© 2000 John Petroff
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© 2000 John Petroff |
An analysis of company sales requires that the data be disaggregated by product line. Sales of each product must be studied by comparing them to industry sales. The analysis involves four steps. First, the past sales pattern reveals growth rate and degree of instability. Second, company sales are compared with industry. Third, the impact of economic trends and cycles is incorporated. Finally, corporate strategies indicate if past patterns will remain or change.
See review questions Q-9E.1 and Q-9E.2.
1)- Past rate of growth
To determine the trend of each product sales, the two or three years of results reported in annual reports is not sufficient. There are two cases where that would not be true. First, for a product that has a very stable and steady market (e.g. a basic consumer item such as milk), sales are increasing from year to year by the same rate (e.g. population growth); but, naturally, that is also the case where there is little to analyze. Second, in the case of new products or company restructuring, only very recent sales are relevant. Consolidated sales data is usually given for several years (five or ten), but sales by major segments of activity go only back one or two years. This means that several annual reports must be obtained. A monthly break-down is imperative to study seasonal variations and to make projections for less than one year. Monthly sales would only be available to an analyst inside the firm. For long term lending or investment decisions monthly data is not necessary. For seasonal lines of credit, loan officer would require monthly sales along with a cash budget.
Once an adequate data set is put together (i.e. a minimum of ten years), an analyst must decide whether to use the actual numbers or adjust them for inflation. See Section B of this chapter and Chapter 2 Section B-1 on the usefulness and problems of adjustment for inflation. If data series are in current currency, an adjustment is not needed. If real data series are used, such as demographic statistics, then sales should first be deflated (i.e. divided by an index of inflation appropriately chosen for the product in question) so that the amounts in dollars correspond better to actual quantities sold. Then, a time-series analysis described in Chapter 5 Section F is used to determine the long term trend in sales growth.
In general, calculation of a growth rate statistic is needed to decide whether the product has a high, low or moderate growth. To determine if a sales growth is high, one would compare it to the average aggregate real rate of growth of personal consumption expenditure for consumer products, or gross domestic investment for equipment and machinery. If the sale growth rate is higher than the aggregate, that indicates that the product life cycle is still in an early stage, otherwise the product is beyond its maturity.
Next, the level of sales instability can be measured by calculating the standard deviation and comparing it to standard deviation of output of the sector, and of other companies in the same industry. Note that aggregate series are by their nature more stable than their constituent components, and it is not very useful to compare their variability with that of a single company.
| In the case of Timken bearings, we observe that the standard deviation of growth rate of the fabricated metal products industry for the period 1990-98 was only 0.035 compared to the standard deviation of Timken bearings growth rate of 0.07. As expected the industry as a whole is less volatile than one company. But the industry grew by only 0.03, while the growth rate of Timken bearings is almost twice that much 0.057. |
It is normally expected that instability and growth go together. If there is no growth but significant instability, that suggests that demand is unstable for this product. This may be caused by large clients placing occasional large orders (e.g. such as those for Airbus and Boeing), or strategies of competitors taking away customers. The emphasis must therefore be placed on an analysis of demand and competitors. Especially, a technological forecast (see Chapter 14 Section F) would show whether potential new products are likely to wipe out all hope of sales recovery. If that is the case, further analytical work is pointless. Otherwise, a temporary slump has to be explained.
If, on the contrary, growth is healthy but very steady, that may suggest that sales are not affected as much by demand as by production. Although that is a desirable situation for the company, an analyst may question whether some demand remains unsatisfied, and that unsatisfied demand may attract new competitors. In this case, it is the constraint existing in production (or legislation) that must be investigated. In addition, market research can reveal the magnitude of the actual demand.
If growth and instability are both high, analysis is difficult. It is possible that if sales are growing very rapidly but by jumps, this may indicate that growth has been generated by acquisitions of other companies.
| Take for instance Merck's phenomenal sale growth shown by the index of sale growing to 456 in 10 years in Table T-9.3 - Merck Growth Index Income Statement (suggesting an annual growth rate in excess of 40%). |
Growth through acquisition is naturally a very good sign of financial strength and market dominance for the acquiring company. But acquisitions must also be digested, and have occasionally gone sour. Moreover, there is a finite number of firms that can be acquired. Lastly, earlier and subsequent comments about conglomerates suggest that conglomerates are incapable of a continued indefinite growth that is healthy.
For all the cases in between (i.e. neither excessive nor non-existent instability), the next step is to correlate the sales pattern to economic patterns.
See review questions Q-9E1.1 through Q-9E1.17.
2)- Relation of sales to economic trends
Economic patterns are either cyclical or long term, as described in Chapter 15 Section A-2 and Chapter 15 Section B. This analysis is most accurately conducted with regression or sensitivity analysis, as outlined in Chapter 5 Section E and demonstrated in Chapter 14 Section E at industry level. A quicker and less formal approach relies on graphs of plotted sales and aggregate economic data.
