Should I buy stock in Company X? - Part 3

Thursday, July 3, 2008

Continuing from our previous post, Kid's Toy Store revenues were $100,000 for the year and they reported $3.40 EPS.  Is this good or bad?  I do not know.  These numbers do not really tell us anything in isolation.  We need to compare the company's performance to that of a competitor within the same industry to determine if the numbers are 'good'.

Here is an example to help illustrate the point. I have a vehicle that gets 20 miles per gallon. My friend’s vehicle gets 10 miles per gallon.  At first glance, my vehicle appears to be the better option. However, this assumes my friend’s vehicle is the same type as mine.  I have a Toyota Corolla and my friend's vehicle is a big 2-Ton moving truck that he uses for his business.  A comparison between the two vehicles is not a fair one, even though we are using the same unit of measurement – miles per gallon.

Likewise, companies must be compared to one another that are in the same industry.  Additionally, a company can be compared to their specific industry's averages.  Let us compare Kid’s Toy Store revenues of $100,000 and an EPS of $3.40 to Children’s Toy Store, a competitor, revenues of $250,000 with an EPS of $5.60.  Also, the retail toy industry average annual revenues are $300,000 and the EPS is $6.20.

Using this data:
                Are Kid’s Toy Store sales higher than Children’s Toy Store?  No.
    Are the earnings greater than Children's Toy Store?  No.
                Does Kid’s earnings and revenue exceed the industry averages?   
                    No, their earnings are below industry averages.

 Kid’s Toy Store does not seem to be performing well, based on the initial comparisons.  Revenues and earnings are only a few factors to consider when performing fundamental investment analysis (which is what we are doing).  Other factors are how much debt does a company have, is management doing a good job of controlling expenses, and does the company distribute some of the profits (earnings) to shareholders?  We’ll explore these in upcoming posts.

Hey, now its time to take a break and grab a snack. Reward yourself, you have earned it. Learning to invest is a process, do not give up. Soon you will have the knowledge to buy and sell shares in the Stock Market. Once you have made money based on what you have learned, you’ll see that it was all worth it.

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