This post addresses these two questions
- What do you think when you read on the news: Retailer A’s sales increased by 9% this year compared to last year?
- What does “a 7% jump in comparables/comps for a retailer” mean?
In addition to revenue growth, look at gross margin as well
The first thing that jumps out of an income statement is revenue or net sales. That’s why it’s often referred to as “top line”. Does a change in revenue say a lot? Not so much. Let’s say if there is a year-over-year decrease in revenue, it’s safe to say that the company goes backwards directionally. If there is an increase year-over-year, the only conclusion that can be made at this stage is: well, at least this year isn’t a disaster, yet. Because there are a lot of factors that can contribute to the increase in revenue and can make such an increase pretty meaningless. It requires further investigation.
Let’s look at an example. You sold 10 tomatoes last year, each of which was bought at $7 and sold at 10$. The total revenue last year was $100 and the gross margin was ($10 – $7)*10 pieces = $30. Gross margin ratio is $30/$100 = 30%.
This year, you sold 15 tomatoes for $12 each, but the cost of sales for each tomato went up $10. The total revenue this year went up to $180, an increase of 80% compared to last year. However, gross margin stays at ($12-$10)*15 = $30 and the ratio, as a result, decreased to $30/$180 or 16.7%. You can see clearly that the unit economics worsened and your business is actually in a worse shape than it was last year. Of course, this doesn’t even take into account other expenses such as Sales and Marketing, Selling, General and Administrative Expenses (SG&A) or R&D. I don’t want to go off track too much and this example should show you that relying on revenue growth alone isn’t anywhere close to being enough.
If gross margin isn’t an issue and revenue increased, does it mean that it’s all good? Not really.
Why do we need comparables?
For instance, if a retailer that operates multiple stores has an 8% YoY increase in revenue, it means that it brings 8% more this year than it did last year. There are two important factors that can contribute favorably to that and potentially mask the true performance of the retailer
- Time: sometimes the comparison is between 52-week and 53-week fiscal years. As a result, it’s not surprising that the 53-week fiscal year brings in more sales. You can see from Figure 1 below Target highlighted the fact that 2017 had 53 weeks and they removed the results of the 53rd week from comparison to make it fair
- Number of stores: if this year’s performance is derived from more stores that last year’s, it’s then not a fair comparison.
That’s why retailers use the comparables concept in their reporting. It reflects the increase or decrease in performance derived from the same stores over the same period of time. Such an approach will result in a true fair comparison and an honest reflection of a company’s health
Figure 2 is a table from Costco’s latest annual report. The changes in comparable sales are smaller than the changes in net sales, albeit that all are positive. It means that in addition to the growth organically from the same stores in 2018, Costco also benefited from opening new stores. Without the breakdown, investors would not be able to discern Costco’s true performance in 2019.
Another useful metric to look at is Revenue Per Square Foot. It divides the total revenue by total square feet and reflects how much money a retailer can generate per a square foot. A square foot’s size doesn’t change over time. Using this metric, investors can generally tell whether a retailer leveraged its retail space better, regardless of how many stores were closed or opened.
In Figure 3, the first number column from left to right is for 2019, followed by 2018 and so on. As you can see, Target increasingly generated more revenue per square foot from $298 in 2017 to $326 in 2019. Generally, it should be a positive sign, but like the case of revenue above, it may still be a misleading metric.
Let’s run a scenario. This retailer ran two stores in 2018 and added one more store during the year of 2019. As you can see, the revenue per square foot in 2019 was higher than that in 2018, but it may not be cause for celebration. Sales in Store A and B declined and the increase in revenue and revenue per square foot came solely from Store C’s performance. It means that there was some trouble with Store A and B; which caused a decrease in revenue.
In conclusion, it’s hardly enough to use one single metric to judge a company’s health. It’s a combination of many. Hope you found this helpful. Have a nice 4th of July.
Minh Quang Duong 