Login | December 08, 2019

Channel stuffing

Ask the Fool

Published: July 16, 2019

Channel Stuffing

Q: What does "stuffing the channel" mean? -- P.D., Mansfield, Ohio

A: If a company inflates its sales numbers by shipping more products than can be sold through its distribution channels, it's stuffing the channel.

Companies often record sales as soon as they ship products, so shipping goods ahead of schedule makes it seem that business is booming. This can result in many unsold products being returned to the manufacturer, so sales that were already claimed never actually occur. This is an illegal way for companies to "cook the books," and some executives have gone to prison for it.

When a company's accounts receivable are growing faster than sales, that indicates possible channel stuffing. One way to check for it is to calculate a company's "days sales outstanding" (DSO): Divide accounts receivable by sales (sometimes referred to as revenue), and then multiply the result by the number of days in the period (often 91 for a quarter, or 365 for a year). This reveals how many days' worth of sales are represented by the current accounts receivable. Between 30 and 45 days is typical.

A company with a low DSO is getting its cash back quickly and, ideally, putting it immediately to use, getting an edge on its competition. Rising numbers can signify channel stuffing. This doesn't work in every industry, though: Cash-based businesses such as restaurants, for example, don't usually have much in the way of receivables.

Q: What's a "block trade"? -- A.K., Fort Myers, Florida

A: Block trades are large orders to buy or sell stocks or bonds at a price agreed upon by two parties, such as hedge funds or pension funds. They typically involve at least 10,000 shares of stock or $200,000 worth of bonds.

Fool's School

Stocks for All Ages

Conventional wisdom will have you shifting assets out of stocks and into bonds as you age and approach retirement. Don't follow that blindly, though, as stocks can still serve older investors well.

The rationale for the rule is that the stock market can be volatile, and retirees won't want to have to sell some stocks after the market has swooned for income to pay their bills or otherwise support themselves. While younger investors can simply wait out downturns, retirees have less flexibility.

On the other hand, stocks tend to average significantly higher growth rates than bonds, so a sharp shift into bonds -- or other "safer" investments such as certificates of deposit (CDs) -- can really slow your portfolio's growth. (Stocks outperformed bonds in 96% of all 20-year holding periods between 1871 and 2012, and in 99% of all 30-year holding periods, says finance professor Jeremy Siegel).

Making matters worse, in periods of very low interest rates, many bonds won't even keep up with inflation, so over time the purchasing power of your money can shrink. Inflation has averaged 3% annually over long periods.

Then there's age. "About 1 out of every 3 65-year-olds today will live past age 90, and about 1 out of 7 will live past age 95," says the Social Security Administration. If you retire at 62 and then live to 95, you're looking at 33 years of retirement. A good portion of your assets could stay growing in stocks for at least the first decade of your retirement.

An old rule of thumb had you subtracting your age from 100 to see what percentage of your assets should be in stocks. So if you were 65, you'd have 35% in stocks. With people living longer, though, many advisers now suggest subtracting from 110 or 120; that would have a 65-year-old investing 45% or 55% of assets in stocks.

For more retirement guidance, try our "Rule Your Retirement" service at Fool.com/services. You might also consult a good financial adviser.

My Dumbest Investment

Stopping Losses in Funds

Without a doubt, my most regretted investment move was not placing a stop-loss order for the mutual funds in which I was invested when the market was roaring ahead in the late 1990s. I was caught up in the euphoria of the long-running bull market; I never thought of disciplining myself to get out of funds that dropped by 10% and to stay in cash while the market continued its downslide. If I had, I'd have been able to buy into some great funds that had fallen and would rebound nicely. -- B., Coeur d'Alene, Idaho

The Fool responds: Remember that hindsight is 20/20. You're wishing that you'd engaged in "timing the market" -- getting into stocks before they soar and then out of them before they drop -- but that's not something easily accomplished.

It's fairly certain that the economic environment will alternate between bull markets and bear markets, but no one knows beforehand just when such periods will start and stop (though some pundits occasionally guess correctly).

Also, because of the way that mutual funds work, you can't place stop-loss orders for them, expecting your broker to sell your shares if they fall to a set level during the day. Mutual fund shares don't fluctuate during the trading day. You can get around that limitation by investing in solid exchange-traded funds (ETFs), which are like mutual funds, but trade like stocks.

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Foolish Trivia

Name That Company

I trace my roots back to the 1930s, when the owner of a service station and motel in the South began cooking for travelers. Today, based in Kentucky, I encompass more than 48,000 restaurants in more than 145 countries and territories. My three main brands are KFC, Pizza Hut and Taco Bell. My name and ticker symbol are what customers might think when they eat my fare. I debuted in China in 1987 and spun off my China division in 2016; it now boasts more than 8,600 locations. Once owned by PepsiCo, I was spun off in 1997. Who am I?

The Motley Fool Take

Aye, Robot

Wall Street didn't like what it saw from the first-quarter earnings report of iRobot (Nasdaq: IRBT), maker of robotic Roomba vacuums, Braava mops and Terra lawn mowers. After revenue missed analysts' expectations in late April, the market punished the stock, sending shares tumbling 23%. Long-term investors might want to treat this dip as a buying opportunity, though.

For one thing, revenue actually grew in the quarter by 9% year over year, and earnings surpassed expectations. Management noted stronger-than-expected demand for the high-end i7 and i7+ Roomba models in the U.S., despite recent price increases to help offset the impact of tariffs. It also touted a "very successful" launch during the quarter for the i7 and i7+ in the EMEA (Europe, Middle East and Africa) region, Japan and China.

The recent stock price drop has had shares trading near a price-to-earnings (P/E) ratio of 29, well below the five-year average of near 35.

IRobot has a massive addressable market -- robotic vacuums recently controlled only about 23% of the high-end vacuum market -- and plenty of room to grow. Its more than 200 U.S. patents and more than 400 international patents can further fuel innovation.

For investors who know enough to look beyond Wall Street's overreactions and into the business's fundamentals, iRobot looks like a great growth stock, especially at this price. (The Motley Fool owns shares of iRobot.)

(EDITORS: For editorial questions, please contact Elizabeth Kelly at ekelly@amuniversal.com.)