Aug

24

 A common mistake that stock people do I think is to pay attention to the increase in sales numbers. What does this have to do with future profits? I would think there is zero correlation given the earnings change since sales are so easy to manipulate by such things as discounts, pre-orders, and incentives for early buying, and reducing inventory et al. How did this ridiculous emphasis on the sales increase become as or more important than earnings relative to expectations in affecting stocks after the earnings report? I recently met with a pairs trading outfit and gave them 100 reasons I don't think it works, but it was from the seat of my pants. The main reason was of course that it goes against the drift. It hedges against the 10,000 fold return.

Gary Rogan writes: 

If sales increase while profits are decreasing, that's a bad sign. However when profits increase while sales are decreasing, this may be very good, but it can't go on too long. Sales trends gained influence as a counterbalance to profit growth being fudged. When you have profits, sales, and cash flows all increasing in unison and indebtedness not increasing, that's as good as it gets. 

Jeff Watson comments: 

Profits increasing while sales are decreasing are usually a sign of increased productivity, better inventory management, better management of labor, and better management of capital. Although Gary says this scenario can't go on too long, it really can go on forever. 

Gary Rogan replies: 

Well clearly it's mathematically possible to decrease sales by .1% per year and increase profits by .1% per year close to forever so "too long" was perhaps a bit harsh, but at some point in the real world gross margins become so high as to make further advances impossible due to competition or substitution. My statement was prompted by not being able to recall a real scenario of sustained profit growth and sales decline resulting in a good outcome having looked at hundreds of income statements, but I've never made a study out of it nor have I looked at multi-year trends. When customers are buying less of your stuff year in and year out that usually means they are not excited about your stuff, because they don't like it but perhaps in this case because the price is too high for them to use more of it. When customers get into the habit of using less of your stuff, that's hard to fight. 

Jeff Watson adds:

The Chair is 100% correct. Going back to Sears as an example…their aggressive pricing will only squeeze their retail operation out of business(if continued long enough), as prices this low are unsustainable in the long run. If a store has a 30 percent increase in sales after implementing a big sale, but it's gross profit goes from 22% to 6% or less, is that a good business plan? Even though Sears is not increasing labor to handle the increase in sales, the model is still badly flawed. I understand that one of the most important things in retail is buying right, but I suspect that most of the things Sears is selling is a loss leader. Maybe they are subscribing to the old cliche, "We might be losing a little money on each sale, so we'll make up for that with the increase in volume."

Russ Sears writes:

Coming from the world of insurance, when things sell unexpectedly well the actuaries double check their pricing. The agents and the market will quickly spot when you are selling $1 or risk coverage for 99 cents. When I started, before rate books were online, a printing error cut-off the $1 handle of 70 year old women term life insurance rate per $1,000 (this was highest age we sold term to). The month after the book went out we had more 70 yr. old women apply for insurance than we had in the past several years combined.

In other words sales increases often indicate increase in claims volatility. Sales increases make me wonder if management really knows what they are doing. One wonders if this rule holds for the retail and stocks in general. 

Carder Dimitroff adds: 

I may be naive, but in some sectors I believe the top line could be critical for long term investments. I'm thinking of regulated and capital intensive companies like electric utilities, gas utilities, water utilities, pipeline companies, transmission line companies and MLPs. In a different way, I'm also thinking of non-regulated utilities, such as independent power producers, refineries and REITs.

In all these cases, if the top line falls, the bottom line is plagued by fixed costs, such as interest, ad volerem taxes, depreciation and amortization.

The second derivative of revenues in such cases is capacity factor. Low revenues suggest low capacity factors. Low capacity factors suggest troubled assets and long-term challenges. The assets could be partially stranded by market conditions.

An example is marginally efficient coal plants. With low market prices for natural gas, many coal plants find themselves out of merit and not dispatched (zero earnings for producing energy). When natural gas prices return, marginal coal plants are again deep in the merit order and they are dispatched frequently or continuously.

Julian Rowberry writes: 

An internet marketing equivalent of over valuing sales figures is over valuing social media subscribers. Twitter followers, facebook likes, page views, ad clicks etc are all very easily manipulated.

Leo Jia adds: 

Here is my two cents regarding growth vs non-growth.

The present value of a business without growth is much lower than that of a similar sized growing business. So one obvious question to any business owner is whether he would like to receive more money or not if the business is to be sold today. The answer is obvious. But one may counter: since he is making good profits on the business, why would he sell it today? Well, isn't that the beauty of modern finance produced through Wall Street? To sell it today, the entrepreneur can collect today all his future earnings projected based on the best periods of his business performance, and with that reward, he can move on with his life, rather than be tied up by the business which may turn sourer later and cause him to suffer.

Why would Wall Street care more about growing businesses? Those people who bought out the entrepreneur have an even higher reward outlook than his and would seek higher profit on the investment.

Art Cooper writes: 

An example of this currently in the news is Hormel Foods, described in the article "Spam Sales Boost Hormel's Profit" on p B4 of today's WSJ.

