Investing Intelligently: Part 2 (Does the company have a track record of sales growth?)

In Part 1 of Investing Intelligently, we looked at determining if we have a reasonable understanding of what a company does as a business enterprise. Once we understand its business model, the next logical step is determining if the company has a track record of sales growth. Sales growth isn't everything, but it is important. We want to be a part owner of companies that are growing and should continue to grow.

In future lessons, we will see why sales growth alone is meaningless when set a part from its ability to actually generate cash. What may look like an Einstein of a business concept and have off the chart sales may in reality be a complete loser of an investment. Remember Enron? They say they make 'em bigger in Texas -- and that includes one of the biggest bankruptcies ever. Enron had solid revenue (sales) growth, but its ability to generate cash -- not good. Toss in a fraud or two later and the company collapsed with billions of dollars of investor equity wiped out. Or take for another example, Krispy Kreme Doughnuts. Now, if you ever had one of their glazed morsels of yum made hot right off the conveyor belt (when hot off the conveyor they are by far the best doughnut ever), you would think that it is a great place to become a part-owner by purchasing a few shares of its stock (Ticker: KKD). Well, it is not. It's a disaster of an investment, because it annually destroys shareholder value. Lesson: If the company has a proven track record of losing money, it will most assuredly find a way to lose your money.

Nonetheless, we'll begin by looking for sales (also called revenue) growth because every business must generate sales growth if it is to stay in business over the long term (unless you are GM and receive a get-out-of-bankruptcy free card from the government... or airlines which are notoriously crappy investments). So, where to start? At SEC.gov any investor (that includes you) can pull up the mandatory financial filings of publicly traded companies... for free. Once on the website, click on 'Search for Company Filings' located under sub-heading 'Filings & Forms.' Next, click on 'Company or fund name, ticker symbol...' From here enter the ticker symbol of one of the company's you are interested in from the screener list of investment possibilities (remember, you got this list from a stock screener... Motley Fool CAPS offers a free one that is very useful).

Let's stick with Krispy Kreme as an example. Enter 'KKD' and you will get a laundry list of its financial filings. The filings that will interest you most as a beginning investor are 10-Ks (annual reports) and 10-Qs (quarterly reports). Go down the list to locate its most recent 10-K filing, which you should see filed on 4-17-09. Click on the tab, and when a new list of docs pulls up, click on the first one titled 'Annual Report.'

With KKD's latest annual report, scroll down to page 25 where you will see a side-by-side comparison of the company's reported financial data taken from its Income Statement (you can find its Income Statement or Statement of Operations on page 62). KKD is kind enough to provide useful comparable date for the previous five years. Frequently, you will have to pull up each annual report for the past 5 years of a company in order to create a side-by-side comparison. It is important to have at least the past 3 years (preferably the past 5 years) of financial data so you can identify whether its sales and earnings trends are trending up or down and by how much. For Krispy Kreme we see that its total revenues in 2005 were $707.8 million; by 2009, its total revenues were down to roughly $384 million. Not good. You want to put your money in a company that is growing sales at a healthy clip year after year; I prefer companies growing at a double-digit rate year after year.

Compare KKD's year-after-year decline in sales to Apple's (Ticker: AAPL) year-after-year revenue growth. On page 35 of Apple's latest 10-K filing you will see its net sales in 2005 were $13.9 billion; in 2009 its net revenues had rocketed to $36.5 billion. That is AWESOME growth. Again, you want to find a company that has at least a three to five year track record of increasing sales because this is a good indicator that the company will continue its sales growth into the foreseeable future. Apple meets that requirement.

In the next lesson we will stick with the Income Statement to identify companies that not only have a track record of revenue growth, but also a track record of improving profitability.

Peace

JMac