A first observation should tell whether company sales vary more, less or to the same extent as the reference business cycle. Sales of very few products move in opposite direction to the business cycle; they are, thereby, labeled counter-cyclical. Attorneys specializing in bankruptcies may be one example (see Chapter 14 Section D-4 for more examples). Less rare are products that are little affected by the business cycle. These are basic items of personal use such as toothpaste, health products and numerous food items. An extreme example is that of funeral parlors. For each of these types of products, linking sales to the underlying demand variable is sufficient.
Most product sales are pro-cyclical, but the sales may precede or lag the pattern of spending in the overall economy. When conducting the regression analysis, one must always test for the presence of a lag or anticipation in company sales pattern relative to the reference cycle. For instance, industries that are affected by cost of capital will precede the business cycle, while industries affected by changes in aggregate output will lag the cycle. If a close fit exists between sales and cycle (lagged or not) it shows that other elements (i.e. industry and long term trends) have only minor influence.
If sales are growing well, but do not coincide with the cycle, there must be some other influence. This influence can be one or a combination of long term changing social patterns which are further discussed in Chapter 15. Sales sensitivity to these patterns needs to be tested. If none give a reasonable explanation, then sales growth must be attributed to company unique strategy and to conditions in the industry.
| Returning to the Timken example, after determining sales growth rate and stability, Timken bearings sales can be analyzed in term of cyclicality and sensitivity. We first choose to test if Timken bearings sales are correlated with statistic for output of non-electric machinery manufacturers. The regression gives a coefficient of determination (i.e. R2) of .92. This strong correlation suggests that it is not necessary to look for another determinant of Timken bearings demand. |
See review questions .Q-9E2.1 through Q-9E2.7
Industry sales are studied in a similar sequence to that of a company: growth, instability, cyclicality and sensitivity to long term social-economic patterns (as shown in Chapter 14). An analyst would indeed want to compare the industry sales behavior with that of the company. This would tell if the company is falling behind, or not, and if sales are affected by similar processes.
A shortcut that avoids this extensive investigation, is to calculate the market share of the company over the period of years studied. If the market share has remained steady, it shows that industry and company sales have moved in parallel, that the market is not subject to aggressive strategies of competitor, and that demand is not much disturbed by changing social patterns. This also suggests that an aggressive company strategy may be a waste of efforts.
If the company market share has been going up, that has to be a good sign. Reasons must be traced to company strategy. If the investigation does not reveal that. Then one must find out why competitors are pulling out of the market.
If the company is losing market share, the causes are of major concern. An analyst must find out what strategies are used by competitors: price, technology, convenience, location, or other. If the investigation does not give definitive answers, then changing socio-economic patterns must be looked at again with greater attention. This would also justify a market research for an analyst inside the company.
See review questions Q-9E3.1 through Q-9E3.5.
A market research can be expensive and lengthy. Clearly, it is recommended only if the sales analysis using available statistical and historical information does not give adequate answers. Market research uses a variety of techniques such as surveys, interviews, panels, market tests and expert opinions, reviewed in Chapter 5 Section I. It is intended to reveal customer preferences: i.e. the reasons why customers buy certain products, and therefore do not buy others. For the company, a market research is indispensable for strategy formulation, and is conducted periodically. For an outside analyst, a market research on a product is inconceivable unless the decision at hand is a purchase of the company.
See review questions Q-9E4.1 through Q-9E4.3.
5)- Foreign market considerations
Sales in foreign markets are studied in the same manner as domestic sales, with the exception that tastes, socio-economic patterns, business practices, legislation and other market conditions, are different and less well understood by the analyst than domestic ones. In addition, statistical data in almost all foreign markets is deficient. On a more positive note, sales growth in foreign markets usually follows by a few years that of the domestic market. In today's increasing global economy, one would want not to make a distinction between domestic and foreign markets. But, except for a few countries that are very close culturally and economically to one's own country, the distinction is still warranted.
See review questions Q-9E5.1 through Q-9E5.4.
6)- Company strategy
After accounting for all external factors (except possibly luck), i.e. business cycle, socio-economic changes, competitors' strategies, consumer preferences and foreign market conditions, what remains are internal reasons for sales variations. One would want to think that company sales are the result of carefully planned and deliberate management decisions in aspects of product, price, place and promotion (also known as the four P's of marketing). Consequently, any change in market share ought to be reflected by a prior marketing strategy, or lack thereof. An analyst must also investigate that the company does not suffer from: defective purchasing or production (i.e. two other P's).
If exceptional sales growth is most certainly attributable to a wise company strategy, an analyst must give management recognition, and take this into account in sales projections. If, on the contrary, sales have been erratic or slumping, suggesting a history of marketing mistakes that the company is correcting in the current plan, that still justifies an analyst's confidence. But no such redemption is warranted if neglect is apparent in company approach to its market.
See review questions Q-9E6.1 through Q-9E6.4.
See research assignments R-9E.1 through R-9E.3.
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