Should I Buy Stock in Company X - Part 5

Saturday, August 2, 2008

As promised in part 4 in this series, we are going to discuss growth.  Growth can be applied to many aspects of a company's performance, we are most interested in revenue and earnings growth.  Earlier we discussed the date when a company releases their financial performance to the public. This is called an earnings release.  This occurs once a quarter or 4 times a year.  For example, Kid's Toy Store will report their 2nd quarter earnings on 8/15/2008.  This information is usually released on the company's website and followed with a conference call.  The conference call is conducted by senior management.  Analysts and investors can listen and ask questions about the latest quarterly report.

One may be asking, 'What does all of this have to do with growth?'  The company's revenue and earnings reported are measured against previous periods.  Let's say for the 2nd quarter of 2007, Kid's Toy Store reported revenues (sales) of $45,000 and this quarter they reported $90,000.  Revenue growth would be 100%.  Another way of saying the same thing is year over year revenue has increased 100%, or top line growth year over year is 100%.  Also, the quarter's revenue number will be compared to last quarter's.  For instance, Kids Toy Store 1st quarter revenues for 2008 were $38,000 will be compared to this quarter's number of $45,000.  So the quarter over quarter revenue growth , otherwise referred to as sequential growth, would be 18.4%.  The same concept is applied to earnings per share (EPS), net income, expenses, debt and other categories.

Now that you know how to compute the percentage growth for revenues and earnings, how do you use this information?  As an investor in the stock market, you must make assumptions about future sales of a company.  Sometimes the company will provide some growth projections (revenues, earnings, etc..) to assist you.  This is called forward guidance.  Your assumptions about a company is crucial to investing in the stock market.  If your assumptions are too high, this could effect the price of the stock.  A conservative assumption could prove to be positive for the company's stock.

Let's look at an example to aid understanding.   Previously we said that Kid's Toy Store 2nd quarter revenues were $90,000 and their earnings per share (EPS) was $1.09.  If you had previously projected that Kid's Toy Store 2nd quarter revenues were going to be $85,000 and an EPS of  $0.99, this would have been lower than what was reported.  This should help the stock price move higher.  On the other hand, if your revenue estimates were $95,000 and EPS was $1.14, you would have been too aggressive in your projections.  The stock might decline in this case.

While conducting your research, you want to find companies that are growing their revenues annually.  Also their revenues should be greater than expenses. This will insure that you are investing in companies that are earning money (profitable).

Until next time, keep learning and remember investing in the stock market can be rewarding.

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