ALEXANDRIA, VA (Oct. 19, 1999) --
Earnings, earnings, getch yer earnings right here!
With earnings season in full swing, Wall Street's obsession is with the bottom-line -- earnings per share (EPS). The analysts' consensus estimate is like the line on a sporting event. Beating the consensus estimate equals a "win." Missing the consensus is a "loss." Just meeting the consensus is a "tie."
That is, unless the market is anticipating a whisper number above and beyond the official consensus estimate. In that case, all the rules change. The whisper number becomes the line by which all bets are cast.
Well, that is, unless there is guidance. If management guides earnings higher for future quarters, or if management is downcast, then it's that outlook for the future that really matters.
I hope not! -- because it's all a waste of time. CNBC and Wall Street like to abstract business results into the number of pennies by which a company beats or misses its EPS estimate. But that's oversimplifying things to the extreme. Progress within a dynamic business cannot be boiled down to a single number.
Regular RM readers know that the income statement is not the be-all-and-end-all of business performance. We need the balance sheet to check that growth of receivables isn't outpacing sales. Otherwise, a company might be booking sales for which it hasn't received prompt payment. The same goes for product distribution. If inventory is building up faster than sales, that may be a sign of faltering customer demand. We need the balance sheet -- and preferably the cash flow statement too -- in order to really assess the health of a business.
Nevertheless, some of our companies only report an income statement with their earnings, so we takes what they gives us -- and we look forward to the release of the 10-Q in about one month from now. In the meantime, there are three metrics we can watch on the income statement: 1) sales growth, 2) gross margins, and 3) net margins. (Those are criteria #6, 7, and 8 on our Rule Maker Criteria.) I'm particularly interested in sales growth. When sales are increasing at a healthy clip, that signals growing demand for our company's products or services. For our large-cap Rule Makers, 10% year-over-year sales growth is what we're looking for as a benchmark.
Not all growth is created equally. Earnings growth without sales growth means that a company is cutting costs -- which is great -- but that can only go on for so long. Eventually, all the fat will be trimmed, and the only route to growth is increased sales. During this earnings season, in the midst of all the noise about bottom-line EPS, let's be sure to pay close attention to the top-line sales. Growth in sales is the most fundamental sign of a growing business.
Sales growth was no problem for Pfizer (NYSE: PFE) during the just-completed third quarter. This morning, the pharmaceutical giant reported diluted EPS of $0.23 -- two pennies ahead of the First Call estimate of $0.21. The headline of the earnings press release boldly declares, "TOTAL REVENUES INCREASE BY 20 PERCENT." But as I explained a few weeks ago, Pfizer's sales are not created equally. During the quarter, "net sales" of Pfizer's in-house drugs grew by 10%, while most of the growth came from "alliance revenues," which increased 159%. The market reacted favorably to today's results, largely because Pfizer indicated that it would achieve full-year 1999 results at the high-end of analysts' estimates for $0.80 - $0.83. In spite of the positive guidance, Pfizer's reliance upon its alliance revenues is still an unresolved issue that investors need to consider.
On Thursday, Phil will take a closer look at these results. He'll also give an update on our other big pharma Rule Maker, Schering-Plough (NYSE: SGP), which is expected to report earnings tomorrow. The First Call consensus is $0.35.
After market close today, Microsoft (Nasdaq: MSFT) reported another quarter of blow-out earnings. The software giant posted EPS of $0.40, well ahead of Wall Street's $0.34 consensus estimate. Sales grew an impressive 28% on the strength of Office 2000. Tomorrow, I'll cover these results in all their delightful detail. In the meantime, you can access the earnings press release and conference call replay at Microsoft's Investor Relations homepage.
Finally, on Thursday we'll also get third quarter results from Coca-Cola (NYSE: KO). Analysts expect $0.32, which was revised down from an earlier $0.34. Coca-Cola is Exhibit A of a company that for a time was able to grow earnings without growing sales. But eventually, the company came face to face with the dilemma of stagnant demand for its beverages. Here's what that dilemma looks like on a three-year stock chart for KO.
Next time Wall Street is whooping it up over great earnings growth, be sure to keep a Foolish eye on top-line demand. Sales growth is where it's at.
I'll be back tomorrow with more on Microsoft's quarter.
ALEXANDRIA, VA (Oct. 19, 1999) --
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