How to Check Balance Sheet Red Flags
On July 22, 2016, shares of Boston Beer Company (SAM) soared 15% to
$190.16 per share after the maker of leading craft beer brand Samuel
Adams reported June quarter results.
Boston reported earnings of $2.06 per share, 12 cents above analysts’
forecasts. Further, revenues (sales) for the quarter totaled $261
million, $5 million over analyst expectations. Boston’s share price
surge wasn’t unusual. The market typically rewards stocks that beat
analyst forecasts.
However, that excitement was short-lived. By September 28, Boston’s
share price had dropped 21%. Why?
Enthusiastic investors didn’t dig into the numbers and overlooked four
“red flags” warning of problems ahead. Two could have been easily
plucked from Boston Beer’s earnings press release, but the other two
required consulting detailed financial statements. In the weeks
following the announcement, analysts caught on and their downgrades
triggered the ensuing share price drop. Here are the four red flags.
Red Flag
#1 Revenues
Boston Beer, a pioneer of the surging craft beer industry, is
understandably priced as a growth stock, and growth starts with sales.
Since beer sales are seasonal, it’s best to compare June quarter sales
to the year-ago number. By that measure, although beating forecasts,
revenues (sales) were actually down 3%, so Boston Beer isn’t growing.
Red Flag
#2 Gross Margins
Gross margin measures the profit a company makes on a product
considering only production costs. A 25% margin means that the company
made 25 cents for every dollar of sales before deducting the other
costs. Gross margins tell you a lot about a company’s position in its
market. Rising margins say a firm’s competitive position is improving
and vice-versa.
You’ll need a calculator, but gross margin is simply gross profit
divided by sales. The June quarter press release listed both. Anyone who
did that calculation would have found that the June quarter GM was 48.6%
vs. year-ago 52.9%, a red flag warning that Boston Beer’s competitive
position was deteriorating.
Red Flag
#3 Inventories
A firm’s balance sheet contains important clues about its fundamental
outlook. Boston Beer did not report sufficient detail in its press
release, but MarketWatch (www.marketwatch.com)
and many other financial sites have the needed information. Using
MarketWatch, after entering the Boston’s ticker (SAM), select
Financials, and then Quarterly Financials and
Balance Sheet. As with sales and margins,
always compare the most recent and year-ago quarters to avoid
seasonality effects.
Inventories (stock on hand) should more or less track sales. Since
Boston’s June quarter sales dropped 7%, you’d expect a similar drop in
inventory levels. Instead, inventories rose 7%.
Red Flag
#4 Receivables
Accounts receivables are the amounts that Boston Beer’s customers owe
for products received. Receivables rising faster than sales tells you
that customers are taking longer to pay their bills. There could be many
reasons, but none are good news. Thus, it’s a red flag when receivables
grow faster than sales, or in this case, rise when sales drop. Again,
comparing the June 2016 and June 2015 quarters, receivables also rose
7%, another red flag.
In the stock market, nothing works all the time. Sometimes you’ll detect
red flags, but nothing bad happens. Other times, stocks crash without
any evident red flags. So consider these red flag checks as another tool
for your stock analysis toolbox, not the final answer.
published 10/3/16 |
