I was all set to spill a bunch of digital ink on how screwed up the market is today for knocking Canon (NYSE: CAJ) down more than 8% on some very impressive results. But why bother? If the market punishes a great company, you don't complain. You figure out whether you're getting a great opportunity.
Canon's results were extremely impressive. Sales were up 11% and margins continued to expand, which pulled operating income up 15%. But the company's decision to change its depreciation method is getting the most attention. It's a change that increases the depreciation expense for this year and in the future, and the change essentially front-loads more of the company's depreciation expense. The change also temporarily gives the appearance of margins being flat instead of improving.
The market is missing the boat entirely on this change. For investors looking at cash flow, the increase in depreciation nets out and, if anything, could improve the cash flow if it lowers the tax bills in the near future -- remember, depreciation is generally deductible for tax purposes. The lower earnings because of the depreciation charge is a big non-story.
But there is one other reason to be excited about Canon getting beaten up today: its DSLR (digital single lens reflex) camera sales continue to go gangbusters. The market for DSLR cameras is dominated by Canon and Nikon (OTC BB: NINOY.PK), with Sony (NYSE: SNE) and a few others hoping to make some noise and get some share. When consumers buy a DSLR, they often start purchasing lenses for the cameras as well. In many cases, a good lens can cost as much or more than the camera, and lens mounts are unique to each manufacturer. So when the time rolls around to upgrade a camera, consumers who have invested in lenses are very likely to return to the same manufacturer for their new camera body, because switching brands means investing a lot of money in new lenses.
That says nothing about the printer business, which has a similar dynamic going for it in sales of ink and toner. But there's a big difference in switching to a competitor when it comes to buying $20 ink cartridges versus $500 or $2,000 lenses. Still, Canon has great imaging technology and competes well against Hewlett-Packard (NYSE: HPQ) and Epson. It is worth keeping an eye on how Kodak (NYSE: EK) develops its printer line, because of the much lower-cost ink.
Canon also has a rock-solid balance sheet. That leaves investors with a business that's growing well, expanding margins, and has a very strong business model. It does have some sensitivity to consumer spending and cycles, but the overall model is strong and the shares are now reasonably priced. That's a combination I'll take any day.
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Nathan Parmelee does not own shares in any of the companies mentioned. The Motley Fool has an ironclad disclosure policy.
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