Feb

7

VNThe bears pretended to go away last week when the S&P went up 5%. They left a 1 day decline of 18 points on Monday as a gift to bulls to buy, but when they did they were hit with a immediate 5% decline the next two days. Its very similar to the Trojan Horse left by the Greeks and one wonders if it's a general tendency that can be quantified. e.g. is there an inordinate tendency to visit the previous 20 day low?

One of the most non-economic things to a businessman is the inordinate tendency that analysts put on sales increases. One of the first things that good businesses do is winnow their customers down so that only the most profitable are there. The wealth of a business is increased when profits go up, not when sales go up. Any business can increase sales by selling low margin goods at a small profit. But the good businesses try to sell their products to the customers that have the greatest desire for it, as that way they can reduce the consumers surplus and increase profits. There must be some very flawed studies relating to biased data files that showed in the past that sales increases add additional information that the earnings changes don't reveal, and this has probably caused countless investors to sell stocks when profits increase and sales decrease or in the case of Cisco, or Microsoft, and countless others, the forecasted sales increase is not up to expectations. It must make treasurers who are business people very jaundiced concerning the rationality of investors when they run their business well, increase profits, in tough conditions, and find that their stock is killed when the sales level is below expectations. Any closely held business would think it magnificent to increase profits on reduced sales.

Perhaps the signaling effect of sales increases is mistaken for good business sense. I would hypothesize that companies that beat earnings forecasts but miss sales forecasts and go down in price perform substantially better than the averages.

Tarred by the same brush. How many times can the market do down irrationally when this or that indicator, this or that official, signals that the economy is not growing as fast as it has in the past x years.Forget about the fact that each months figures are generally reversed or revised in the next announcement,and that the figures generally are meaningless because of special seasonal adjustments, and assumptions, and political tinkering in many cases, and that sometimes bad sales for a retailer and many others is much better than good sales because it means they got rid of all the good stuff in the previous month. Suppose the worst is true, and the rate of growth slowed from  3% to 0% or -1%. ? The recession would be brief, the bounce would come, and what difference does it make if the economy goes down  1%, then up 4% two years versus up 3% each year. Stocks are supposed to be valued based on an infinite stream of discounted earnings. That's not affected by one years change in the path. Nor are recessions a good time to sell stocks as the same way when the market turns down when the news is recessionary, the market will look for any silver lining for a change in direction when the economy is in the doldrums.

The Nikkei which closes at 0115 gmt continues to forecast the US market with reasonable accuracy . The most recent was the 5% decline on 2 06 in Japan which forecasted the subsequent 2% decline in the US on 2 06. The Nikkei closed at 13080 on wed morning in the us. It is trading at 13060 as I write, up from a 13005 open.

Dan Grossman wonders:

DVGPerhaps modern tech businesses like Microsoft and Cisco have such high gross margins that sales are always profitable and it is never good to have sales growing at less than forecast by management or predicted by analysts.

You and I are used to old-time businesses with low margins and high overheads that have variable aspects. In these businesses it would sometimes be valuable to get rid of less profitable customers. But perhaps in the software business with 70 and 80% margins,  no customer is worth getting rid of.

Steve Leslie comments:

I have always thought that earnings can be anything you want them to be, based on accounting choices such as depreciation rules, depletion, inventories, not to mention shell accounts (ENRON), outright fraud, and other sophisticated techniques and methods. However sales are what they are. You either sold a product or you did not. It is a more objective indicator.

Price to Sales Ratio (PSR) is just one useful measure. I am sure there are a host of others that the fundamentalist can use to extract information out of a company’s cash flow statement and balance sheet.

I like to use services such as IBD and research companies such as Zack’s and Value Line to provide valuable information and I go from there.


