Revenue Misses Can Be Good by David Merkel, CFA of AlephBlog
Few like revenue misses, but let me point out a few significant things that investors should care about:
- If a company misses revenue estimates around 50% of the time, that can be an indicator that it doesn’t play around with revenue recognition, which is probably the most common way of shading accounting results. Honest accounting is worth a lot in the long-run, even if the market won’t pay up for it in the short-run.
- If a company beats revenue estimates nearly all the time, do a little digging into revenue recognition policies. Have they changed? It may be that the company is hitting on all cylinders, but that is difficult to keep up for a long time. How do accounts receivable look?
- If a company misses revenue estimates nearly all the time, take a look at what they are saying about their marketing, and analyze the industry and competition. If it is due to the industry, that might not be so bad if you are getting the company’s shares at a cheap valuation. If it is due to other reasons, it might be time to look elsewhere…
- If you are late in the company’s product pricing cycle, and competitors are overly aggressive, good companies may take a step back and emphasize profitable business over volume, if fixed costs aren’t too high. In a pricing war, analyze who has the capability of living through it — maybe it is time to avoid the sector, or simply own the strongest company there, as you wait for capacity to rationalize.
Regardless, it can be a good exercise to look at the current asset accruals of the non-financial companies that you own to see if they look high, because of the higher odds of an earnings disappointment if those accruals are too aggressive. If you need a summary statistic to look at, perhaps use normalized operating accruals or the days outstanding in the cash conversion cycle for receivables plus inventories minus payables as a fraction of revenues.
That’s all for now.