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Earnings Beats Are Not Enough: Are You Checking Earnings Quality?

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Earnings season is nearly done and there’s a kind of euphoria over the general results that while declining from last year and not expected to recover until 2021, were nevertheless much better than feared.

We now know that the virus has a low death rate as long as we don’t overwhelm the healthcare system. So there’s the need to be innovative, digitized and determined about our approach to continued business activity.

So when we take stock of what has gone by, it’s clear that these earnings beats were fairly easy, which means they may not tell us that much about which stocks are truly worth adding. It’s only when they are also undervalued that we may hope for some gains.

But investing isn’t only about the daily trade. This is the time we must take a closer look at what the numbers are telling us. We must try to understand the quality of earnings.

And how to go about doing that?

For starters, just think about the kind of company you’d want to own. Would you want something that’s seeing declining revenues and uncertain demand? Of course not. So look for these things. When revenue growth projections are positive, there’s a better chance of generating earnings. Ultimately, every cent of profit is what trickles down after deducting expenses from revenue. So revenues are very important.

Second, you want to take a look at the receivables. A certain amount of receivables growth is okay because it’s a natural follow-on from the increases in total sales volumes. But if it isn’t commensurate with the increase in revenue and continues on that path for a considerable period of time, the company is having difficulty with collections. Read this as a warning sign because it increases the risk of debts going bad as the company isn’t able to recover dues.  

Third, take a look at the debt. In some capital-intensive segments of the market, a high debt load may be normal. But we need to see if there’s sufficient infrastructure on the ground to justify the debt burden (this will show up in the net PP&E number). Companies may also incur debt for acquisitions. This is not a bad thing because acquisitions bring assets, experience, knowhow, brands and may also include infrastructure. So there should be proper justification for a high debt load. Otherwise, there’s a chance that the company is in bad financial trouble and is borrowing money to keep itself afloat. Debt also brings interest with it, which directly impacts earnings. A high debt load always adds to the risk of investing.

See the illustrations below-

Turning Point Brands, Inc. (TPB - Free Report)

Turning Point Brands provides tobacco products including moist snuff, loose leaf chewing tobacco, cigarette papers, make-your-own cigar wraps and cigar smoking tobacco, cigars, and liquid and tobacco vapor. Its portfolio of brands includes Zig-Zag(R), Beech-Nut(R) and Stoker's(R).

Zacks Rank #1

Momentum Score A

Industry: Tobacco (top 12%)

2020 revenue expected to grow 3.8% and 2021 revenue 4.4%

2020 earnings expected to grow 33.9% and 2021 earnings expected to grow 0.4%

June quarter earnings beat the Zacks Consensus Estimate by 31.5%, after which 2020 estimates grew 18.6% in the last 30 days

Both inventory and receivables show normal seasonal trends. The debt cap ratio is high at over 73%. But after declining to this level in the December 2019 quarter, it has held steady. It follows the net PP&E pattern, indicating that the company has been investing heavily in its fixed assets to drive growth and these investments are beginning to pay off. The dividend remains steady at 5 cents a share since the December 2018 quarter.

Valuation: Based on price to forward 12 months’ earnings, the stock is trading at 11.94X, which is below its median value of 12.65X over the past year.

Carriage Services, Inc. (CSV - Free Report)

Carriage Services is a leading provider of death care services and products in the U.S spanning funerals, burials and cremations, including the use of funeral homes and motor vehicles, the performance of cemetery interment services and the management and maintenance of cemetery grounds. it also sells related products and merchandise including caskets, burial vaults, garments, cemetery interment rights, stone and bronze memorials, etc.

Zacks Rank #2

VGM Score B

Industry: Funeral Services (top 7%)

2020 revenue expected to grow 12.7% and 2021 revenue 4.5%

2020 earnings expected to grow 29.2% and 2021 earnings expected to grow 35.5%

June quarter earnings beat the Zacks Consensus Estimate by 36.4%, after which 2020 estimates grew 10.7% in the last 30 days.

Receivables jumped to 20-year highs in the December 2019 quarter but have been declining since then. But since revenues are at all-time highs, this is to be expected. The debt cap spiked in the March quarter but dipped to a more acceptable 65% in the last quarter. The quarterly dividend remains steady at 8 cents a share.

