After reading the last post: Annual Result
You started the adventure of stock selection. As per the blog, now you even have a strategy. Just select stocks which show at least 20% growth in EPS for 3-5 years. And you made an investment in the stock which is showing the highest YOY growth. You are happy about the investment.
Unfortunately, as it turns out stock started running south (lower) after a few weeks. And you feel helpless as you have followed a decent strategy. Now here you start to think of what went wrong.
Let’s figure out what went wrong here:
- Even though YOY performance was good. It doesn’t assure the current year performance of the company.
- Now did we checked the current year performance of the company?
- But which indicator in current year financial we need to focus on.
Let’s work on solutions one at a time. First what to see for current year performance
The stock you select for investment should show a major percentage increase in current year quarterly earnings per share, as compared with prior year’s same quarter respectively.
Earning per share (EPS) is calculated :
Company’s net profit / Number of outstanding shares
In our view, the percentage increase in EPS is one of the important factors to notice in stock selection.
Now if you think it’s easy to look for this detail. Wait a minute. Companies won’t let you know bad reports of themselves. So as it turns out it require a lot of your vigilence to find current year performance detail. Lets discuss these factors in detail.
Misleading Reports of Earnings:
Do you ever see a corporate report that mentions:
We had a horrible first three months. Our earnings are turning down due to our inefficient performance. Our competition got a better product than us, so our sales are badly affected. Also, our management decisions were big blunders on their part.
You would never see these statements. Rather this is what you would see:
XYZ industries have attained a remarkable sales growth of 20% march quarter as compared with the quarter last year. It is great if you own this stock. Now you think it is the perfect stock to be in and reports boost up your confidence.
Are the record-breaking sales announcement a good report?
Let’s suppose that earnings per share have increased from 4 to 4.1 (+2.5%) in the same quarter whereas sales have increased 20%. Now the question arises why the sales were 20% up and earnings ahead of only 2.5%. Clearly, signals something is wrong. Maybe operating profit margins are crumbling?
So don’t be an investor who is a victim of companies impressions. As companies always love to put their best foot forward. You should be able to watch out for the gaps in the published reports of the company.
Now let’s understand one more example :
Consider that a company sales have grown by 10% and net income advanced to 12%. You think this sounds good. But wait what if the company has issued additional shares or did some other form of dilution(this mean as additional share or dilution took place, it will decrease the value of an individual share . As same value now has to shared with additional stocks too).
So even sales and net profit for a company doesn’t provide you the complete picture
Break the Results:
Suppose a company announces that its earnings for six months have increased by 25%. You think that the stock is in great shape and you can’t ask for more.
But wait. The company has reported earnings for six months. Here the question comes is what are the earnings in last quarter. Maybe for the March quarter EPS has grown from 1 to 1.6 respectively. But this leaves June quarter with EPS of 0.9. This is not so good report after all. Here you should be vigilant as companies know how to make a bad report sound terrific.
Ignore a company’s one-time gains:
If an organization’s earnings for last quarter include profits from the sale of real estate or any other non-production sources, that part should be subtracted from consideration. Why? Because this is one-time non-recurring earnings does not represent true profitability of operations of the company.
Benchmark Earnings Increase :
Some investors take 25% to 30% earnings increase in a quarter as the benchmark to consider a stock. We insist you to consider last two quarters and each should show significant percentage increase in quarterly earnings compared to prior year’s quarter earnings. My point is why not choose the very best merchandise available?
This looks simple, but then how people make mistakes. Many investors and institutions choose to buy a stock with earnings down in recent quarters just because they like the company and find stock’s price cheap. Now, in this case, they are assuming that earnings will rebound in near future. We don’t deny the fact that sometimes it does happen. However, we believe at anytime there are multiple opportunities available in the market. Why accept promises of earnings that may never occur when you can choose an alternative investment that is actually showing earnings advance.
It’s better to check industry group of the stock you are interested in. If you are able to find at least one more stock in the industry showing good earnings growth. It is an assurance that the industry is growing too. As per our experience if you cannot find other company in industry reflecting strong earnings increase, then maybe the industry in which stock belong is not growing and eventually, your stock will reflect the same. Mean trouble.
Sign of Trouble:
When rate of earnings growth starts to decelerate for eg. rate of earnings decelerate from 50% to 15%. It is a sign that stock has either reached its peak or would dwindle into a lengthy and unrewarding price consolidation period. We prefer to consider two quarters earnings slowdown before turning negative on a stock.
- YoY performance of a stock is important but QOQ is equally important to consider.
- When assessing for QOQ performance EPS is the factor in consideration.
- Check for at least two previous quarter results as an assurance.
- Verify the industry in which your stock belongs to is growing too.
Experience of 8 years in stock investment. I learned everything by making a lot of mistakes and losing a good amount of money, I am here to make sure you don’t lose on either: Hope or Money.