3 Questions to Take a Bite Out of Your First Stocks

Dave is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Recently, I was watching the TV show “Shark Tank,” in which business pitches from aspiring entrepreneurs are accessed by a panel of potential investors. While watching, I noticed specific questions and themes repeating themselves again and again. It occurred to me that, by applying those practices to my investing, I could become a better investor myself. So, let’s dive into the Shark Tank, and take our first strokes toward determining the investment potential of Nike (NYSE: NKE), Lululemon Athletica (NASDAQ: LULU), and Sodastream (NASDAQ: SODA) by considering three questions:

1. What does the business do?

2. Is the business making any money?

3. Where does the money come from?

What do you do?

Nike has been “just doing it” for decades: designing, manufacturing, and selling branded athletic footwear and apparel. Lululemon designs and sells branded technical – Yoga inspired – athletic apparel. And finally, Sodastream manufactures patented household size soda makers, carbonating bottles, CO2 cylinders, and refill flavors.

Okay, as silly as it may seem to tell you Nike makes shoes, consider this an exercise, and an essential first step to get your wheels turning. I bet just using the short descriptions of each company you could start making inferences about potential competitors and possible market sizes for each product. Also, remember that Nike doesn’t just make shoes, it makes Nike shoes.

Show me the money

Once you’ve nailed down what exactly the company does, it’s time to determine profitability. Below is a chart describing total revenue, net income – in millions – and profit margins from 2012.

<table> <thead> <tr><th> <p><strong>Company</strong></p> </th><th> <p><strong>Total Revenue </strong></p> </th><th> <p><strong>Net Income </strong></p> </th><th> <p><strong>Profit Margins </strong></p> </th></tr> </thead> <tbody> <tr> <td> <p><strong>Nike</strong></p> </td> <td> <p> $24,128</p> </td> <td> <p>$2,223</p> </td> <td> <p>9.2%</p> </td> </tr> <tr> <td> <p><strong>Lululemon </strong></p> </td> <td> <p>$1,001</p> </td> <td> <p>$184</p> </td> <td> <p>18.4%</p> </td> </tr> <tr> <td> <p><strong>Sodastream </strong></p> </td> <td> <p>$436</p> </td> <td> <p>$44</p> </td> <td> <p>10.0%</p> </td> </tr> </tbody> </table>

All three are profitable, which is great, but the numbers displayed above paint a poor picture -- or, rather, an unfinished picture – of what exactly is going on. This is precisely why year-over-year comparisons are a necessity, and it would be helpful to know that SodaStream, Lululemon, and Nike’s net income grew 329%, 216%, and 17% respectively, between 2009 and 2012. Whoa! Now that’s a game changer.

Where’d you get all that money?

To this point, it’s clear the three aforementioned companies do something, and each does it well enough to make a profit – but that’s not much to go on. Although, it does lead us into the next important question when analyzing a company: where does the money come from?

Nike is the largest athletic footwear and apparel company on the planet, spreading from North America to China, and invading everything In between. However, what would happen to Nike if people stopped buying Nike shoes?

<img alt="" src="http://g.fool.com/editorial/images/27195/nike-2012-revenue-by-brand-jpeg_large.JPG" />

With footwear making up more than half of Nike’s revenue, it’s fair to say, it would be downright catastrophic! The same can be asked of distribution in global markets. In 2011, the tsunami in Japan had a devastating effect on the country, and Nike’s sales in the region. However, Japan only accounts for a small portion of Nike’s total revenue, and with the company’s expansion into South America, Nike still experienced strong net income growth -- just one of the many perks that go along with investing in larger, more stable, companies.

<img alt="" src="http://g.fool.com/editorial/images/27195/nike-2012-global-distribution-jpeg_large.JPG" />

Lululemon

The company has a few locations in Australia and one in New Zealand, though I wouldn’t exactly consider it an international brand. For now at least, the fate of Lululemon relies much more heavily on U.S. sales.

As for reaching customers, Lulu uses a two channel approach. The first, its 174 corporate-owned stores, accounts for more than 80% of its revenue. The second is the company’s website, making up a smaller portion of sales. Now, John Currie – Lululemon’s Chief Financial Officer – has stated that the company plans to grow its online capabilities. This will certainly be something to keep an eye on, because a stronger second channel could lead to nice revenue gains in 2013 and beyond.

Sodastream

Sodastream may be a one trick pony, but to the company’s credit, a household size soda maker is a pretty impressive trick. Moreover, with distributers like Macy’s, Costco, Walmart, and Target – just to name a few – dishing out Sodastream products shouldn’t be a problem.

When it comes to determining where the company’s revenue comes from, Sodastream is similar to a Kindle or video game console. There is an initial boom in console sales, and then as console sales slowdown enhancement products -- like books and games – take off.

The U.S. is still in the first stage of this process, with soda maker sales accounting for almost half of total revenue. However, if Sodastream stays true to form, the U.S. should evolve to match the more mature Switzerland market, where soda makers only contribute 18% of sales, allowing for C02 canisters and refill flavors to flourish. And according to Sodastream’s March 2013 presentation, profit margins actually increase during the maturation process. If the trend continues, Sodastream would be in a great position to maintain profitability into the distant future.

In conclusion

Today, we’ve dug into three of the first, and most important, questions to ask when beginning to evaluate a company. So far, I like what I’ve seen. All three companies have innovative products, shown strong growth, and have developed clear channels for streaming profits. However, we’re far from determining which, if any, of the companies mentioned today are sound investments. Therefore, I’ll be diving right back into the Shark Tank next week with all new questions to continue chipping away at Nike, Lululemon and Sodastream.


Dave Koppenheffer has no position in any stocks mentioned. The Motley Fool recommends Lululemon Athletica, Nike, and SodaStream. The Motley Fool owns shares of Nike and SodaStream. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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