Are Shorts Watching This Number at Suntech?

There's no foolproof way to know the future for Suntech Power Holdings (NYSE: STP  ) 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. 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 -- 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 Suntech 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 Suntech 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

 Suntech $744 272
 JA Solar (Nasdaq: JASO  ) $541 21
 MEMC Electronic Materials (NYSE: WFR  ) $503 48
 Yingli Green Energy (NYSE: YGE  ) $491 50

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 Suntech 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, Suntech Power Holdings's year-over-year revenue grew 57.2%, and its AR grew 5.6%. That looks OK. End-of-quarter DSO decreased 32.9% from the prior-year quarter. It was down 6.9% versus the prior quarter. 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.

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. Suntech is a Motley Fool Rule Breakers selection. 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 Report this Comment icon found on every comment.

  • Report this Comment On December 03, 2010, at 9:28 AM, assetclass wrote:

    STP's current price to book is .97 (source Yahoo finance). There may be some negative surprises but this should keep a floor on a big drop in the stock price.

    However, with such a negative bias built into the stock price, I see plenty of reasons for upside;

    - Only solar pure play run by a founder/entrepreneur

    - Biggest solar pure play in revenue over 2 of last 3 quarters, should retake the lead in Q4 based on business outlook

    - Located in China where biggest growth in solar investment estimated to take place in coming quarters

    - STP aggressively pursuing reduction in cost structure.

    I think STP has potential to be a 10 bagger from current stock price of ~$8

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