The Magical and Powerful Penny

How much is a penny worth?

Did you say one cent? Wrong!

How about billions or even trillions. No, I am not going crazy just yet! But, as head into the first quarter earnings report of 2014 where most of the S&P 500 companies in the US will meet or beat quarterly earnings expectations.

Which, as strange as it may sound, it works like this: A stock analyst follows a company like Wal-Mart and will call Wal-Mart investor relations department and have the following conversation;

Analyst: “How are things going?”

WM: “Great.”

Analyst: “What is the next quarter will be like?”

WM: “It will be about the same the same as in the first quarter last year…”

Analyst: “You mean it will be about $1.67? ”

WM: Yeah, about there, but please do read our forward looking statements.”

(A forward-looking statement is a document that is drawn up by their attorneys that basically says don’t hold us to anything we have said because it is an educated guess and all investments have risk and if we are wrong you cannot sue us.)

And, believe or not, it is an educated guess because they really do not know.  However, here is the strange part: On the day that their earning is released (98% of the time) it will read $1.68C and everyone will be happy because Wal-Mart which has over 469 Billion (yes, billions with a B) in annual revenue beats the street crystal ball type prediction by one penny. The stock price will go up(gain)$3.11 from $68.36 to $71.36 dollars. In other words, Wal-Mart valuation will go up by 10.20 Billion (they have 3.29 Billion shares outstanding; $3.11 x 3.29 Billion = $10.20 billion).

I like to call it the magical penny, because if Wal-Mart missed this estimation by, say a penny, in this case if the actual number was $1.66c, Wal-Mart Stock would have dropped by about 15% or $10.20c.This  means Wal-Mart valuation would go down by over $33 Billion — $33 Billion just vaporized because of one single penny!

Let take this one step further; if 10 of the 30 stocks that make up the DOW also missed by one penny, you could see a 20% correction in the global market; we are now talking Trillions of equity just gone in the blink of an eye like a chocolate chip cookie in the hands of a 5-year-old boy.

Now how much do you think a penny is worth?

I prefer to look at revenue (the top line) as most smart investors do, such as Intelligent Investors like Warren Buffet. In order to get to the bottom line to squeeze out that extra penny, most corporations do, in fact, cook the books; they will flip & switch different costs to different periods just to please the street. For example, most of the S&P 500 companies since the last stock market crash (in 2008, the US Economy took a head dive into a recession that we are still trying to recover from) have not increased their revenue (top line) but they have found a way to increase profit (bottom line) by laying off employees.

So the next time you see a penny on the ground, please pick it up because millions of lives could change because of this mystical, magical Penny.

“Lynch once said in an interview with PBS that putting money into stocks and counting on having nice profits in a year or two is “just like betting on red or black at the casino. . . . What the market’s going to do in one or two years, you don’t know.”

Peter Lynch

Sherwin Brown

About Sherwin Brown

Sherwin has been an entrepreneur since he was twelve years old. He currently teaches, writes, and speaks to people about how to improve and safeguard all aspects of their financial portfolios.