Monday, April 11, 2011

Breaking Down Revenues

Edit:  Exciting news!  My article is being featured in The Carnival of Value Investing!  Check it out!

Hey everyone,

Last week I alluded to the never-ending rabbit hole of looking through financial statements.  I want to expand upon this a bit for my first post delving into financial statements.

For this week I have selected a company completely at random, which coincidentally happens to be a company that I have owned at one point in the past:  Owens Illinois, ticker symbol OI.  Let us pretend that OI is on the my short-list that I asked you all to create last week, and that I am eager to know more about this company.  Let me first pull up the income statement on Yahoo! Finance and see what sort of data I get.  It is as follows:

Now, please do not think that I am getting at Yahoo! Finance with what I am about to say:  Yahoo! provides an excellent service by serving up financial information in a condensed fashion that is easily accessible, for, as far as I can tell, all publicly traded U.S. companies.  Yet, there is so much information lacking from the above data churn that I need to warn you against analyzing a security just based upon the above data.

While we can be fairly sure that the above data is accurate, a perfect illustration of this lack of detail is in the top line:  Revenues.  This company could be an insurance company that generates income through underwriting profit, or it could be an industrial company that manufactures livestock feed.  At this point, we have no idea where the money is coming from.  If we attempt to make any sort of meaningful projection about these revenues through a numerical approach (Example: presuming revenue grows at 4% a year) our projection will be entirely without substance and fall flat.  We need to dig deeper.

It seems fitting, at the beginning of the exploration of financials, to start with revenues, too.  This is the welcoming gate for all goods and services rendered, so it behooves you to be pretty familiar with all the sources of revenue your company generates.

So where do we go to dig deeper, you may ask?  Check out this tutorial if you're unfamiliar with looking up financial statements.

Now, we're looking for Owen Illinois's most recent annual filing, which is the 10-k filed on the 10th of February, 2011.  If we look at the Business section of this report, we see that Owens Illinois is a worldwide manufacturer of glass packaging.  This makes the diversity of our products relatively simple: there is only one product, which is glass packaging.  However, this does not mean that our revenues should remain consolidated.  We can break down revenue by country of operation.  Refer to Item 7, a breakdown of revenues by country.  

You may be asking yourself, why is this important?  What information can we glean from this?  Well, look closer.  I have made a common size statement in excel (meaning "written as a percentage based on 2008's data") which should help make it more clear:

(By the way, if you don't already love Excel, you will when you have played with financial statements for long enough...)

Notice from the common sized statement that, if you just looked at sales, you may think that things, while markedly worse in 2009 which you could write off to the recession, sales have essentially stayed flat in 2010, with revenue/sales only dropping a meager 0.2%.  You might deduce from solely this information that Owens Illinois has reached some sort of plateau and may reverse course in 2012.  Yet, there is a more ominous picture being painted here.  Look at how in both Europe and North America, during 2010 sales, continue to drop at a pretty astounding rate.  The only thing that obfuscates the drop in these sales is the increase in activity from South America and Asia Pacific.  This is a clear indication that further research needs to occur, which requires us to come up with a few good questions for Owens Illinois' investor relations department when we call them.  

I would love to hear others opinions about the following question: Is glass packaging really a necessity anymore, or is it more of a luxury?

Is it a luxury that North Americans and Europeans would prefer to do without?  50 years ago you would always find Coca Cola in its iconic glass bottle, now one pays four to five times as much for coke in a glass bottle as in a plastic bottle.  Why get a beer out of a bottle when beer out of a can does the trick? On a cursory examination, one might be overjoyed to find that Owen Illinois dominates the glass bottling/packaging industry.  Yet, the glass industry is itself in jeopardy.  Sectors themselves fall under attack by better, more efficient sectors.  Are smartphones a different ballgame than desktop PCs?  Is Dell safe from HTC, or not?  We cannot simply consider other glass manufacturers as potential competitors for Owens Illinois.  When we look at OI under more intense scrutiny, the competitive advantage we demand for potential investments disappears.

Back to revenues.  In this case, product breakdown was not an issue, but in many other cases it is something to consider.  It is always a wise decision to attack each accounting item in an attempt to further dissect the company.  Security analysis is about attention to detail!  It is details that go undetected, and it is details that can ruin firms.  Remember, when we value invest, we are already finding companies that we can confirm are serious bargains- if they simply survive at a sustained level of profitability, we will make above average returns because of the price we acquire them at.  When you see a number in a financial statement, attack it in every way possible!

See you next week!


  1. Great post. I have never thought of breaking down the revenue (by region). Thanks!

  2. Hey Jacob! Thanks for commenting.

    Breaking down revenues (and virtually all financial statement line items) is critical to spotting potential flaws in companies which will help one avoid all sorts of problems when investing. If you just look at revenues, it is like looking at the earth from the moon without a telescope- you will never see a small fire starting before it becomes a large fire! So get out that magnifying glass while looking through your company's financials!

    Thanks for reading!

  3. Owens Illinois is a company thats been around a very long time indeed.