There's no foolproof way to know the future for China Finance Online (Nasdaq: JRJC ) or any other company. However, certain clues may help you see potential stumbles before they happen -- and before your stock craters as a result. Rest assured: Even if you're not monitoring these metrics, short-sellers are.
A cloudy crystal ball
I often use accounts receivable (AR) and days sales outstanding (DSO) to judge a company's current health and future prospects. Doing so is an important step in separating the pretenders from the market's best stocks. Alone, AR (the amount of money owed the company) and DSO (days' worth of sales owed to the company) don't tell you much. However, by considering the trends in AR and DSO, you can sometimes get a window onto the future.
Sometimes, problems with AR or DSO simply indicate a change in the business -- such as an acquisition -- or lax collections. However, if AR grows more quickly than revenue, or DSO balloons, you might be looking at a desperate company that's trying to boost sales by giving its customers overly generous payment terms. Or the company could have sprinted to book a load of sales at the end of the quarter, the way used-car dealers on the 29th of the month. Sometimes, companies do both.
Why might an upstanding firm like China Finance Online do this? For the same reason any other company might: to make the numbers. Investors don't like revenue shortfalls, and employees don't like reporting them to their superiors.
Is China Finance Online sending any potential warning signs? Take a look at the following chart, which plots revenue growth against AR growth, and DSO:
Source: Capital IQ, a division of Standard & Poor's. Data is current as of last fully reported fiscal quarter. FQ = fiscal quarter.
The standard way to calculate DSO uses average accounts receivable. I prefer to look at end-of-quarter (EOQ) receivables, but I've plotted both above.
Watching the trends
When that red line (AR growth) crosses above the green line (revenue growth), I know I need to consult the filings. Similarly, a spike in the blue bars (DSO) indicates a trend worth worrying about. As another reality check, it's reasonable to consider what a normal DSO figure might look like in this space.
| China Finance Online
| Baidu (Nasdaq: BIDU )
| Sohu.com (Nasdaq: SOHU )
| Yahoo! (Nasdaq: YHOO )
Source: Capital IQ, a division of Standard & Poor's. DSO calculated from average AR. Data is current as of last fully reported fiscal quarter. LFQ = last fiscal quarter. Dollar figures in millions.
Differences in business models can generate variations in DSO, so don't take this as the final word -- just consider it a way to add some context to the numbers. But let's get back to our original question: Will China Finance Online miss its numbers in the next quarter or two?
Investors should watch the top line carefully during the next quarter or two. For the last fully reported fiscal quarter, China Finance Online's year-over-year revenue grew by 24.4%, and its AR grew by 525.0%. That's a yellow flag. End-of-quarter DSO increased by 402.5% over the prior-year quarter and 135.1% versus the most recent quarter. That demands a good explanation. Still, I'm no fortune teller, and these are just numbers. Investors putting their money on the line always need to dig into the filings for the root causes and draw their own conclusions.
I use this kind of analysis to figure out which investments I need to watch more closely as I hunt for the market's best returns. However, some investors actively seek out companies on the wrong side of AR trends in order to sell them short and profit when they eventually fall. Which way would you play this one? Let us know in the comments section below, or keep up with the stocks mentioned in this article by tracking them in our free watchlist service, My Watchlist.