Sales by Operating Unit or Product
With core earnings in mind, we may be troubled by the inclusion of
interest income with retail activity. It would be a more accurate form
of disclosure to separate out the two, including a breakdown of gross
profit, expenses and net earnings for merchandise and credit in sep-
arate columns.
The analysis points out the difficulty of understanding and in-
terpreting core earnings in such instances. By removing interest in-
come from the Sears results, we were able to estimate that gross
margin and the expense trends were not as positive as they seemed
at first glance. At the same time, the accuracy of removing credit sales
entirely—either for the purpose of detailed analysis or as part of an
adjustment for core earnings—is questionable. We can only interpret
the numbers based on the level of detail supplied in the annual reports.
Another level of interpretation involves a study of the compo-
nents that make up total revenue. In the case of Sears, the mix of mer-
chandise and interest revenue is inconsistent, and it confuses the
analysis itself. In other situations, the study of a company’s operat-
ing units provides us with a more meaningful and accurate level of
analysis and aids our interpretation of what the overall trend actu-
ally means.
Example: Looking at a three-year history of revenue for IBM
(http://www.ibm.com), we find an overall year-to-year decline (in $ mil):
71
CHAPTER 3•TREND INTERPRETATION
2000 $85,089
2001 83,067
2002 81,186
This suggests that operations are progressively poorer from one
year to the next. But is that enough by itself? A test of gross margin
shows that each year’s profit equals 37% or 38% of revenues, so that
is consistent, indicating that there has not been a change in the mix
of business, even though IBM reports five major sources of revenue.
The largest, global services, reported increases in revenue of ap-
proximately $1.5 billion per year. However, these increases were off-
set by declines in hardware revenues of approximately $4 billion
per year.
Before even making adjustments for core earnings, a study of
net income shows (in $ mil):
2000 $8,073
2001 7,713
2002 3,579
This is translated to declining earnings per share in the three
years of $4,58, $4,45, and $2.10.
The comparison between revenues and earnings for IBM is sum-
marized in Figure 3.1.
By comparing IBM’s sales to a competitor, we can better under-
stand the meaning of the revenue and earnings trend.
72
STOCK PROFITS:GETTING TO THE CORE
REVENUE
EARNINGS
86,000
85,000
84,000
83,000
82,000
81,000
80,000
81,000
80,000
$
M
I
L
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,000
0
$
M
I
L
2000 2001 2002
revenues
earnings
Figure 3.1 Summary of IBM’s revenues and earnings.
Example: In the case of Microsoft (http://www.microsoft.com),
revenues increase each year (in $mil):
2000 $22,956
2001 25,296
2002 28,365
If we were to limit the analysis to just revenues, the conclusion
would be that the growth curve looks good. However, the combined
operating costs and expenses (before core earnings adjustments) also
grew during this period. They went from 52% to 54% to 58%. As a
result, net earnings (before core earnings adjustments) were (in $mil):
2000 $9,421
2001 7,346
2002 7,829
A summary of Microsoft’s revenues and earnings is shown in
Figure 3.2.
73
CHAPTER 3•TREND INTERPRETATION
REVENUE
EARNINGS
29,000
28,000
27,000
26,000
25,000
24,000
23,000
22,000
21,000
$
M
I
L
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,000
0
$
M
I
L
2000 2001 2002
revenues
earnings
10,000
9,000
Figure 3.2 Summary of Microsoft’s revenues and earnings.
Both IBM and Microsoft are limited in this analysis to the rela-
tionship between sales and net earnings as reported and without ad-
justing for core earnings. The purpose here is to demonstrate how
a change in the mix of components makes a difference in the sales
trend. IBM has historically depended on hardware sales, where costs
are far higher than software, which accounts for only about 15% of
total sales. In comparison, Microsoft depends almost entirely on
software sales, with a corresponding higher gross margin. These
variations certainly affect profitability as well as potential long-term
growth for both companies.
A summary of revenues for each company makes this point and
is shown in Table 3.3.
Key Point: In comparing trends—such as gross margin—be-
tween companies, we need to also understand the differences
74
STOCK PROFITS:GETTING TO THE CORE
Year 2000 % 2001 % 2002 %
IBM:
Global services 33,152 39.0 34,956 42.1 36,360 44.8
Hardware 34,470 40.5 30,593 36.8 27,456 33.8
Software 12,598 14.8 12,939 15.6 13,074 16.1
Global
financing
3,465 4.1 3,426 4.1 3,232 4.0
Other 1,404 1.6 1,153 1.4 1,064 1.3
Total (%) 85,089 100.0 83,067 100.0 81,186 100.0
Microsoft:
Software 20,410 88.9 22,720 89.8 23,786 83.9
Services and
devices
1,654 7.2 1,961 7.8 3,531 12.4
Other 892 3.9 615 2.4 1,048 3.7
Total (%) 22,956 100.0 25,296 100.0 28,365 100.0
Source: Web site annual reports at
http://www.ibm.com and http://www.microsoft.com
Table 3.3 Revenue by Segments: IBM and Microsoft (in $ mil)

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