Scotts Miracle-Gro Passes This Key Test

There's no foolproof way to know the future for Scotts Miracle-Gro (NYSE: SMG  ) 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 and days sales outstanding 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 Scotts Miracle-Gro 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 Scotts Miracle-Gro sending any potential warning signs? Take a look at the chart below, which plots revenue growth against AR growth, and DSO:

Source: S&P Capital IQ. 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 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 indicates a trend worth worrying about. Scotts Miracle-Gro's latest average DSO stands at 60.6 days, and the end-of-quarter figure is 44.3 days. Differences in business models can generate variations in DSO, and business needs can require occasional fluctuations, but all things being equal, I like to see this figure stay steady. So, let's get back to our original question: Based on DSO and sales, does Scotts Miracle-Gro look like it might miss its numbers in the next quarter or two?

I don't think so. AR and DSO look healthy. For the last fully reported fiscal quarter, Scotts Miracle-Gro's year-over-year revenue grew 0.3%, and its AR dropped 25.5%. That looks OK. End-of-quarter DSO decreased 25.8% from the prior-year quarter. It was down 36.5% versus the prior quarter. 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.

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 has no positions in the stocks mentioned above. Motley Fool newsletter services recommend The Scotts Miracle-Gro Company. 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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  • Report this Comment On October 04, 2012, at 1:45 PM, FillaNeed wrote:

    Over the years I've followed Scott's Miracle-Gro and one thing I've learned to admire about them is they don't sugar cote problems. That's good long term but can be jarring short term. Last year you saw how much pressure they were under to call up their numbers to meet the street's runaway expectations after a warm and early spring. Even though they met their projections they were punished. Thank goodness they didn't raise projections because the mass merchants were unusually tepid regarding laying in the inventory to meet the shock demand of the early spring and then temps. shot to 95 degrees (too hot for most gardeners). Every year is different in the lawn and garden business largely because of the weather but three constants exist. One- Scott's Miracle-Gro/Ortho with Round-up pretty much define the entire category. SMG and all the retail buyers are applying the lessons of last year in their plans for next spring. Any increase in inventory prepositioned at the stores to reduce the out-of stocks has to be given dating (ie sold on credit) Third- good or bad they have the intestinal fortitude to be straight shooters.

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