2 Comments
 

Also someone else recommended this book before (I cannot attest to quality because I never read the book): Financial Modeling For Equity Research: A Step-by-Step Guide to Earnings Modeling and Stock Valuation for Investment Analysis

Someone else posted this before:

Revenue

  • First is just extrapolation
    • Why did revenue grow at x% this quarter--were there one-time factors that impacted revenue, for instance, or was the quarter before impacted by such non-recurring dynamics, making the comparison "hard" or "easy"
    • Look at multi-year trends, 2 and 3 year revenue "stacks" (read: CAGRs)
  • Channel checks, when possible
    • Talk to the company's distributors, public and private.
    • Talk to its suppliers, public and private
    • Frankly, for some industries sell-side just does this better than me, as they have surveys, etc. which have been running for years.
  • Data
    • Sometimes there's credit card data, email receipt data, web-scraped data, etc., available through data brokers, etc., which can show how consumer-facing sales look
    • This data is widely distributed, so it's almost always in the price already
  • Management checks
    • First is just tone--is IR/CFO/CEO confident? How does this change over the course of the quarter?
    • Second, and this is really the most important, is new initiatives and business dynamics: is the company doing something that would accelerate growth?
      • Is there a new product launch?
      • Is a product being brought to a new region?
      • Is there a price increase coming in a key segment or product?

Gross Margin

  • Raw materials and FX
    • You need to have a (very rough) idea of what your company is buying in its COGS. IR is usually willing to help
    • For instance, does the company primarily source in USD? Does sell in foreign FX? Some basic math can show the impact of a strengthening/weakening dollar on margins
    • Is the company buying significant amounts of commodities as inputs? If so, track their prices to get a sense of what's happening
  • Channel checks
    • Again, talking to suppliers can help piece together what's happening here
  • Extrapolation based on recent trends is of course important too, as are management checks

SG&A

  • Labor trends can be relevant
    • If your company employs union labor, is there a major contract that's been signed?
    • If your company has minimum wage workers, what are minimum wage trends in their areas?
  • Major tech initiatives are often called out in earnings calls
    • The company might say, "we are expecting $100M of investment into a new ERP system this year" Incrementally, SG&A should rise by $100M above normal trends this year, and then mostly fall back the next year if they say this
  • SG&A should be extrapolated on a year-over-year or sequential basis
    • The classic error in sell-side models is that they model SG&A as a % of revenue. But for SG&A, % of revenue is an output, not an input
    • Revenue does not directly impact SG&A's growth, so if you hold the % of revenue flat, you tend to under-estimate fixed cost leverage in a good/bad quarter

So that's a high-level view of how you'd model earnings. But I think earnings are often the wrong metric to focus on. In so many industries, the most important KPI (because it's most relevant for longer-term growth) is the most forward-looking indicator of revenue growth: bookings/billings for software companies, backlog for industrial companies, comps for retailers, etc. Almost no company does well when its forward-looking revenue indicator is weak, no matter how much it beats on earnings. And even earnings misses don't matter that much if there are signs that revenue is accelerating. The market knows it's not hard to restore margins when revenues are healthy, but it's very hard to sustain margins when revenues are weak.

Focusing on key factors and front-running PEADS / analyst revisions

 

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