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Easier
Stock Analysis
Good news for
fundamentally inclined stock investors. Put away your green eyeshades,
analyzing stocks just got easier.
Morningstar
recently upgraded its free stock financial reports. Among the
improvements, two significant features stand out. First, we don't need
our calculators because Morningstar computes all the essential analysis
ratios for us.
Equally
helpful, Morningstar’s financial reports now show each stock’s
fiscal year data going back 10 years, as of now, to 1994. Besides for
the fiscal year figures, the reports also show the most recent four
quarters (trailing-12-months or TTM) data. Viewing the most recent
numbers next to the 10-year figures helps you put the current data into
historical context.
Among the
many advantages, Morningstar’s new reports make it easy to evaluate
operating margins and accounts receivables, two factors that I consider
among the most important when analyzing a stock.
I’ll
demonstrate by using these two factors to compare two U.S. software
giants, Microsoft and Oracle.
You’ll find
the 10-year operating margin history on Morningstar’s Profitability
report. Get there from Morningstar’s homepage (www.morningstar.com)
by entering a stock’s ticker symbol into the “quotes/reports” box
near the top, which will take you to the Quotes
page. From there, select Key Ratios on the left-menu to see the Profitability
report.
Operating
Margin
Operating margin tells you how much a company makes on each dollar of
sales before deducting interest expenses and income taxes. Interest
payment and taxes both vary greatly between firms, and even for the same
company in different years. So OM is better than net income or earnings
per share for viewing a firm’s long-term trends, or for comparing
competing companies in the same industry.
When
analyzing a single company, focus on the long-term operating margins
trend. The best case is when operating margins are increasing over time,
meaning that earnings growth is outpacing sales growth, signaling the
likelihood of better than expected future earnings reports. Conversely,
declining margins portend future earnings shortfalls.
If you’re
comparing two companies in the same industry, the actual operating
margin number is also important. All else equal, the company with the
highest operating margin is usually your best bet.
Looking at
the reports, Microsoft’s OM, currently at 38 percent, has been falling
since it peaked at 50 percent in 1999. Conversely, Oracle’s OM, now at
37 percent, up from 21 percent 10-years ago, has been steadily moving
up.
My take is
that, although Microsoft and Oracle’s operating margins are currently
about even, Oracle’s margins are headed up, which portends good
things, while Microsoft’s margins are trending down.
Receivables
Next, we’ll analyze accounts receivables using Days Sales Outstanding
(DSOs), which is on Morningstar’s Efficiency Ratios report. Get there
from the Profitability report by selecting Efficiency
Ratios on the top menu.
Scrutinizing
receivables is important because many experts consider rising DSOs the
most reliable “red flag” pointing to future earnings shortfalls. In
case you’re not an accountant, I’ll start by explaining the terms
accounts receivables and DSOs.
Manufacturing
companies don’t usually sell COD; instead their customers have a
specified time to pay, typically 30 to 90 days. So when a company
delivers a product or service, but hasn’t yet been paid, the unpaid
amount is added to its accounts receivables total. When the customer
pays the bill, the payment is deducted from receivables.
Should
Track Sales
When things are going well, receivables generally track sales. That is,
if sales double, receivables also double. If the company gets better at
collecting its bills, then sales rise faster than receivables, which is
a good thing.
What isn’t
good is when receivables increase faster than sales, which means that
customers are taking longer to pay. There are several reasons why that
could happen, and none are good news.
It’s
possible that customers are dissatisfied and are withholding payments
for negotiating leverage. Or, it may be that the firm’s simply don’t
have enough cash to pay their bills. That happened frequently in 2000
and 2001 when many telecom equipment buyers went belly up.
Soaring
receivables could also warn of channel stuffing, meaning that, in the
face of slowing sales, a firm is giving its customers better payment
terms to stimulate buying.
Days sales
outstanding, or DSOs, is, in essence, accounts receivables compared to
sales. DSOs rise when receivables increase faster than sales. So growing
DSOs signal problems. Ideally, you’d like to see flat or falling DSOs.
DSOs are
useful only for studying trends within a single company. Most companies
have unique payment terms, so you won’t gain anything by comparing
DSOs of different companies, even in the same industry.
Microsoft’s
DSOs ranged between 26 and 34 in the 1994 to 1998 timeframe, and then
started moving up in 1999, warning of deteriorating fundamental
conditions. Microsoft’s DSOs peaked at 59 in its 2003 fiscal year,
which ended just last June. Apparently, the receivables situation is on
the mend. The report shows the most recent (TTM) DSOs at 50, albeit
still far above its pre-bubble levels.
By contrast,
Oracle’s most recent 58 DSO figure is at an all time low, at least
going back to 1994. Oracle’s DSO’s were at 74 in 1994. They peaked
in the mid-80s in the bubble years, and then dropped to 76 in Oracle’s
2003 fiscal year, which ended last May.
What We
Learned
Comparing Microsoft and Oracle, it looks to me as though Microsoft’s
DSOs, although recently improved, are arguably trending up, or at the
very least, much higher than they were in the 1994-1997 timeframe.
Oracle’s receivables didn’t spike as much as Microsoft’s when the
bubble burst, and look like they’re trending down to me.
Looking only
at operating margins and DSOs, Oracle looks like the best bet. But,
there are many more pieces to the puzzle. So don’t dump your Microsoft
and load up on Oracle based only on this analysis.
published 2/22/04 |