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14 Comments so far

  1. Craig Bowles on February 7, 2008 12:13 pm

    Longer term, we’ve been following the 1995-2001 market if you look at a monthly chart. More recently, we’re even getting the choppy improvement seen in early 2001 which would last to early March and then take another leg down. I don’t think we’ve ever had a sustained bull market when the composite economic indexes are inverted with the lagging index the strongest with the leading inflation having positive growth rates. Strong earnings push on an inflation string. Bull markets normally begin when the lagging indicators (debt, etc) move into negative growth rates and the inflation index is weaker than the leading economic index. It’s odd to have inflation problems this late in a cycle. While the Fed gets a lot of flack, they’ve never been so proactive in lower rates compared to the combination of CPI and coincident index growth rates. If you look at long-term 2-yr smoothed growth rates the only times we’ve had such an inverted economy are two times in the 1970s before recessions. If the Fed wouldn’t fight the recessions, we’d quite getting the excesses. A successful Fed, just props up the Lagging index which needs to correct for equity investors. Gold historically advances with a strengthening lagging index, so the Fed could help that.

  2. George Parkanyi on February 7, 2008 1:34 pm

    I predict …

    The market is going to do the exact opposite of what I position for it to do.

    It’s the like the laws of queuing …

    First Law of Queuing: The length of a line is completely independent of the time it takes to get served.

    Second Law of Queuing: You always end up in the line that takes longest.

    Cheers, :)
    GP

  3. Mulholland Drive Street Racer on February 7, 2008 3:36 pm

    i’m keeping a close eye on 10 and 30 year Tsy. yields. today they are concerning.

  4. Eric Blumenschein on February 7, 2008 5:16 pm

    The question I am curious about is if profit margins fall then will business retrench like they did in the 2001 recession. During that time the consumer spending and housing sectors held up but I expect housing not to do so well this year. Fiscal tax relief should bouy the consumer into the late spring. Fed interest relief should bouy business into middle summer (assuming a nine month delay from the start of rate cuts to impacting the economy). Factory orders as released on the 4th came in lower then expected. Should be interesting to see Industrial Production on the 15th Feb.

  5. Rich Dirker on February 7, 2008 9:48 pm

    At times a business may settle for lower profits in return for attaining significant or if at all possible dominant market share. The business may speculate that the next economic downturn may wipe out some competitors that lost market share to the stronger players. Some competitors may become available for acquisition. Once the economy turns around fatter profits will come. However, this strategy requires deep pockets and a long term view.

  6. George Parkanyi on February 8, 2008 1:46 am

    Earnings being whatever they want to be - I like it.

    Earnings heart-to-heart with his son …

    “Son, you’re petty cash now, but when you finally make it to the bottom line, you can be whatever you want to be - inflation adjusted, on/off-balance sheet, before-tax, after-tax, GAAP, diluted, un-diluted, operating, options-expensed, capitalized - the world is your oyster (adjusted for currency re-patriation). Be creative, be retained (but avoid dot.com start-ups - there’s no future for you there).

    You may not believe me now, but as you get older, this is something you’re going to come to depreciate more and more.”

    Cheers, :)
    GP

  7. Tom on February 8, 2008 2:41 am

    Steve Leslie,

    You say you use sales because it is more objective than earnings. Why don’t you use cash flow instead?

  8. James Miles on February 8, 2008 3:44 am

    Company managements rarely predict improving margins in their discussions with analysts, and are often reluctant to talk about projected sales mix, which might give a clue to margin progression. Similarly, information on individual product margins is often considered too sensitive to publish. Hence, analysts run crude excel models with % sales growth and % sales margin, distrusting margin improvements and emphasizing volume.

    Equities are not in reality valued off infinite streams of dicounted earnings because returns to capital vary so much over time across products and sectors. Not much is sustainable. Fluctuations in earnings/cash flows in the short term are potentially meaningful with regard to their level over the long term. Similarly, at the macro level, five or ten years of economic growth from one source need not be repeated over the next five or ten years: what risk deflation?

  9. steve on February 8, 2008 10:48 am

    this is not an endorsement of technical analysis just a reporting from the for what it is worth category.

    On Fast Money recently Louise Yamada technical analyst and former head of technical research for Smith Barney said that the market as shown by the s&p 500 broke its 5 year uptrend and peaked in the fall of last year. Since then it has broken down and started a down trendline as evidenced by a head and shoulder which is easily seen on a one year chart of the spx. Its failure to rise back above the 1400 level puts it in dangerous territory.

