Growth
Fundamentals -
revenue and net income
Overview
While no fundamental
or technical indicator can give you the
whole picture, looking at revenue and net
income will give you some necessary information
about any company you might be thinking
of investing in. These two fundamentals
will tell you whether the company is investing
in growth or generating more cash and generally,
if it is financially healthy.
The assumption
in charting net income and revenue growth,
is that the growth/loss in revenue and net
income growth from year to year will be
reflected in the historical price chart.
If the company brings in more revenue each
year its size and market share should also
increase. The company's stock price will
also be affected by whether profits are
used to pay out dividends or reinvested
in the company. If the company is growing,
the growth in revenue will outpace it's
net income, if the company is paying dividends,
the two growth rates should be similar.
Stocks
for companies that reinvest their profits
to earn more revenue, are called growth
stocks, and do not to pay dividends. Companies
that pay dividends with their profits are
called income stocks. Companies that report
higher revenues/net incomes each year, tend
to have the potential to generate the most
income for investors. Revenue and net income
growth are not the only criteria that should
be used to screen potential stocks. But
adding them to your analytical strategy
may help you to zero in on the type of stocks
you are looking for.
Charting revenue/net
income growth
Charting revenue
and net income growth will give you an idea
of the growth of a company. Optimally, you
want to invest in a company that has more
revenue and more net income than the previous
year. By charting the growth, you will also
get some indication of the target revenue/income
goal for the next year. If the company's
revenue/income grows by 50% per year, in
theory, the stock price should also grow
by that percentage.
The following
example will use net income, however you
can also apply this example with revenue.
| !
The difference between revenue
and net income. Even though a
company has growing revenue it could
actually be running a deficit. Net
income is revenue after expenses. |
Example:
4 year net-income chart for Coca-Cola
To chart revenue
and net income, simply grab some graph paper
and chart the historical revenue and net
income. Ideally both charts should be trending
upwards (i.e. the line goes up).
There appears
to be some correlation to the growth in
net income/revenue and the price charts.
Above you see a 5-year price chart of Coke.
In the last 5 years the stock price has
gained approximately 20% ($40 -> $51).
Example:
4 year net-income chart for Coca-Cola
By extending
your graph into the future, you can get
some indication of what the expected net
income and revenue should be to continue
the growth in the stock price.
Sample study
of net income growth
In the
sample stock screen below (Figure 1, created
by the ChartFilter StockScreener), we are
looking for every listed company that has
met the following conditions.
Figure
1
It's
important to note that the ratios
are year 1 vs year 2, year 1 vs
year 3 and year 1 vs year 4. This
is how we search for a growing ratio.
The revenue should grow more from
year 4 to 1 than year 2 to 1. In
the case of our first screen I have
used a 2-year ratio of 1.25, 3 year
ratio of 1.5 and a 4 year ratio
of 1.75 (experiment with these numbers).
In other words, the revenue grew
by 75% from year 1 to year 4 (or
the ratio from year 4 reported earnings
and year 1 reported earning has
grown by 75%). The revenue grew
50% since year 3, and 25% from year
2. The average growth per year should
be greater or equal to 25% per year
for last 4 years.
Also
included in this screen is the actual
net income (year 1,2,3,4) greater
than 1 million since we are interested
in companies that are profitable.
Without this criteria it could have
returned companies with growing
net income with the net being negative
(i.e. a deficit). There are no technical
conditions in this screen. A minimum
dividend payout was included, because
without this criteria, the screen
returns over 300 results.
Also,
when screening for companies based
on net-income or revenue, the differences
between revenue and net income should
be taken into account, since the
type of companies returned in the
screen are very different.
|
Figure 2 shows
the actual historical net income and the
net income growth ratio for each company.
Figure
2 (top 10 results from Figure 1 screen)
For example,
Screen Result
#1 (from figure 2), symbol coke
Reading the results,
starting from the top left on Figure 2 above:
Symbol: coke
Exchange: nasdaq
Company: Coca-Cola
Last close 53.35
Date screened 2004-11-24,
NetRatio2: means that Coke had 1.35 times
the net-income than the previous year
NetRatio3: means that Coke had 3.25 times
the net-income compared to 3 years ago
NetRatio4: means that Coke had 4.89 times
the net-income than 4 years ago
NetYr1: means that the last reported net-income
for Coke was 30.7 million
NetYr2: means that 2 years ago the net-income
was 22.82 million
NetYr3: means that 3 years ago the net-income
was 9.47 million
NetYr4: means that four years ago the net-income
was 6.29 million
Looking at the
5-year chart for Coca Cola, we should immediately
see a correlation between the net-income
growth (profit) and the stock price.
COKE (Coca-Cola
Bott Consol):
Net income year
1, 30.7 million,
Net income year 2, 22.82 million,
Net income year 3, 9.47 million,
Net income year 4, 6.29 million.
Screen result
#3 (from figure 2), symbol ubmt
5
year price chart for #3 on results list,
Symbol: ubmt
Screen result
#5 (from figure 2), symbol kmi
5 year price
chart for #5 on results list, Symbol: kmi
Charting earnings
per share
In the case of
coke, one should also see a correlation
between the earnings per share and the stock
price. Some argue, that this forms a closer
correlation than net income. Let's have
a look.
First, earnings
per share or EPS, is a company's profit
divided by the shares outstanding. Based
on the number of shares outstanding, the
profit per share will give you a better
idea if the current price is undervalued
or overvalued based on comparing historical
trends and/or similar type companies.
Example:
COKE (Coca-Cola Bott Consol):
2004 earnings
per share 2.41
2003 earnings per share 3.40
2002 earnings per share 2.56
2001 earnings per share 1.07
A growing
(up-trending) chart of earnings per share
shows that the company is growing in a favorable
fashion.
