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Author: yodaorange Big red star, 1000 posts Feste Award Nominee! Feste Award Winner! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 465006  
Subject: Separating the Top Line from the Bottom Line Date: 10/24/2012 1:04 AM
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During the 2008 credit crash corporate profits took a swan dive, but recently they have come roaring back. Profits as a percentage of GDP are close to all time highs. All fine and good.

When I read an earnings report, the first data I search out is the “top line” aka revenues. Before the crash a typical earnings report would show X percent growth in the top line and ~ X percent growth in the “bottom line” aka earnings. This indicates that the net profit margin for the company was relatively unchanged. It made for a simple formula, increased sales lead to increased earnings.

That all changed after the crash. The typical earnings report had a disconnect between the top line and the bottom line. The top line might be flat to down, yet the bottom line showed impressive growth. Stated differently profit margins improved. Companies have a lot of levers they can push to change profit margins. One lever they used extensively post crash was to reduce payroll costs through layoffs and/or outsourcing. If your company can produce the same output of goods and services with less people it is called improved productivity. You can argue that this proves that companies were NOT at peak productivity before the crash. Stated differently they had a lot of things like “excess employees” that were NOT needed to maintain the top line sales.

Usually there is an asymptotic limit as to how much productivity improvement you can squeeze out of a company. In the end if you lay off all of the employees, you have no ability to produce the goods and services to sell for the top line. Of course, there are other methods of improving profit margins, like cutting salaries, 401k matching, other benefits, cost of office space, etc.

In the end game, you have to start GROWING the top line to grow the bottom line. Recently the news on top line growth has been discouraging. Factset reports that so far this earnings season 42% of companies have reported sales above estimates. [1]This is the lowest percentage since we were in the middle in the crash back in 2009.


However, only 42% of companies have reported sales above estimates. This percentage is well below the average of 55% recorded over the past four quarters. In fact, it is the lowest percentage of companies to report sales above estimates at this stage of the earnings season since Q1 2009 (35%).



This is NOT good news. Couple that with Q3 earnings looking like they will shrink by 2.3% and the picture is NOT optimistic. Understand that Wall Street is all about expectations. If they have a one foot high hurdle set and you clear it, you are a hero. If they have a 7 foot hurdle set and you jump 6 feet 11 inches, you are an idiot. Your stock will be trashed.

There is one other broad implication that is not widely discussed at this time. If companies are missing on the top line, they HAVE to cut costs to maintain their profit margin. If they want to grow earnings, they have to double cut costs. Unfortunately, the fastest and easiest way to do this is to layoff employees. US companies have evolved to a shoot first, aim later mentality. At the first sign of weakness they tend to layoff employees until waiting to see how long/deep the downtrend will be. If I was an employee of a company that missed the top line forecast, I would be very nervous about job security. . .

The investing thesis is not as clear cut. Poor top line results is proof positive that the Fed and Politicians need to do more to “get the economy going.” Some form of stimulus would normally be what the doctor ordered. In today’s climate with the election coming up plus the fiscal cliff looming, it looks like the Fed is the “only game in town” for a while longer. I wouldn’t be surprised if they announced a major new initiative the day after the election. Something like doubling the QE or announcing direct investments in securities might do the trick.

BOTTOM LINE is that we have to see corporate top line growth if we ever want to grow the economy, much less produce more US based jobs.

I recommend you take a look at the graph on the link. It is very insightful IMO.

Thanks,

Yodaorange

[1] Factset “Lowest percentage of S&P 500 companies beating sales estimates since Q1 2009”
http://www.factset.com/insight/2012/10/earningsinsight_10.19...
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Author: flyerboys Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 406721 of 465006
Subject: Re: Separating the Top Line from the Bottom Line Date: 10/24/2012 2:28 AM
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So, every now and then I have to break form and thank people who are asking, thinking through and then Oh so kindly, posting the answers to crucial questions I Would Not Even Think to Ask if Not for Them.

THANK YOU YO!!! For this one and many others! This one goes to the heart of the macro mess we are slogging through.