The article notes that Hormel's Q3 earnings rose 13%, led by strong growth in products such as Spam and Mexican salsas, continuing a trend of higher YoY earnings. "Even so, rising commodity costs and shoppers' resistance to higher prices are pressuring its profit margins, which could affect its results in future quarters."

HRL's price has been roughly flat for a year.

Jan

9

McDonaldsJust caught on the news that Mc Donalds will add a 'coffee bar' and make more dramatic changes to their drink menu than they have in the past 30 years. I enjoy their Bravo coffee and am sure I will enjoy the drink additions when they reach my area. Mc Donalds is apparently still setting the pace in many areas as it was also announced that Starbucks now plans to make changes.

Sam Marx adds:

Although Starbucks gets a different niche of customers, this not good news for Starbucks .

A coffee bar and wi-fi at McDonalds, then Starbucks really has a problem.

Adam Robinson reflects:

I've always believed that the ethos of a corporation pervades, DNA-like, throughout all manifestations of the corporation, however small the "cell." If you want to discover the values of a company, you can look anywhere, from its choice of stationery down to the cleanliness of its floors.

Back to Starbucks. It was telling for me regarding the company's values that, living as I do five blocks from the former World Trade Center, I was shocked that in the days following, when rescue workers, many of them volunteers, flooded the area to begin cleanup, the local Starbucks was selling bottles of water. I'm as much a capitalist as anyone, but the outrage this opportunism occasioned in the local community, and subsequent bad publicity — Starbucks quickly reversed its policy and began handing out bottles for free – rankles to this day. The positive publicity it could have garnered by donating the water to relief workers would have more than paid for the negligible profits "sacrificed."

Ray Kroc was fanatic about cleaning his stores, and making everything perfect. Moreover, McDonald's franchisees are a powerful force for innovation and market research. I doubt that Starbucks has any such credo. And were I a fundamental investor, I'd bet on McDonald's in the race with Starbucks.

Ryan Carlson adds:

A worthy read about McDonald's is Ray Kroc's Grinding It Out. My favorite passage:

The key element in these individual success stories and of McDonald's itself, is not knack or education, it's determination.  This is expressed very well in my favorite homily: 'Press On: Nothing in the world can take the place of persistence. Talent will not; nothing is more common than unsuccessful men with talent. Genius will not; unrewarded genius is almost a proverb. Education will not; the world is full of educated derelicts. Persistence and determination alone are omnipotent.'

Henry Gifford dissents:

Starbucks and McDonalds offer entirely different products in terms of the cultural experience they sell.

On Broadway in Manhattan, two blocks from me, there is usually a homeless person "working the door" at the McDonald's, opening the door for customers and asking for spare change. Once McDonald's put a guy with a bow tie there to open the door for free, but that didn't last long, and the homeless guy is there every day. Also, the workers in McDonalds don't hesitate to stand around and chat and ignore customers.

At Starbucks a block away I've never seen a homeless person "working the door," (nor at any of the other stores nearby), I don't see homeless people sitting there, and the workers have a spring in their step.

Jim Rogers counters:

As someone whose first career was in the hospitality industry, I can state that McDonald's moves markets in more ways than one.

The difference in demographics, however, is a present condition and certainly not a necessary condition. McDonald's has always put its eggs in two baskets: families (especially those with small children) and value. In the past, their offerings were weighted more heavily on the family side of the spectrum. Now, thanks to a number of cultural shifts (including those driven by Starbucks), McDonald's has realized that they can capitalize on the public's perception of additional value. Before, it was all about quantity (the Super-size phenomenon). Now, it's about quality (better coffee, more aesthetically pleasing decor, fresher menu items). In the past 24 months, the majority of McDonald's top line revenue growth has been driven by menu items at the top of the price scale, especially new salad offerings. There are a couple of interesting points that McDonald's has embraced: the masses (or at least a historically large percentage of the masses) will pay for quality, and design makes a difference. It made a difference in attracting the kids thirty years ago, and now it's making a difference as it re-attracts adults (with or without children) with Wi-Fi, coffee, and more pleasing decor.

Marion Dreyfus opines:

Whatever the relative merits or demerits of the individual loci, the Starbucks habituee will not 'descend' to the perceived downmarket of McD's, which is a brand-association drummed into our consciousness by millions of ad messages over decades. The food may be better, the prices definitively so, at McD's, but the smart set will not cotton to the overbright, plastic-dominated perceived lower-ranking environment of kid-friendly McD's.

The escalation of prices for a simple beverage to unheard-of stratospheres is one thing that has, to date, ensured the rarefied perception of Starbuck's as being compatible with the upward-striving status-jumper.

So unless McD's radically alters its branding, the trendoids will find it distasteful to step lively in those swinging doors, even if their coffee tastes more acidic and sets them back more by a factor of twice or thrice the McD's coffee.

Ken Smith comments:

Ronald McDonald is five blocks east of me in Seattle, a short walk downhill a ways. Property they have is also just a short walk uphill to Childrens' Hospital. Parents can stay at Ronald's place while visiting kids, many with cancer. Ronald's facility is commendable for its architecture. One can have nothing but praise for Mr. Ronald, whose plastic body is standing out front of the facility, smiling with welcome. Kids love him.

