Sunday, July 26, 2009

Its All About Revenue Growth: Versus When Though?

Over 70% of companies reporting second quarter earnings during this reporting period have beat analyst earnings expectations. Year over year top line revenue growth has been anything but nonexistent. And this focus on lack of revenue growth is an often sighted issue with the bearish market participants. The lack of revenue growth is based on comparison of the second quarter 2009 revenue versus the second quarter of 2008, i.e., year over year. The issue with this earlier period reference point is simply it is the wrong one.

Companies have gone through a significant right sizing period by slashing cost wherever possible. The brunt of this cost cutting has been centered in the employment area. As the below chart shows, the overall employment level has been reduced to late 2004 levels.

The point is an investor needs to look for growth in revenue, and earnings for that matter, based on a period in time comparable to a period which comes close to mirroring a time in which a company's operations looked similar to today. In many cases, this is 2003 or 2004. So can the company grow, say third quarter revenue and earnings, compared to the third quarter of 2004? If so, what does this growth rate look like vis-à-vis the companies current valuation. If one continues to look for the normal year over year growth, it could be several years before a company gets back to that type of favorable comparison. For some companies though, the revenue and earnings bar is pretty low when looking at fourth quarter 2008 or first quarter 2009.

In looking at United Technologies' (UTX) historical and projected earnings per share, if one is waiting for 2008 levels to be exceeded, it might be as late as 2011 before that bar is crossed. When in fact, the earnings growth estimates for 2009 through 2011 do not look too bad. If one continually compared 2009 levels to 2008, you might not get back into the stock until the company exhibited the positive YOY comparison sometime in 2010.

How much stock price upside would one have missed then? Like March through June of this year?

Disclosure: Long UTX

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