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Growth Fundamentals, revenue and net income PDF Print E-mail

Growth Fundamentals - revenue and net income

Overview

While no fundamental or technical indicator can give you the whole picture, looking at revenue and net income will give you some necessary information about any company you might be thinking of investing in. These two fundamentals will tell you whether the company is investing in growth or generating more cash and generally, if it is financially healthy.

The assumption in charting net income and revenue growth, is that the growth/loss in revenue and net income growth from year to year will be reflected in the historical price chart. If the company brings in more revenue each year its size and market share should also increase. The company's stock price will also be affected by whether profits are used to pay out dividends or reinvested in the company. If the company is growing, the growth in revenue will out pace it's net income, if the company is paying dividends, the two growth rates should be similar.

Stocks for companies that reinvest their profits to earn more revenue, are called growth stocks, and do not to pay dividends. Companies that pay dividends with their profits are called income stocks. Companies that report higher revenues/net incomes each year, tend to have the potential to generate the most income for investors. Revenue and net income growth are not the only criteria that should be used to screen potential stocks. But adding them to your analytical strategy may help you to zero in on the type of stocks you are looking for.

Charting revenue/net income growth

Charting revenue and net income growth will give you an idea of the growth of a company. Optimally, you want to invest in a company that has more revenue and more net income than the previous year. By charting the growth, you will also get some indication of the target revenue/income goal for the next year. If the company's revenue/income grows by 50% per year, in theory, the stock price should also grow by that percentage.

The following example will use net income, however you can also apply this example with revenue.

! The difference between revenue and net income. Even though a company has growing revenue it could actually be running a deficit. Net income is revenue after expenses.


Example: 4 year net-income chart for Coca-Cola

To chart revenue and net income, simply grab some graph paper and chart the historical revenue and net income. Ideally both charts should be trending upwards (i.e. the line goes up).

There appears to be some correlation to the growth in net income/revenue and the price charts. Above you see a 5-year price chart of Coke. In the last 5 years the stock price has gained approximately 20% ($40 -> $51).


Example: 4 year net-income chart for Coca-Cola

By extending your graph into the future, you can get some indication of what the expected net income and revenue should be to continue the growth in the stock price.

Sample study of net income growth

In the sample stock screen below (Figure 1, created by the ChartFilter StockScreener), we are looking for every listed company that has met the following conditions.

Figure 1

It's important to note that the ratios are year 1 vs year 2, year 1 vs year 3 and year 1 vs year 4. This is how we search for a growing ratio. The revenue should grow more from year 4 to 1 than year 2 to 1. In the case of our first screen I have used a 2-year ratio of 1.25, 3 year ratio of 1.5 and a 4 year ratio of 1.75 (experiment with these numbers). In other words, the revenue grew by 75% from year 1 to year 4 (or the ratio from year 4 reported earnings and year 1 reported earning has grown by 75%). The revenue grew 50% since year 3, and 25% from year 2. The average growth per year should be greater or equal to 25% per year for last 4 years.

Also included in this screen is the actual net income (year 1,2,3,4) greater than 1 million since we are interested in companies that are profitable. Without this criteria it could have returned companies with growing net income with the net being negative (i.e. a deficit). There are no technical conditions in this screen. A minimum dividend payout was included, because without this criteria, the screen returns over 300 results.

Also, when screening for companies based on net-income or revenue, the differences between revenue and net income should be taken into account, since the type of companies returned in the screen are very different.

Figure 2 shows the actual historical net income and the net income growth ratio for each company.

Figure 2 (top 10 results from Figure 1 screen)

For example,

Screen Result #1 (from figure 2), symbol coke

Reading the results, starting from the top left on Figure 2 above:

Symbol: coke Exchange: nasdaq
Company: Coca-Cola
Last close 53.35
Date screened 2004-11-24,
NetRatio2: means that Coke had 1.35 times the net-income than the previous year
NetRatio3: means that Coke had 3.25 times the net-income compared to 3 years ago
NetRatio4: means that Coke had 4.89 times the net-income than 4 years ago
NetYr1: means that the last reported net-income for Coke was 30.7 million
NetYr2: means that 2 years ago the net-income was 22.82 million
NetYr3: means that 3 years ago the net-income was 9.47 million
NetYr4: means that four years ago the net-income was 6.29 million

Looking at the 5-year chart for Coca Cola, we should immediately see a correlation between the net-income growth (profit) and the stock price.

COKE (Coca-Cola Bott Consol):

Net income year 1, 30.7 million,
Net income year 2, 22.82 million,
Net income year 3, 9.47 million,
Net income year 4, 6.29 million.

Screen result #3 (from figure 2), symbol ubmt

5 year price chart for #3 on results list, Symbol: ubmt [IMAGE="12126820951197592.jpg"/]

Screen result #5 (from figure 2), symbol kmi

5 year price chart for #5 on results list, Symbol: kmi

Charting earnings per share

In the case of coke, one should also see a correlation between the earnings per share and the stock price. Some argue, that this forms a closer correlation than net income. Let's have a look.

First, earnings per share or EPS, is a company's profit divided by the shares outstanding. Based on the number of shares outstanding, the profit per share will give you a better idea if the current price is undervalued or overvalued based on comparing historical trends and/or similar type companies.


Example: COKE (Coca-Cola Bott Consol):

2004 earnings per share 2.41
2003 earnings per share 3.40
2002 earnings per share 2.56
2001 earnings per share 1.07

A growing (up-trending) chart of earnings per share shows that the company is growing in a favorable fashion.