Can We Predict Our Stock Earnings Accurately?

Hi Investors,

One of the least quantitative aspects of investing is deciding how company management will affect the price of a stock purchase. Recognizing that qualitative measures may be the best we have to work with, is there a list we should look at? A possible list is given below.

  1. Does the stock price gyrate wildly over time?
  2. Have sales/revenues increased over time?
  3. Have earnings per share increased over time?
  4. Has book value increased over time?
  5. Does management own a significant number of shares of company stock?
  6. Are management salaries inappropriate versus annual net earnings?
  7. Does management return excess earnings to shareholders?

 

In the long term what every stock owner should be after is predictability in earnings since earnings determine price. Therefore looking at price, revenues and earnings through the last two recessions should provide a good surrogate of management efficiency.

  1. If stock prices fluctuate widely then management is not managing earnings expectations through their use of earnings forecasts. Expectations of earnings, not actual earnings are what control short term stock price movements.
  2. For a growing company sales/revenues should increase over time. If they do not then management is not doing their job or you are investing in a poor sector/stock. Use of past year revenues to expand the company’s current year sales/revenues is the primary role of management. Note we are not talking about expanding earnings per share here. Many rapidly growing companies consume all their earnings to fund growth and actually assume debt.
  3. When sales/revenues expand so should earnings per share unless the company is rapidly growing.
  4. Book value, regardless of earnings, should increase over time. If the company is growing then the resources (book value) it needs to generate more sales/revenues should also grow.
  5. When management has a significant portion of their net worth tied up in company stock they act differently than if they merely have stock options. In the first case they try to increase the book value of the company, in the latter they may be satisfied to merely increase the stock price. Given the huge range of net earnings there is no hard and fast rule, but a range of 2 – 50% insider ownership is what I typically use. Insider ownership above 50% must be evaluated on a case by case basis. For very large companies insider ownership in the 0.20 range may be acceptable.
  6. Determining the value of management is one of the hardest exercises in stock research. In general if any management staff is paid more than 0.1% of net earnings I immediately look at another stock.
  7. Increase in sales/revenues is paramount. In cases where the market environment is not favorable, has management been able to buy back shares cheaply or increase dividends through use of retained earnings?

 

 

Examples

Data for Pepsi, Symbol = PEP

 

Year 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
High Price, $ 50.46 53.50 48.88 55.71 60.34 65.99 79.00 79.79 64.48 68.11 71.89 73.66 87.06
Revenues, B$ 23.15 25.11 26.97 29.26 32.56 35.14 39.47 43.25 43.23 57.84 66.50 65.49 66.42
EPS, $ 1.36 1.69 2.07 2.47 2.43 3.41 3.48 3.26 3.81 3.97 4.08 3.96 4.37
Book

Value, B$

8.65 9.53 11.9 13.57 14.23 15.45 17.32 12.2 16.91 21.27 20.7 22.42 24.41
Shares, B 1.75 1.73 1.72 1.63 1.66 1.64 1.61 1.55 1.56 1.58 1.56 1.55 1.53
Dividends, $ 0.57 0.59 0.63 0.85 1.01 1.16 1.43 1.65 1.77 1.89 2.02 2.13 2.24
Retained Earnings, $B 11.519 13.489 15.961 18.730 21.116 24.837 28.184 30.638 33.805 37.900 40.316 43.158 46.420

 

Insider ownership 0.1%

Salary  Ms. Indra K. Nooyi M.P.P.M.          5.73 M$          Net Income Avl to Common (ttm): $B 6.84 Ratio, %  =  0.08%

 

Management at Pepsi has grown revenues, earnings per share and book value significantly since 2001. They have done this while decreasing shares, increasing retained earnings and increasing dividends almost 4 fold. No member of staff seems to be paid excessively and insider ownership while low is acceptable given the number of shares. Share price has not fluctuated widely indicating management is successfully managing earnings expectations.

 

 

Data for Ford, Symbol = F

 

Year 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
High Price, $ 31.42

 

18.23 17.33

 

17.34

 

14.80

 

9.48

 

9.70

 

8.79

 

10.37

 

17.42

 

18.97

 

13.08

 

 18.02
Revenues, M$ 161 162 166 172

 

177

 

160

 

171

 

144

 

116

 

129

 

136

 

134

 

147

 

EPS -0.44

 

0.47

 

1.14

 

2.11

 

1.28

 

-1.50

 

-0.19

 

-3.13

 

-0.28

 

1.91

 

1.51

 

1.41

 

 1.62
Book

Value, B

7.79

 

5.59

 

11.65

 

17.44

 

13.44

 

-3.46

 

5.63

 

-15.72

 

-7.82

 

-0.673

 

15.03

 

15.95

 

26.38
Shares, B 1.81 1.83

 

1.83

 

1.83

 

1.86

 

1.89

 

2.11

 

2.39

 

3.31

 

3.75

 

3.80

 

3.81

 

3.94

 

Dividends, $ 1.05

 

0.40

 

0.40

 

0.40

 

0.40

 

0.25

 

0.00

 

0.00

 

0.00

 

0.00

 

0.05

 

0.20

 

0.40

 

Retained Earnings, $B 10.502 8.659 8.421 11.175 12.461

 

-.017

 

-1.485

 

-16.32

 

-13.60 -7.038

 

12.98

 

20.976 23.658

 

Insider ownership 0.46%

Salary  Mr. Mark Fields       5.28 M$          Net Income Avl to Common (ttm): $B 6.61 Ratio, %  =  0.08%

Management at Ford has had a hard time growing revenues, earnings per share and book value consistently since 2001. Shares have increased while dividends have decreased. No member of staff seems to be paid excessively and insider ownership while low is acceptable given the number of shares. Share price has fluctuated significantly indicating management has difficulty managing earnings expectations.

 

Data Sources: www.fastgraphs.net

http://www.sec.gov/cgi-bin/browse-edgar?CIK=f&Find=Search&owner=exclude&action=getcompany

http://finviz.com/quote.ashx?t=pep

http://finance.yahoo.com/q/ks?s=F+Key+Statistics

Will share my tips and tools in my next post!

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Mind Kinesis Research Team

 

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