Is Oracle Going to Burn You?

By Seth Jayson | More Articles
September 26, 2011 | Comments (3)

There's no foolproof way to know the future for Oracle (Nasdaq: ORCL ) or any other company. However, certain clues may help you see potential stumbles before they happen -- and before your stock craters as a result.

A cloudy crystal ball
In this series, we use accounts receivable (AR) and days sales outstanding (DSO) to judge a company's current health and future prospects. It's an important step in separating the pretenders from the market's best stocks. Alone, AR -- the amount of money owed the company -- and DSO -- the number of 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 (like an acquisition), or lax collections. However, AR that grows more quickly than revenue, or ballooning DSO, can also suggest a desperate company that's trying to boost sales by giving its customers overly generous payment terms. Alternately, it can indicate that the company sprinted to book a load of sales at the end of the quarter, like used-car dealers on the 29th of the month. (Sometimes, companies do both.)

Why might an upstanding firm like Oracle 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 Oracle sending any potential warning signs? Take a look at the chart below, 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.

Company	LFQ Revenue	DSO
Oracle	$10,775	47
Informatica (Nasdaq: INFA )	$193	51
Citrix Systems (Nasdaq: CTXS )	$531	55
SAP (NYSE: SAP )	$4,791	81

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 consider this the final word -- just a way to add some context to the numbers. But let's get back to our original question: Will Oracle miss its numbers in the next quarter or two?

The raw numbers suggest potential trouble ahead. For the last fully reported fiscal quarter, Oracle's year-over-year revenue grew 13.4%, and its AR grew 18.7%. That looks ok, but end-of-quarter DSO increased 4.7% over the prior-year quarter. It was up 22.6% versus the prior quarter. That demands a good explanation. Still, I'm no fortuneteller, 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.

What now?
I use this kind of analysis to figure out which investments I need to watch more closely as I hunt 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, profiting when they eventually fall. Which way would you play this one? Let us know in the comments below, or keep up with the stocks mentioned in this article by tracking them in our free watchlist service, My Watchlist.

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The Steve Jobs Betrayal
You may already know that in the final year of his life, Jobs revealed a stunning betrayal — and told his biographer, "I will spend my last dying breath... and every penny of Apple's $40 billion in the bank to right this wrong." What was it that made Jobs so irate — and why could it make a few in-the-know investors some major profits over the coming months and years?

Enter your email address below to find out what made Jobs so enraged!

Seth Jayson had no position in any company mentioned here at the time of publication. You can view his stock holdings here. He is co-advisor of Motley Fool Hidden Gems, which provides new small-cap ideas every month, backed by a real-money portfolio. The Motley Fool owns shares of Oracle. Motley Fool newsletter services have recommended buying shares of Informatica. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment icon found on every comment.

Report this Comment On September 26, 2011, at 12:54 PM, dever1025 wrote:

As of SAP's most recent earnings report, DSO was 63 days. SAP CFO Werner Brandt remarked on a "significant reduction in Days Sales Outstanding, which came down to 63 days in the second quarter 2011 compared to 73 days in the prior year’s quarter."
Report this Comment On September 26, 2011, at 1:12 PM, dacarlq wrote:

Oracle "a desperate company that's trying to boost sales by giving its customers overly generous payment terms"? Oracle booking "a load of sales at the end of the quarter, like used-car dealers"? Not astonishing. Their hardware business is losing share and they haven't recently had large acquisitions to co-mingle with their base business so true organic growth becomes more evident for all to see. Good analysis. Caveat emptor.
Report this Comment On September 27, 2011, at 1:13 PM, zoningfool wrote:

A few points:
According to its SEC filings, Oracle does not use 'average accounts receivable' to calculate its DSO, but rather end-of-quarter a/r's:
"Days sales outstanding, which is calculated by dividing period end accounts receivable by average daily sales for the quarter"
Using Oracle's past 10 years of quarterly DSO's (those calculated using EOQ receivables, the average DSO is as following:
10-year average DSO: 55 days
5-year average DSO: 51 days
2-year average DSO: 50 days
MRQ DSO: 45 days
Not exactly an alarming trend or one that should be setting off red flags.
As far as A/R's growing faster than revenues:
Looking at the past 2 years of sales (quarterly YoY and ttm YoY) & a/r growth (YoY):
Aug 2009 sales -5%; ttm sales -1%; a/r's -21%
Nov 2009 sales 4%; ttm sales -1%; a/r's -5%
Feb 2010 sales 17%; ttm sales 2%; a/r's 29%
May 2010 sales 39%; ttm sales 15%; a/r's 26%
Aug 2010 sales 48%; ttm sales 27%; a/r's 44%
Nov 2010 sales 47%; ttm sales 38%; a/r's 43%
Feb 2011 sales 37%; ttm sales 42%; a/r's 15%
May 2011 sales 13%; ttm sales 33%; a/r's 19%
Aug 2011 sales 12%; ttm sales 25%; a/r's 13%
So:
in the quarter ended Aug 2009, a/r's grew less than either quarterly or ttm sales
in the quarter ended Nov 2009, a/r's grew less than either quarterly or ttm sales
in the quarter ended Feb 2010, a/r's grew more than either quarterly or ttm sales
in the quarter ended May 2010, a/r's grew less than quarterly sales but more than ttm sales
in the quarter ended June 2010, a/r's grew less than quarterly sales but more than ttm sales
in the quarter ended Nov 2010, a/r's grew less than quarterly sales but more than ttm sales
in the quarter ended Feb 2011, a/r's grew less than either quarterly or ttm sales
in the quarter ended May 2011, a/r's grew less ttm sales but more than quarterly sales
in the quarter ended Aug 2011, a/r's grew less than ttm sales, only slightly more than quarterly sales
So in only one quarter (Feb 2010) did a/r's grow more than both quarterly and ttm sales. Again, no red flags are being set off for me here.
Another metric I personally track is A/R's as a % of sales. I use TTM revenues as the base, btw. The reason I track this is to see how much of sales are being gained by 'borrowed money'--iow, how much of Oracle's sales is Oracle financing by extending credit in the form of trade receivables. A higher number--especially a trend towards an increasing %--would be the red flag for me. This is how the past 3 years look--the average for 10 years worth of data is 16%, btw:
Aug 2008 14%
Nov 2008 14%
Feb 2009 13%
May 2009 19%
Aug 2009 11%
Nov 2009 13%
Feb 2010 16%
May 2010 21%
Aug 2010 13%
Nov 2010 14%
Feb 2011 13%
May 2011 18%
Aug 2011 12%
Again--no red flags.
In summary, judging by the metrics of DSO, a/r growth relative to sales growth, and a/r's as a % of sales, no red flags are being set off for me. Also notable is that the DSO for the quarter ended August 2011 is at the 10-year low of 45 days (the 10 year DSO range is 45-70). A/R's as a % of sales for the MRQ is also near the low end of 10 years worth of data--the actual number was 11.50% vs a 11.25% ten-year low.
As far as "potential trouble ahead". I simply do not see it.

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