Valuation: Based on price to forward 12 months’ earnings, the stock is trading at 12.41X, which is below its median value of 13.65X over the past year.

Silgan Holdings Inc. (SLGN - Free Report)

Silgan Holdings is a leading supplier of rigid packaging for consumer goods products with 110 manufacturing facilities in North and South America, Europe and Asia. Its products are used in diverse end markets including human and pet food (largest supplier in North America); custom-designed plastic containers for personal care, healthcare, pharmaceutical, household, industrial chemical, food, pet care, agricultural chemical, automotive and marine chemical products; and metal, composite and plastic closures for food and beverage products.

Zacks Rank #1

VGM Score B

Industry: Containers - Metal and Glass (top 1%)

2020 revenue expected to grow 6.0% and 2021 revenue 1.9%

2020 earnings expected to grow 28.7% and 2021 earnings expected to grow 2.6%

June quarter earnings beat the Zacks Consensus Estimate by 34.9%, after which 2020 estimates grew 15.4% in the last 30 days

Both receivables and inventories are showing normal seasonal trends and reflect revenue growth. The debt cap is very high at 74%. Net PP&E grew 13.5% over the past year and the company also makes frequent acquisitions (which is the reason for the huge debt load). As has been the tradition for several years, the quarterly dividend was raised in the March quarter by a penny and remains at 12 cents.

Valuation: Based on price to forward 12 months’ earnings, the stock is trading at 13.28X, which is its median value over the past year.

Spectrum Brands Holdings Inc. (SPB - Free Report)

Spectrum Brands Holdings is a global consumer products company with a portfolio of leading brands in product categories like residential locksets, plumbing, electric shaving and grooming products, personal care products, small household appliances, specialty pet supplies, lawn and garden, and home pest control products and repellents. It manufactures, markets and distributes products in around 160 countries of North America, Europe, Middle East & Africa (EMEA), Latin America and the Asia-Pacific region.

Zacks Rank #1

VGM Score C

Industry: Consumer Products - Discretionary (top 14%)

2020 revenue expected to grow 0.4% and 2021 revenue 2.0%

2020 earnings expected to grow 25.5% and 2021 earnings expected to grow 16.1%

June quarter earnings beat the Zacks Consensus Estimate by 41.7%, after which 2020 estimates grew 24.2% in the last 30 days

Both inventory and receivables show a stable trend. The debt cap ratio moved up from Jun 2019 to March 2019 and started moving down in the last quarter to end at a manageable 66%. PP&E however moved down during this same period but stabilized in the last quarter. The quarterly dividend held steady at 42 cents a share. It does look like the company went through a rough patch and borrowed money to maintain the dividend and that things may be looking better from here on out.

Valuation: Based on price to forward 12 months’ earnings, the stock is trading at 14.49X, which is below its median value of 15.28X over the past year.

Reynolds Consumer Products Inc. (REYN - Free Report)

Reynolds Consumer Products is a consumer branded and private label products company. It produces and sells branded and store-branded things like cooking products, waste & storage products and tableware. The company's flagship products include Reynolds Wrap(R) aluminum foil, Hefty(R) bags, and Hefty(R) party cups. Prior to the corporate reorganization and IPO in the February 2020, the company operated as a part of RGHL Group.

Zacks Rank #2

VGM Score A

Industry: Consumer Products - Discretionary (top 14%)

2020 revenue expected to grow 4.8% and 2021 revenue 2.1%

2020 earnings expected to grow 32.4% and 2021 earnings expected to grow 1.2%

June quarter earnings beat the Zacks Consensus Estimate by 7.8%, after which 2020 estimates grew 2.1% in the last 30 days

The company’s receivables and inventories and revenues were showing declining trends in the last filed annual report but subsequent quarterly reports show increases from last year (inventory remains relatively low). The long term debt shows a similar trend although net PP&E has grown steadily higher. Overall, the numbers are harder to read because of the recent reorganization but the trends look positive.

Valuation: Based on price to forward 12 months’ earnings, the stock is trading at 16.62X, which is below its median value of 17.54X since it started trading earlier this year.

 

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