When choosing stocks, it’s tempting to let a company’s current earnings and profits sway the decision. At DYF Investing we recognize there is more to a company’s story than its most recent earnings. This month we want to address the impact an “event” has on a company and the metrics you might use to evaluate potential purchases.
We start by defining an event as something that significantly affects the company, but is outside of its control and not reflective of management or product. People already familiar with this concept will recognize the pandemic as a major event that had a tremendous impact on thousands of businesses, and who had no ability to control it.
For example, the travel industry saw hotels, cruise lines, airlines, and booking services struggle to stay in business. Not because of bad management or a shoddy product, but because of worldwide travel restrictions. This industry saw a massive drop in sales and revenue that clearly affected profits in 2020.
Another industry significantly impacted by the pandemic was online shopping. While the travel industry was negatively impacted, sending solid, well-managed companies to the brink of collapse, online services saw just the opposite. With millions stuck at home, starving for entertainment or basic goods, some online ordering and home delivery services – even ones that were poorly managed or with no unique niche in the market – saw soaring profits in 2020.
What Happens During an Event
During an event some of the company’s metrics are artificially skewed either up or down. For example from 2011 to 2019 Norwegian Cruise Line (NCLH) demonstrated consistent growth of about 8-10% each year. But in 2020 they took a crippling hit with an 80% decrease in profits, and a whopping 466% drop in earnings per share (EPS). The steady growth they’d shown for nearly a decade prior to the pandemic is a good indicator that NCLH was a well-managed company with a viable and profitable product. The sudden plummeting in revenue then came from outside factors, had little to do with the company itself. On paper though, this loss in profits looks quite shocking and might scare would-be investors away.
Not All Events are Equal
If Norwegian Cruise Line is a good example of how an event can make a solid company look like a poor long-term investment, the opposite can be true as well. While NCLH saw an astronomical drop in EPS in 2020, Amazon’s (AMZN) rose by 150%. Because EPS is widely viewed as a way to estimate a company’s value, in this scenario, it can paint an inaccurate picture. Amazon did not necessarily make any broad, systemic changes to generate the higher revenues they saw during the pandemic. Instead, this impressive rise was the direct result of consumers being trapped at home, and might not be sustainable once the pandemic ends.
How Events Affect a DYF Score
When researching long-term investment prospects, it is critical to look at a company’s history to understand its intrinsic, or deeper value. It is also important to understand patterns and trends and how changes to them might indicate such an event might be happening. At DYF Investing, profits, losses, and EPS certainly factor into the DYF score.
We want our score to reflect a company’s genuine intrinsic value. If you take the pandemic out of the equation, Norwegian Cruise Line’s EPS demonstrates a slow, but steady rise. While Amazon has also demonstrated a rise in EPS over the last 10 years, it has also suffered losses, and does not boast nearly the consistency NCLH has shown. That alone tips the scales in favor of NCLH, but might be missed when glancing at recent numbers*.
By effectively accounting for outliers in our score, DYF Investing patrons are afforded a certain sense of confidence, and a great starting point for their own research. A company with a high score demonstrates historical patterns that indicate value and longevity. Because the score is less affected by temporary, external events, it provides a clearer, less emotional view of a company’s investment potential.