Wednesday, March 25, 2009

Seeing Into The Future

Have you ever examined a company's financials from last quarter, but wondered how well the company is doing right now? We'd all like to know the future; after all, when we buy a stock we are buying its future income. Fortunately, there are some clues we can use to get an idea of how well the company is currently doing.

One such useful piece of info comes from the "Deferred Revenue" line of the company's balance sheet. When a company receives payment for a service it has not yet performed (e.g. pre-paid magazine subscriptions, a downpayment on a home that has not yet been built, season tickets for a sports franchise, gift certificates at retailers), it does not get to record revenue, so this money does not show up in past revenue results. However, the company does receive cash and makes an entry under its liabilities called "Deferred Revenue", i.e. revenue it will receive when the service has been performed.

Taking a look at this line item year over year can give you a good idea of whether the company in question has decent prospects going forward. Of course, you cannot consider this line in isolation. For example, growth in this line item for a retailer could simply be part of the growing trend of consumers switching to gift cards over hard goods as presents for loved ones, and may not signal that the company's overall sales are strong. Steady deferred revenue for a magazine may signal a sharp reduction in prices, and actually suggest an upcoming downward trend!

On the other hand, for some companies steady deferred revenue in this environment can be an indicator of resilient demand for its products. For an NFL football team, steady season ticket revenue (since we're talking about a finite number of seats, as opposed to an unlimited number of magazine subscriptions) in this environment could signal strengthening demand for tickets. For a company like LoJack (LOJN), which takes the cash up front but recognizes its revenues over the term of its service contracts, a look at its deferred revenue changes over time can offer a hint as to whether the company is able to renew contracts at the same rate as they expire.

Deferred revenue is only one of the clues we can use to determine a company's future performance. Management guidance, economic and industry expectations can also help. What are some of the other clues you like to use?

Readers interested in "seeing the future" on the price of oil may be interested in this free video, brought to you by our sponsors at INO TV.

1 comment:

Mike said...

Hey Saj, for manufacturing companies I like to look at the new order backlog. I know nothing is set in stone but for manufacturing companies to have a strong order backlog in this kind of economic environment is something I like to see.

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