The first step in looking at a potential stock is looking at the company’s past financial performance. This lays the foundations for our understanding of why the company’s stock price has moved the way it has, and also helps us start to think about how we should view the stock.
To demonstrate this, we’re going to do a 4-step look at Aeropostale (ARO), a stock that lost most of its value in the last year and has recently spiked on speculation. Now a penny stock, this was once a significant player in the retail fashion market. A look at a couple of websites and a few minutes in Excel makes it clear what went wrong.
Step 1: Get Financial History
On Google Finance, look up Aeropostale and click on “Financials” on the left hand side. You’ll see income statements, balance sheets, and cash flows. First we will look at the income statement:
With this we can immediately see the company’s revenue, gross profit, operating expenses, and operating income for the last 5 quarters. There are many more important metrics, but for now we’ll stick to these four. We want to transfer this info into Excel, keeping an empty row below each:
Step 2: Calculate the Trends
Apparel is very much a seasonal business, so we want to know the year-over-year changes for each of these numbers. That’s what the space below is for; we can easily compute that with a simple formula, copy and pasting, and getting the past FQ data from Edgar and Aeropostale’s investor relations page:
Note how this is about 15 minutes of web surfing and Excel data entry, but already we have some nice information right at our fingertips. Now we can start to do some analysis.
Step 3: Find the Trends and Variations
Now we can identify some clear and consistent trends, as well as some interesting changes in ARO’s financial activity:
- Revenues keep falling, and the rate of decline is worsening
- Gross profits vary significantly, going from profit to loss
- Operating expenses have been falling wildly, indicating effective cost-cutting
- However, operating income has absolutely cratered on a year-over-year basis and the company has not operated profitably for over a year.
Step 4: Analyze the Data and Compare with Others
When we look at this, and we look at the stock price, the market’s behavior makes total sense. The stock has lost 85% of its value in the last year, causing its market cap to shrink to less than $38 million. Effectively, it has become a penny stock. With worsening revenues and an inability to be profitable despite cost cutting, there has been little reason to invest in the company on the thesis that it will grow.
That doesn’t mean there’s no reason to buy ARO, however, and one hedge fund has increased its holdings in the company lately.
For this story, we need to look at the company’s balance sheet (also on Google Finance). The company’s total equity has evaporated and it has gone from $50 million in May 2015 to -16 million in October. At this point, the market has priced in a bankruptcy in Aeropostale’s future, but investors should also remember that the company is still able to sell over $1.5 billion in clothing in a calendar year. Even if that is shrinking, a restructuring of the company and a change in management could potentially unlock shareholder value.
But that is an extremely high risk investment thesis, and even a restructured ARO might find the market has moved away from its business model and fashion will not give the brand a second chance. This is why it has become a penny stock with a low market cap, and is also why the vast majority of institutional investors are staying away.