Stock markets go through many different cycles. In each one, there are one or two elements that make a successful investment. For example, interest rates are always a concern for financial institutions or companies that borrow a large amount of money. For these groups, the higher interest rates go, the lower profits will most likely be unless they are able to raise prices and/or cut costs faster than interest rates rise.
Right now, the main focus for most investors should be revenues. That's because without increasing revenues, there is an absolute amount of profits that any company can achieve. Simply by cutting costs, a company can increase profits, up to a point. But eventually lowering expenses isn't enough because there are only so many costs that can be cut before a product or service begins to weaken and affect sales.
Recently Hewlett Packard Co. (HPQ) reported a 14% increase in profits for its fiscal fourth quarter while sales were down 8.4%. HP is the largest tech company and has overtaken Dell Inc. (DELL), which showed a slip of 54% in its quarterly profits in the most recent period. So HP is the new bellwether for tech.
"We feel as good about our portfolio and our market position as we ever have," said Mark Hurd, HP's chief executive, during a conference call. "So make no mistake about that. If you talked about our view of our competitive position, it just has never been stronger."
HP is ready for whatever economic rebound is waiting. The only problem for investors is that if the wait is too long, profits most likely won't be increasing. HP cut expenses and is looking to lose more. One of its new divisions, EDS, is about a third of the way through a $3 billion annual cost saving plan. That will help. But soon there won't be much more to cut without losing essential people and/or programs that made HP number one.
Another company, Hormel Foods Corp. (HRL) which makes Spam and other meat products, increased its profits by 54%. But sales were down 10% as volume fell 3%. It will no doubt continue to cut costs to improve profits, but sales have to improve if sustained profit growth is to continue.
Many other companies are reporting the same news: higher profits but lower sales. That's not the formula for success. While it speaks to better efficiencies, it doesn't address the main element for continued growth. Higher sales is the only way to do that.
As investors, the current important element in a stock is sales growth, not just profit growth. While profits are what ultimately drive a stock's price, they ultimately rely on sales for better results. Without increased sales, there can't be a sustained improvement in profits.
For the current market cycle, then, one of the crucial elements for investing success is sales growth. Look for companies that are either selling more products and services or are buying others to expand market share. The ones acquiring other companies will most likely find efficiencies through consolidation and improved profitability. But they need to keep selling more or profits will stall.
To help investors discover companies that are increasing revenues, The Online Investor is adding a new column that will list the top five companies in an industry that are growing their top lines.
Ted Allrich is the founder of The Online Investor, chairman of the board of Bank of Internet USA, as well as the author of the book Comfort Zone Investing: Build Wealth and Sleep Well at Night. In this weekly column, he offers advice to investors who are just getting started.
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