By DAVID MOON, Moon Capital
August 31, 2003
Too many investors ignore the earnings of a company when evaluating an
investment. They get excited or depressed by a report on CNBC or something
they heard on the golf course. Ignoring earnings is a critical investment
mistake. But blindly placing faith in earnings can be just as big of a
In June, DaimlerChrysler reported earnings that exceeded the expectations of
most analysts. Profit margins were up; investors were excited. This
was especially noteworthy, since the rest of the automobile industry suffered
from a viscous price war in June. DaimlerChrysler, however, accumulated
more than $800 million in additional cash during the quarter.
How did one automobile company manage to avoid the pitfalls experienced by
its competitors? You didn't see substantially more new Voyager minivans
driving around last month. If DaimlerChrysler didn't sell a bunch more new
cars, what did they do?
They were foreign exchange traders.
Over half of their operating profits came from foreign exchange transactions
- betting that the Euro would strengthen against other world currencies.
If you focused solely on the earnings, you never would know that the operating
results at DaimlerChrysler suffered like everyone else.
There is nothing inherently wrong with DaimlerChrysler engaging in foreign
exchange transactions, particularly if intended as a hedge against the currency
risk in its core business. But investors need to realize that every dollar
of earnings is not equal. Some dollars are more important than
If Microsoft earnings increase because more people are buying Windows, that's
one thing. But if Microsoft meets analysts earnings expectations by
selling shares of publicly traded stocks it owns, those earnings increases have
nothing to do with the operations of the company. They aren't nearly as
significant as core operating earnings ' even if Microsoft categorizes the stock
sales as operations.
For years, Coca-Cola would massage its earnings within a period by buying or
selling bottling subsidiaries. It had nothing to do with how many Cokes
people drank, but the results of the realized transactions would be reported as
Apparently, a dollar's worth of earnings at a Krispy Kreme shop is worth more
if the company owns the restaurant rather than a franchisee. When Krispy
Kreme buys a franchisee, they typically pay 7 or 8 times operating
earnings. But investors currently value Krispy Kreme shares at 25 times
operating earnings. If your favorite doughnut shop generates $300,000 a
year in earnings, why are those earnings worth three times more if a public
company owns the businesses rather than a local operator? They
Albert Einstein once said that everything should be made as simple as
possible, but not more so. When you focus exclusively on a single number '
such as reported earnings ' you are trying to make something simpler than it
is. Pay attention to earnings, but not blindly.
David Moon is president of Moon Capital Management, a
Knoxville-based investment management firm. This article
originally appeared in the News Sentinel (Knoxville, TN).