Nowadays, the "Top Line" Matters.


david fb

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Author: warrl Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 406722 of 465006
Subject: Re: Separating the Top Line from the Bottom Line Date: 10/24/2012 2:55 AM
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In the end game, you have to start GROWING the top line to grow the bottom line. Recently the news on top line growth has been discouraging. Factset reports that so far this earnings season 42% of companies have reported sales above estimates. [1]This is the lowest percentage since we were in the middle in the crash back in 2009.

Speaking strictly hypothetically, this COULD mean that the analysts are getting better at making these estimates and forecasts.

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Author: jgc123 Big gold star, 5000 posts Top Recommended Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 406736 of 465006
Subject: Re: Separating the Top Line from the Bottom Line Date: 10/24/2012 11:34 AM
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After reading your link, I also noted that the worst performing sectors were energy and materials. I can't help but think that those are *real* economic indicators in the sense that reduced energy use and materials production reflect reduced consumption and/or production in a tangible way that would be hard to hide with fudged numbers.

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Author: WendyBG Big gold star, 5000 posts Top Favorite Fools Feste Award Winner! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 406747 of 465006
Subject: Re: Separating the Top Line from the Bottom Line Date: 10/24/2012 1:20 PM
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< energy and materials. I can't help but think that those are *real* economic indicators in the sense that reduced energy use and materials production reflect reduced consumption and/or production in a tangible way that would be hard to hide with fudged numbers. >

What a great insight!

The Control Panel includes the energy index (price of energy) and copper but supply also affects price.

I would like to add quantity of energy and materials. Anyone who has a link, please share so I can add it to the Control Panel.

Wendy

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Author: jerryab Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 406760 of 465006
Subject: Re: Separating the Top Line from the Bottom Line Date: 10/24/2012 2:52 PM
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I would like to add quantity of energy and materials.

Two problems.

Energy can be created--but not necessarily USED (i.e. batteries). Thus, this needs to be examined carefully. Plus, with new energy sources, fuel may be bought--but energy generated "on site" (so no transmission of energy from a large producer to an end-user). That would be a significant break from the last 75 years of domestic energy consumption.

Materials today come from new supplies discovered AND from recycling. Thus, copper would be one of those "hard to figure" numbers. Plus, if the US telco network does go all digital, there will be a large influx of old copper but no corresponding need for the same material to replace it.

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Author: WendyBG Big gold star, 5000 posts Top Favorite Fools Feste Award Winner! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 406801 of 465006
Subject: Re: Separating the Top Line from the Bottom Line Date: 10/24/2012 10:00 PM
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jerryab, your points are reasonable.

What are your recommendations?
Wendy

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Author: OrmontUS Big gold star, 5000 posts Feste Award Nominee! Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 406812 of 465006
Subject: Re: Separating the Top Line from the Bottom Line Date: 10/24/2012 11:12 PM
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I would point out that one of the easiest places to save money is to cut research & development.

Jeff
(Tongue in cheek)

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Author: markr33 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 406814 of 465006
Subject: Re: Separating the Top Line from the Bottom Line Date: 10/24/2012 11:43 PM
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401k matching

This reminds me of a factoid I heard this week. During the financial crisis, many companies suspended their 401k match. Well, as of this month, 90+% of them have reinstated their 401k match.

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Author: markr33 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 406815 of 465006
Subject: Re: Separating the Top Line from the Bottom Line Date: 10/24/2012 11:45 PM
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After reading your link, I also noted that the worst performing sectors were energy and materials. I can't help but think that those are *real* economic indicators in the sense that reduced energy use and materials production reflect reduced consumption and/or production in a tangible way that would be hard to hide with fudged numbers.

Folks have been using such indicators (energy use, copper use, etc) to measure the real growth in China as opposed to government reported growth.

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Author: markr33 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 406816 of 465006
Subject: Re: Separating the Top Line from the Bottom Line Date: 10/24/2012 11:47 PM
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I would point out that one of the easiest places to save money is to cut research & development.

But you couldn't save much that way. If R&D is 4% and you cut it by a full quarter, you would only save 1% gross. And with various tax credits/deductions, it would would net out to even less than that.

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Author: jerryab Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 406864 of 465006
Subject: Re: Separating the Top Line from the Bottom Line Date: 10/25/2012 6:03 PM
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your points are reasonable.

What are your recommendations?


Don't know. The old systems are being changed due to tech change (how, where, when something happens--if it happens at all).

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