Wednesday, November 24, 2010

Measuring The Bottom

Due to cyclical lag effects, recessions affect different industries at different times. This makes it difficult to know whether a particular company has hit bottom, or whether the worst is yet to come. But there are clues investors can use to make this determination. For example, consider EnviroStar (EVI), a stock that currently sits on the Stock Ideas page.

EnviroStar distributes industrial laundry and dry-cleaning equipment, some of which requires long lead times. Intuitively, it's not easy to tell whether the recession (in the form of reduced equipment orders by customers, which belong to several industries) would hit EnviroStar early, late or somewhere in between.

But by looking at the company's receipts of customer deposits (which are essentially down payments on future purchases), investors can get a sense of how revenues are trending. Consider EnviroStar's customer deposits over the last few quarters:

As can be seen from the chart, deposits have been down for several quarters until recently rebounding, suggesting revenue may be on the rise. Seeing as how the company managed through the worst part of the recession without losing much money at all suggests this is a safe investment, particularly considering the company's cash balance.

Investors must, however, be careful not to rely too much on such data. For one thing, just because the trend is up for now does not mean it can't go back down. Furthermore, such data is susceptible to random (quarter-end) timing, particularly as customer deposits represent only a portion of one quarter's revenues. Finally, it should be noted that EnviroStar has been using its cash assets in order to finance some customer purchases; this may be serving to increase sales in the short-term at the expense of taking on higher risk.

Disclosure: Author has a long position in shares of EVI

This article was written by Saj Karsan of Barel Karsan. If you enjoyed this article, please consider subscribing to the feed.


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