    She went on to say that she is seeing this pattern in other indices around the world.

    sl.

  10. steve on February 8, 2008 12:16 pm

    to Toms point. excellent suggestion you make on cash flow.

    I only meant that sales is one number that can not be manipulated as much as earnings.

    It is not a magic bullet and I do submit that one can increase sales by reducing inventories or selling products at cost or even below cost(Dell is famous for this one. They used this to drive out their competition in computers and make their money other ways.) This addresses Vics comment on earnings and sales. Of course one needs to be aware of the industry one is addressing. Technology must be looked at far differently than retail or oil for example.

    Cash flow is an excellent number to look at since you can’t spend what you dont have. There are many more numbers, and I am sure they can all assist one in evaluating a company. What I like about IBD is that it gives the earnings growth of the company and the relative strenth of its stock.
    .
    Zacks gives a picture of its financial health.

    Getting back to earnings, I remember back to the days of “Chainsaw” Al Dunlap famous for slashing costs in a company by laying off people to prop up earnings. He had excellent short term results by comparison but sacrificed the company in the long run. By then of course he was long gone. Look at his resume sometime.

    sl.

  11. George Parkanyi on February 8, 2008 1:37 pm

    Steve,

    You gotta understand where Louise is coming from. She’s a practical joker from way back. I fell for that 5-year trend-line crap once and sold everything right at the bottom in 1998. She laughed and laughed. Man, was I pissed. (Many years) later I forgave her and now we can BOTH laugh about it over a beer. But - fool me once, shame on you; fool me twice, shame on me.

    And I WILL get her back (ON her blog site I’ve been going on about being, like psycho long - but between you and me I’m really shorting everything in site.)

    Cheers,
    George

    DISCLAIMER: everything above is a complete fabrication. :)

  12. Tom on February 8, 2008 4:25 pm

    Instead of Louise Yamada I’d rather trade off the market views of my two-year old daughter or my three-year old dog.

  13. gabe on February 8, 2008 11:32 pm
  14. George Parkanyi on February 10, 2008 1:05 am

    Great video Gabe. Good fun.

    You know, given the proliferation of convenience stores, I’ve often wondered what an “inconvenience” store would be like. (Box stores are pretty close. For a forgetful guy it can be pretty excruciating to forget that pack of nails missed 18 aisles back at the other end of the store.)

    In the same light we have the “prudent man” rule in the financial industry. Compliance is built around the question “What would a prudent man do in this situation?” In keeping up with the times I suppose, it seems today a prudent man would take your grandmother’s savings, pay nuisance interest to be polite, and promptly invest the proceeds in derivates, sub-prime mortgages, DERIVATES of sub-prime mortgages, credit swaps, and “junk” bonds. I wonder if grandma knows? “Sonny, the stock market is for gamblers. Keep your money in a bank where it’s safe!” Yes, grandma.

    So what is an “imprudent man” to do? What’s left? Vegas?

    BANK ACCOUNT APPLICATION OF THE FUTURE …

    “Good morning, Mr. Parkanyi. How can we help you?”

    “I’d like to open a chequing account.”

    “Very well, we’ll need these 16 forms filled out, and 3 pieces of identification.”

    “No no no. You don’t understand. I’LL need from YOU, affadivits swearing that the signatories for the bank are in fact employees, with copies of the police record checks. Then I’ll need copies of your business plan and latest financial statements, with the auditor’s letter attached. The interest rate will prime + 1% subject to a review of your Moody’s rating, and you’ll need to post a surety bond of 90% of the face value of the money I will be transferring to you until your credit with me is established. There is of course the facilition fee for my time and effort. I believe the customary amount is 5%, which will be withheld from the disbursement going into the account. Please have the documents prepared for me by 11AM tomorrow.”

    “But sir - we have … deposit insurance!”

    “Yes, yes, like you have credit default insurance. I understand. Um, no, let’s just do it my way. 11 tomorrow then?”

    Cheers, :)
    GP

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