If You're Focusing on the Obvious, You May Be Dead Wrong

If I grabbed some random Joe off the street and asked him how Apple (Nasdaq: AAPL  ) makes its money, he'd probably tell me that it's from selling iPhones, iPads, and iPods. And he'd be right.

It's true that Apple does, in fact, sell full-on computers and the $22 billion in revenue from Macs last year is hardly a rounding error. But with total Apple sales at more than $100 billion for 2011, the sales of desktop and laptop computers shouldn't be investors' primary concern.

In other words, when it comes to Apple, we hear a lot about iPhones and iPads. They seem like the obvious drivers of the business and they are the big drivers of the business.

But it's not always that easy.

In its earnings release this week, Goldman Sachs (NYSE: GS  ) listed its top "highlight" of the quarter as:

Goldman Sachs continued its leadership in investment banking, ranking first in worldwide announced mergers and acquisitions for the year-to-date.

That's not bad news, but it's not as great as some investors may assume. Goldman Sachs is referred to as an "investment bank," but it's not investment banking that's primarily paying the bills -- or the shareholders -- these days.

Investment banking -- which derives its revenue from fees on advisory services from initial public offerings, mergers, and the like -- accounted for $4.4 billion of Goldman's 2011 revenue and $1.4 billion of its pre-tax earnings. In total, the bank notched $6.2 billion in pre-tax profit for the year on $28.8 billion in revenue. But institutional clients services -- the division that houses Goldman's trading operations -- was the real breadwinner, as it raked in more than $17 billion in revenue and $4.6 billion in pre-tax profit.

Division

2011 Revenue

Percentage of Total Revenue

Institutional Client Services $17.3 billion 60%
Investment Management $5 billion 18%
Investment Banking $4.4 billion 15%
Investing and Lending $2.1 billion 7%

Source: Goldman Sachs 2011 10-K.

The iPhones and iPads for Goldman Sachs isn't the obvious investment banking practice, it's the bank's trading operations.

Goldman is hardly alone in this. Considering Las Vegas Sands' (NYSE: LVS  ) name, the casual observer might assume that the city of Las Vegas has a lot to do with the company's financial health. But that casual observer would be wrong. Dead wrong. In fact, Las Vegas Sands' financial performance has relatively little to do with the U.S. at all.

Geographic Segment

2011 Casino Revenue

Percentage of Total 2011 Casino Revenue

Macau $4.2 billion 57%
Singapore $2.4 billion 32%
Las Vegas $431 million 6%
Bethlehem, Pa. $377 million 5%

Source: Las Vegas Sands' 2011 10-K.

The shopping and room revenue from the Las Vegas operations are higher than in the company's other geographic segments, but the $450 million in Las Vegas room revenue -- versus $268 million in Singapore and $276 million in Macau -- hardly bridges the massive gap in casino rake.

To a somewhat lesser extent, the same could be said for General Electric (NYSE: GE  ) . In 2007 and 2008, many investors were caught off guard by just how massive the company's finance segment was. It made sense that banks were plunging during a financial crisis, but the more than half-trillion dollars in assets that GE had in its finance arm meant that it was in a leaky boat as well.

GE's history is long and storied and so it's easy to think of it as simply a massive industrial powerhouse. But investors focusing on only that obvious aspect of GE would miss the fact that finance is still an outsized part of the company. In 2011, GE Capital contributed 31% of the company's revenue. GE Capital was the largest segment of the business, followed by Energy Infrastructure with a 30% revenue share.

As my middle school biology teacher chided me, assuming "makes an ass out of you and me." Assuming that you understand a business based on what seems obvious about it can be a big mistake any time of the year. During earnings season, though, it can be particularly dangerous if you overlook weakness in important parts of a company's operations as management loudly touts strong performance in some small, inconsequential division.

The solution is simple. First, if you haven't already, make sure you read through the annual report for the companies you own. Everything you need to understand what really drives the business is in there. And if you still don't have a good sense about what makes the company tick after reading that, you may want to consider whether that company is one you really want to own.

Then, when the company's earnings release hits the wires, make sure you read it all the way through. Don't just stick to the back-slapping highlights at the beginning.

If you want to get some timely thoughts on what to expect during earnings season from some of my fellow Fools' favorite stocks -- including Apple -- check out the special report, "5 Stocks Investors Need to Watch This Earnings Season." You can access this report for free by clicking here.

The Fool owns shares of Apple. Motley Fool newsletter services have recommended buying shares of The Goldman Sachs Group and Apple. Motley Fool newsletter services have recommended creating a bull call spread position in Apple. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Matt Koppenheffer does not have a financial interest in any of the companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or Facebook. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.


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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 Report this Comment icon found on every comment.

  • Report this Comment On April 19, 2012, at 4:19 PM, DBrown7 wrote:

    Nice article Matt, but I think your middle school biology teacher stole that line from Felix Unger (aka Tony Randall) of the Odd Couple. Of course, it probably didn't originate from him either. I just remember it from that show. Regardless, a great thought.

  • Report this Comment On April 19, 2012, at 6:39 PM, Mega wrote:

    Have you ever met a GS shareholder who didn't know that most of their income comes from trading?

  • Report this Comment On April 20, 2012, at 4:40 AM, ahrahr wrote:

    BTW, I find amusing that people keep doing their business with Goldman Sachs at all.

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