Examining the Revenue Side of a Potential Investment
Last week I started to pull the curtain back on how you go about monitoring one of your portfolio holdings. The example looked at changes in the cost side of the equation for Starbucks (SBUX). This week, we’ll touch on the potential revenue side, as well as how all of this shakes out relative to Wall Street expectations.
A quick note on those Wall Street expectations -- they’re the consensus figures for revenue, profits or earnings per share that are obtained by averaging published expectations from all of the investment professionals that publish their forecast for a particular company.
Geez, that’s not as straightforward as it sounded inside my head. Since we’ve been sticking with Starbucks, we can turn to Yahoo Finance (or any other financial resource that publishes analysts’ expectations), and we find the average prediction of the 25 analysts who publish earnings per share estimates for Starbucks was $0.43 for the quarter ending September 2015. You’ll notice the “Low estimate” and "High estimate” for that three-month time period -- 0.43 and 0.45, respectively -- which give us the expected earnings range for that quarter.
For the same three-month period, only 22 analysts have shared their revenue expectations, and that average is $4.90 billion, up 17.2% year over year. Unlike the relatively narrow expected earnings range, the expected revenue range is much wider, at $4.78 billion on the low side and $5.14 billion on the high side. As you can see, depending on the period of time, more or fewer analysts publish their forecasted figures.
[Click to enlarge]
Source: Yahoo! Finance
As we saw in the commodity input price charts last week, the cost side of the equation for a company can swing based on supply, demand and other factors -- like weather, for example. What we need to figure out is if Wall Street’s expectations have caught up with what has been going on in reality. In the case of Starbucks, as seen in the EPS (earnings per share) Trends box above, there has been little movement in earnings expectations for the September 2015 and December 2015 quarters, as well as the coming year that ends September 2016. [Note: Starbucks is what we call a “funny fiscal” because its fiscal year ends at the close of September, not December like the vast majority of companies.]
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Looking at that lack of change during the last 90 days, and comparing it to the changes in coffee, dairy, wheat, sugar and cocoa prices, there may be a reason to think those Wall Street expectations may be a bit conservative. Viewing the Earnings History box, however, we find that Starbucks seems to be one of those companies that tends to deliver exactly what’s expected when it comes to its bottom-line earnings -- note all the zeroes between EPS estimated, EPS actual, Difference and Surprise %. This tells us that Starbucks is pretty adept at managing expectations for its revenues and earnings in upcoming quarters.
Now, why did I point all of that out?
In addition to knowing what’s expected, we want to determine if there has been an upward or downward move in those expectations during the last week, month or more. If we see that key input costs are moving in a direction that is favorable for a company -- as we saw with coffee, dairy and sugar prices for Starbucks -- or signs that revenues may be picking up or, better yet, both, but we don’t see revenue or earnings expectations being changed to reflect those moves, it could mean that the group of analysts following the company are asleep at the switch. This could spell opportunity, as upside surprises tend to lead to pops in stock prices, particularly if the company issues a rosier-than-expected outlook.
Similarly, if costs are moving in the wrong direction and/or revenue looks to be hitting a serious headwind, and the analyst group hasn’t updated its expectations to account for this, it could signal that a revenue or earnings shortfall could be had. In recent years, even a small miss for reported earnings vs. the consensus expectation has led to sharp drops -- in the range of 10-20% -- for a company’s stock price.
As I mentioned above, Starbucks has been a “steady Eddie” when it comes to meeting expectations, so we must briefly turn our gaze to a different company. In this case, it’s footwear and accessory vendor DSW Inc. (DSW), which on August 25, 2015, reported quarterly earnings of $0.42, missing the Thomson Reuters consensus estimate of $0.43 by $0.01. DSW generated revenue of $627 million during the quarter, which missed the consensus estimate of $636.86 million. The combination of those two shortfalls saw DSW shares drop more than 11% in trading on Aug. 25 to $27.28 from the closing price of $30.87 the day before. That is but one example, and when we think of the 500 companies that comprise the S&P 500, there are more to be had with each quarterly reporting cycle.
If you “bought and slept,” you may not have picked up on the signs that DSW was in for a rough earnings patch. Some of the signs you could have seen were weak monthly Retail Sales reports published by the Commerce Department, the lack of wage growth in data released by the Department of Labor, the huge increase in average credit card debt reported by CardHub or the wide miss by Macy’s (M) relative to expectations and the cut to its full-year outlook on Aug. 12, some 13 days before DSW reported its quarterly results. By looking at the developments in and around your investments, you can put the noise into context and wind up with either confirming or warning signals.
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If you’ve collected a string of confirming signals, then you probably want to continue to hold the security.
If, on the other hand, you’ve collected a basket of warning signals, or even a basket of mixed signals, well, now we’re talking about one of the bigger, if not biggest, questions faced by investors -- when do I sell?
More on that next week, but before then, I invite you to sign up for an educational webinar. On Saturday, Oct. 3, my good friend Bob Lang, the founder and chief strategist of Explosive Options, and I will be sharing what we see on the current and evolving economic landscape, the data we’re looking at and, more importantly, how we are positioning ourselves for what’s to come. We’ll be sharing the essential questions you have to ask before you consider buying any stock, as well as how you can use technical tools not only to refine entry and exit points, but identify investment contenders. Learn details about this full-day webinar on options, trading, strategy and MORE, “Trading for Income: Proven Ways to Up Your Game.”
In case you missed it, I encourage you to read my e-letter column from last week about a deep dive into Starbucks. I also invite you to comment in the space provided below my Eagle Daily Investor commentary.
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