Analyzing Earnings Across Different Sectors
By Conner W. Mays
Given that we are now in the heart of earnings season I wanted to follow up my last post with a quick discussion about the different and quite unique performance metrics that are used in different industries.
When I first began investing, I often found myself completely confused when a company would beat consensus EPS estimates (if this sounds like gibberish I recommend you check out my last post) and the stock price would plummet. As I learned more about investing I found out some sectors are driven more by their own bespoke metrics, which may or may not be applicable in different industries. The key idea here is the majority of such metrics aim to provide insight on future earnings vs. current earnings. Given the prudent, patient investors that we all are, we are more concerned with future or long term earnings vs. current earnings.
I certainly don’t want to downplay the importance of current profitability. The sector specific metrics we will discuss shortly have a goal of explaining future profitability so it is important to first understand the a few common fundamental measures of profitability.
If you have kept up with my articles you have heard me discuss EPS time and time again. EPS is the dollar value of profit a common shareholder is entitled to by owning a share of stock. For example, let’s look at Bank of America Corporation (BAC) as it was a huge story in the news this week.
If you were watching CNBC on the morning of April 18th you would have seen a headline similar to the following:
“BAC posted earnings of $0.41 vs. consensus estimates of $0.35 on revenues of $22.2 billion vs. expectations of $21.6 billion and net income of $4.9 billion.”
Earnings of 41 cents? The company made $4.9 billion! Remember, EPS stands for Earnings-per-Share. Earnings-per-Share is derived exactly as the name implies:
EPS=Net Income ÷Common Shares Outstanding
Therefore, $4,900,000,000 / 10,900,000,000 shares = 0.41 (approx..) this means that for each share of BAC owned by an investor, they are entitled to $0.41 of the $4.9 billion the bank earned over the first quarter of 2017.
Internet / Technology Companies
In today’s market – there are very few sectors that are sexier than internet/social media. One of the most common and most important metrics in this space is Daily Active Users (DAU.)
DAU is a quantification of unique daily users or visitors of a website, app, product, game, etc… It is one of the only ways to measure the number of eyes that are on an internet platform. Why does that matter? Social media companies like Facebook, Snapchat, Twitter, etc… earn a large portion of their revenues by selling advertising space.
To connect the dots (in a perfect world):
More DAUs = More Eyes = Higher Advertising Fees = Higher Future EPS = Higher Stock Price
There are numerous instances of companies posting higher than expected current earnings but missing their DAU target. When that happens, you can expect the stock price to fall based on expectations of lower future earnings.
Consumer / Retail Companies
Think about how much time you spend in retail stores, restaurants, etc… It may not be as much time as you spend on social media but it is still a huge amount of time and people tend to spend money while we are there. One easy way for retail stores and restaurants to grow revenues is to build more locations, pretty simple idea. Imagine you look into the financials of a retail chain over the past few quarters and you see revenues have been increasing at an average 15% – great! How can we evaluate the strength of the brand and the company’s performance without the effects of new locations?
In the consumer/retail space you will often hear about a financial metric “Same-Store-Sales.” Same-Store-Sales is the dollar value of sales generated over a period in stores that have been operating for a year or more.
Same-store-sales has huge implications on the valuation of retail companies, it also does a phenomenal job of helping us analyze the strength of a company’s brand vs. purely it’s ability to grow revenues through expansion (which can’t go on forever – just ask Starbucks.)
If you aren’t buying what I’m selling, imagine, a new restaurant opened in town and you and your friends want to check it out. Unfortunately the food is average at best, the service is terrible and the environment reminds you of your middle school homecoming dance – needless to say, you will not be going back. The money you spent that night will be included in the company’s revenues for the current quarter – but probably never again.
Now, imagine it was the best meal you have ever had, the drinks were awesome, your waiter was the coolest person you have ever met, etc… it could possibly become your new go-to and the money you spend in the future will not only be included in the current quarter’s revenues – it will also be included in the Same-Store-Sales metric a year from now. Who knows, you could even tell your friends about it and they might start hanging out there too.
This hypothetical situation can help to understand what Same-Store-Sales is aiming to represent and why we should care.
Putting it all together
Like I said earlier, although these metrics are unique to certain industries they all have the same goal – to shed some light on the future earnings potential of a company. Whether it be social media, retail, the airline industry, oil & gas exploration & production, etc… each industry has its own unique metrics and it is extremely important you know what they are and what they are trying to explain.
Diversification is an extremely important part of investing and our league play within Coper Street. As you select winners in different industries you will climb toward the Top Trader spot, demolish your friends and take one more step toward becoming financially independent.
If you have any questions / comments or general topics you would like me to discuss please let me know. Shoot me an e-mail at firstname.lastname@example.org
Thanks for reading!
I wrote this article myself, it expresses my own personal beliefs and opinions. Nothing contained herein should be considered actionable investment advice relative to specific securities. I am long Bank of America Corporation (BAC).