For many investors, relative performance and relative valuation analysis are key to knowing which stocks look expensive and cheap.
Peer analysis of earning power performance also provides insights into competitive strategies and results.
Imagine the confusion when finding out that two peers like FedEx and UPS have such different accounting that basic calculations like earnings are totally incomparable.
What’s really happening between these two delivery giants?
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CFA Societies around the world – for Chartered Financial Analyst charterholders – seem to really love when we present this example of FedEx versus UPS.
These two giant delivery and logistics firms are such close competitors with such similar business models that it really brings to light their terribly mismatched financial statements and metrics.
One of the first presidents of the first CFA Societies in New York was Shelby Davis. That was 1947. That same year, Davis borrowed $50,000 from his wife to focus on investing in stocks.
Davis conducted numerous speeches on the problems inherent in financial statement structure and presentation. He very vocally noted the lack of consistency between the financial statements of even the closest peers.
One particular speech was titled very simply:
Seems like very few paid attention. Certainly not the accounting governance bodies.
Following his own advice and research, Davis turned that $50,000 into an $850 million dollar fortune. He is one of the greatest investors in history.
What is the power of Uniform Accounting? FedEx (FDX) and UPS (UPS) make for perfect examples.
Using as-reported metrics, for much of the past 5 years and before, UPS and FedEx look like very similar businesses in terms of profitability.
Both had as-reported ROA around 7%-9% levels. But when looking at the two businesses, FedEx looked like a much more stable business, and therefore a higher visibility investment.
In reality, key distortions between the two companies’ accounting, in particular how they choose to finance their fleets of trucks and airplanes, make their financial statements totally incomparable.
FedEx leases most of their equipment, UPS mostly owns their equipment. Under prior accounting rules, companies were not required to show leased assets on their balance sheets.
That meant FedEx showed far less in invested capital than UPS showed, for most of the trucks and airplanes they operated.
While the accounting rules changed, GAAP and IFRS have still failed to fix this terribly inconsistent distortion. Firms that lease assets heavily, like FedEx, still cannot be compared to firms that buy their assets.
It’s still apples and oranges in the financial statements.
Earning Power Revealed
After we make our Uniform Accounting adjustments though, both of the company’s returns become more apparent. UPS has actually had much more robust returns than FedEx most of the past 5 and 10 years. And they’ve also been mostly stable until 2017-2018. Uniform Accounting lets us avoid making wrong conclusions about companies.
Sometimes, you don’t even need to make Uniform Accounting adjustments to realize one company is significantly better than a competitor, you just have to ignore the lazy comparables investors have a habit of making.
Being able to compare the quality of the earning power of two companies is a key driver of the investment process of many great investors.
The problem is, using as-reported metrics to do this analysis and make investment decisions can lead to directionally wrong buy/sell decisions.
It’s as dangerous to make decisions using as-reported accounting as it is to make investment decisions by making overly simplistic comparisons of one company to another, assuming that just because they’re competitors, an underperformer can replicate a best-in-class company’s strategies.
United Parcel Service Tearsheet
As our Uniform Accounting tearsheet for UPS highlights, UPS trades around corporate average valuations. The company has recently had an 18% decline in Uniform EPS growth. EPS is forecast to actually rise by 55%, in 2019, but then slow down to 6% levels in 2020.
At current valuations, the market is pricing the company to see earnings grow by 10% a year going forward.
The company’s earnings growth is forecast to be above peer averages in 2019, but the company also trades at a slight premium over average peer valuations. The company has below average returns and high cash flow risk going forward.
As our Uniform Accounting tearsheet for FDX highlights, FDX trades around corporate average valuations. The company has recently had 50% Uniform EPS growth. EPS growth is forecast to turn negative, at -21%, in 2019, before returning to positive 10% levels in 2020.
At current valuations, the market is pricing the company to see earnings decline by 2% a year going forward.
The company’s earnings growth is forecast to be below peer averages in 2019, but the company is trading at a premium over average peer valuations. The company has strong returns, and no cash flow risk going forward.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research