is but you have to watch out for potential monkey business here. Is the revenue
sustainable? What contributed to this surge? And how much did their account
receivables go up? Your stock price may not necessarily go up if the revenue
was due to a one off event such as a short lived fad. You also have to keep an
eye on their credit sales, if they made credit more easily available to their
customers then of course sales would increase. However, at the same time the
quality of such receivables may have gone down because they had to loosen their
lending policies to get people to make purchases. Try comparing the dollar increase
in sales with the increase in account receivables, preferably you want the
increase in sales to be much greater than the increase in receivables.
"Our sales grew
8% year over year."
Again, we have to look deeper into this and in addition to
the above paragraph. How much did the industry sales go up by? If everyone else
is growing their sales by 15% and the company is growing at 8%, that means the company
is losing market share! That is definitely bad news because when we invest, we
don't invest because of what they did in the past, we invest based on our
perception of their future and losing market share is not a good sign.
What if they announced that their income grew 8% year over year?
Well then, we have to look at how the increase came about
except this time we look at their expenses too. If they had cut back on crucial
expenses, such as R&D, rather than deriving it from increased efficiency of
operations, then that's bad for future concerns. Sometimes in order to meet
bonus thresholds, management may get short-sighted and start cutting expenses
that they really shouldn’t be cutting. Typically any major cost reductions and how it was realized can be found in the Management Discussion & Analysis (MD&A) if it's an annual earnings report, otherwise it should be in the press release.
Where am I going to obtain all this information you speak
of?...
Many good reliable sources out there, personally I use
Google Finance and TD Waterhouse's own investor information platform. TD
actually gives you a history of previous earnings per share (EPS) information compared
with past analyst expectations, this I think is great because it would take you
forever to find all of the previous estimates and EPS info yourself. Haven't
tried other discount brokers but I suppose they should have similar information
available as well.
Hmm, I should write an article on how to pick stocks, be on
the lookout for that in the near future. Good luck folks!
-TT
