Minyan Mailbag: Receivables Growth vs. Sales Growth
Editor's Note: Minyanville is a community of people who share an interest in fiscal literacy. As perspective is an important aspect of our daily routine, we share this exchange with hopes that it adds balance to your process.
I wrote this on my blog, fyi:
Snapshots of receivables growth
They used to say that earnings are easily manipulated through accounting tricks but a sale is a sale. In that line of thinking, earnings growth in the absence of top line growth (sales) will typically not be rewarded. In the era of sales emphasis in order to attract investors' attention, CEOs are scrambling to boost sales. There are good and bad ways of increasing sales. The right way is of course the best way when there is a genuine demand for your products and it naturally flows through your top line growth, creating shareholder value. The bad way is to artificially boost it by heavy discounting or give it away (BUY.COM model).
There is a third kind that is called vendor financing. This kind typically won't impact your margins such as heavy discounting would to your P&L. Basically, you give finance to your customers to buy your goods. What it does is that the company will book top line for that product sales and the relevant earnings, so it has a positive impact on the earnings statement. On the cash flow basis, it has a negative impact since the company has not received cash for it.
There are several reasons why a CEO may opt to do this:
1) Financing costs are cheap, so why not
2) Things may be slowing but I would to book more sales
3) Look at that credit default, it's marvelous, who is going to default on me
4) Look at that sales number, Wall Street don't look at balance sheet data anyway
5) Look at the response of my stock price whenever I print huge sales number
6) Returns are through the roof, my board and shareholders are going to love me
Having said that, when a company is doing it excessively, it may point to potential problems down the road such as defaults as the portfolio of receivables grow bigger. Suddenly 1% default rate looks big on a 1 billion dollar portfolio. In addition, a company may rely on debt as an incentive to continue its growth (sounds familiar?).
So what is the metric we should look at in judging a company's financial health. One of the things that I'd look at is the receivables growth rate. If it is greater than sales growth rate, it is a red flag. I'm not predicting that all is bad when that happens but the odds of potential problems down the road is greater than a company that does not rely on receivables to generate growth.
The following is the highlights of several companies that showed receivables growth greater than its sales growth in its latest quarters:
Dell (DELL) sls +15% rec +23%; Cisco (CSCO) sls +11% rec +51%; Home Depot (HD) sls +12% rec +42%; Wal-Mart (WMT) sls +10% rec +31%; United Technologies (UTX) sls +16% rec +23% General Motors (GM) sls -2% rec -1%.
For GM, I have included their held for sales receivables without which receivables would have declined quite a bit. I figured the total amount of receivable is more appropriate as companies do factoring (i.e. sls of receivable) all the time.
If market participants were this rational the market would be much lower: the market would demand a higher risk premium for these companies.
I wrote about this a while ago and mentioned it again Wednesday. We have built a portfolio of long volatility where the options are cheap enough in these and several other names. This profile (long volatility) gets around the problem of shorting too early; it is a break-even strategy as these stocks go up and when/if they correct when the market changes its risk premium it makes good money fast.
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