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Michael C. Thomsett is a widely published options author. His "Getting Started in Options" (Wiley, 9th edition) has sold over 300,000 copies. He also is author of "Options Trading for the Conservative Investor" and "The Options Trading Body of Knowledge" (both FT... More
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  • Net Return – Analysis Tells The Real Story 0 comments
    Jun 29, 2013 10:14 AM

    One of the most important fundamental trend tests is calculation of net return. This is the percentage derived by dividing net profit by revenues. At first glance, it is a simple indicator and one whose meaning is clear. But that is not always the case.

    The trend in net return reveals several possible scenarios:

    1. Increases in every measure. When revenue and net profit are rising, it is a positive sign, but only if the net return (percentage) is holding steady or rising as well. This is a sign of real growth. It is also a sign of strong internal controls on the part of management.

    2. Increases in dollar value but declines in net return. When revenue or profits (or both) rise each year but net return falls, it signals that management is not controlling expenses. This is a negative signal which, if it is not corrected, eventually erodes profitability.

    2. Declines in revenue and profit, but steady or rising net return. When dollar value of revenue and profits are falling but the net return is positive, it signals that management is controlling its expenses well. The decline may be broadly economic rather than competitive, so also check other companies in the same industry to get the real story.

    A good example of the comparison is the case of Wal-mart (NYSE:WMT), Target (NYSE:TGT) and J.C. Penney (NYSE:JCP). The 8-year trend among these three competitors is vastly different:

    (In $ millions)

    Fiscal Net Net

    Year Revenue Profit Return

    Wal-mart (WMT)

    2006 $312,427 $11,231 3.6%

    2007 348,650 12,178 3.3

    2008 378,799 12,884 3.4

    2009 405,408 13,254 3.3

    2010 408,214 14,414 3.5

    2011 421,849 15,355 3.6

    2012 446,950 15,766 3.5

    2013 469,162 16,999 3.6

    Target (TGT)

    2006 $ 52,620 $2,408 4.6%

    2007 59,490 2,787 4.7

    2008 63,367 2,849 4.5

    2009 64,948 2,214 3.4

    2010 65,357 2,488 3.8

    2011 67,390 2,920 4.3

    2012 69,865 2,929 4.2

    2013 73,301 2,999 4.1

    J. C. Penney (JCP)

    2006 $ 18,781 $ 977 9.4%

    2007 19,903 1,134 5.7

    2008 19,860 1,105 5.6

    2009 18,487 567 3.1

    2010 17,556 249 1.4

    2011 17,759 378 2.1

    2012 17,260 - 152 - 0.9

    2013 12,985 - 985 - 5.5

    Wal-Mart has reported consistent growth in revenue and net profit over many years. The net return has been steady as well, always between 3.3% and 3.6%. This makes the trend in net return very predictable. Target, however, has reported rising revenue, inconsistent net profit, and falling net return. Their record is not as positive; however, the range of net return has remained fairly small, within less than 1% difference from high to low. The most disappointing record is that of J.C. Penney. Both revenue and net profit have been difficult to track, although overall profitability has fallen through the 8-year period. The most troubling aspect of this summary is net return, which has fallen significantly from 9.4% in fiscal 2006 down to -5.5% in fiscal 2013.

    These results demonstrate that even in the same economy, companies in one sector often record very different results. Inconsistency equals doubt in the stock market, so those companies that produce steady rises in revenue and net profit, along with steady or rising net return, are able to compete favorably with more volatile companies in the same sector.

    To gain more perspective on insights to trading observations and specific strategies, I hope you will join me at ThomsettOptions.com where I publish many additional articles. I also enter a regular series of daily trades and updates. For new trades, I usually include a stock chart marked up with reversal and confirmation, and provide detailed explanations of my rationale. Link to the site at ThomsettOptions.com to learn more. As a new member, if you buy a one-year subscription, you also get a free copy of one of my books, including this new one recently released.

    I also offer a bi-weekly newsletter subscription if you are interested in a periodic update of news and information and a summary of performance in the virtual portfolio that I manage. The newsletter is free until August 1; after that, it requires a paid subscription, but members can subscribe for a reduced rate. Join at Weekly Newsletter I look forward to having you as a subscriber.

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