Vitaliy N. Katsenelson analyzes:

SBUX stock is transitioning from 'growth' to 'value' investors. However, it is not cheap enough for value guys. At least not yet. Also, with current news cycle it will likely see the other extreme of its valuation. In the not so distant future it will probably have to rationalize its store base, close some underperforming stores and slow its growth expansion.

Jim Rogers notes:

Fast-food restaurants, due to their staffing policies, are much more likely to employ legal immigrants than you might think. The biggest offenders in the food world for using illegal labor: high-end restaurants, because they lack the institutional oversight and back-office support to adequately check a lot of prep cook and porter staff applications (and some are simply dishonest). If you're looking for a trade opportunity in the event of some strict anti-immigration policy, short higher ticket restaurant groups.

Scott Brooks writes:

McDonalds will have to work hard to overcome their persona. They have cultivated that image for a long time. I have often joked (with an air seriousness to it) that one of the greatest inventions/innovations of the 20th century was the McDonalds Playland!
 
I absolutely hate the food at McDonalds and will move heaven and earth to not eat there. But my kids like it. So when the wife needs a break and the kids want to go play, I'll take them to McDonalds, buy a few Happy Meals and let the kids play and eat.
 
Actually, they don't so much eat as graze. They play, come back and grab a few fries and bite or two of their burger/McNuggets and go back to playing.
 
As much as I don't like the food at McDonalds, they are an incredibly innovative company that I respect immensely. And with their distribution chain and the demographics of America changing, don't underestimate what McDonalds is capable of.
 
That clown may look stupid, but underneath there is a shrewd businessman!

Nigel Davies ponders:

I'm just wondering what the real appeal of McDonalds is and what really gets people in the doors.

I often eat at McDonalds during tournaments because there's usually one around, probably they won't poison me and if they do (and I live) I can sue them.

On the other hand my five year old son much prefers the relatively civilised atmosphere of Pizza Hut, so much so that I can use the 'Would you like to go to McDonalds for lunch?' gambit as a threat. Now it turns out he quite likes pubs that do food, but the big thing here was getting him in the door and outside his comfort zone. Now he does miss the balloons but there again he's taken a liking to turkey.

So it seems to me that a lot of this is down to parental choice, the main driver here being cost. Of course most parents are going to be struck by severe pangs of guilt should there be even a whiff of a rumour that the food served up is unhealthy. So with BSE (Mad Cow Disease)/cholesterol etc appearing on the horizon, it was inevitable that McDonalds would take a hit until it overhauled its menus and image.

In this respect I see the coffee/WiFi as being a really clever means of making them look like Starbucks and feeding off the modern, trendy and healthy image of the coffee house chains. But are they a 'competitor'? I really don't see it, and I don't see a Starbucks denizen suddenly switching to McDonalds because of the cost. To me it looks more like an image thing to get the old customers back in the doors.

Julian Rowberry submits:

Starbucks never really caught on here in Australia. Its brand name and attempt at exporting US culture is a tad brash for the local market. Plus there's already a vibrant cafe scene. The Maccas Cafe has been here for years. It's aiming at the fast and convenient 'healthy eating' market that companies such as Subway feed on. Not branded wanker latte drinkers.

Alston Mabry recounts:

Burger KingAt Burger King the other day (I'm not a big fan of fast food, but I am a Coke addict, and my dogs love the burgers on the dollar menu), I hit the drive-thru, and when I pulled up to the window, the Latina there said they needed to cook the burgers and would I mind pulling into the parking lot in front for about three minutes (they know their cooking times). No problem. I don't mind waiting in the car because I always have a good book to listen to, this time Adventure Capitalist. I'm listening away, and the pooches are quiet in the back, when I notice it's been almost ten minutes. So I go back through the drive-thru, and there is a young guy at the window this time. I start to explain, and he thinks I'm placing an order. His English is good, but he is obviously from Mexico or Central America. I show him my drink and the ticket and he gets it and starts rattling away in Spanish with the staff. I realize he is the shift manager. He comes back, apologizing profusely, and explains that they accidentally gave my food to somebody else who was also waiting, that they will cook fresh burgers for me and that he will bring them out to me personally. I think he was worried that I would be angry, but I wasn't at all. We park again, and a few minutes later he appears with the food and apologized otra vez.

The point of the story is this young guy. He was a good-looking kid, maybe twenty. He was running the show, working hard on his English, taking reponsibility for the results, apologizing for mistakes and personally delivering the goods. And here was Burger King providing the structure for him to be successful. Not a dead-end job at all, not for this guy. I was very impressed.

Scott Brooks adds:

I had an funny thing happen in fast food to me in about 1985. I was a manager of a Taco Bell, putting myself through college. We had hired a new girl who had previously worked at Burger King. It was her first day and I had her working the drive-thru.
 
The drive thru "dings" with her very first customer. She says into the microphone: "Welcome to Burger King, can I help you." I thought it was pretty funny, she thought it was pretty funny, but the guy in the drive-thru began laughing hilariously.
 
But he placed his order and pulled to the window. The reason he was laughing so hard? It turns out he was the guy who owned the Burger King where she used to work.

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