For a while now, every earnings season has had its share of companies blaming the high dollar for disappointing results. So much so, in fact, that most investors seem to have become inured to it. We hear a CEO or CFO earnestly explaining that the strong dollar has had a negative impact, then telling us that their earnings in “constant currency” are actually quite good, and we believe that is the case and that their miss is actually a beat. But is that true, or even if it is true, is it relevant? How do currency fluctuations impact profits, and are they really a good excuse for missing expectations or targets?
First, it should be explained that, from a broader market perspective, currency impacts work both ways. Some companies are hurt by a strong dollar, but simultaneously, others benefit. What matters in that regard is where a business sells products and where they buy raw materials or supplies. If a company has a lot of overseas sales relative to their overall income, a strong dollar is a negative, but if they sell primarily in the U.S. and import the goods sold or used to make what is sold, it is a positive. That is best explained by a couple of simple examples.
Let’s say Apple (AAPL), at a time when Dollar Yen (USD/JPY) is at 100, sets the price of its newest iPhone in the U.S. at $1,000 and wants to get the same Dollar amount for it in Japan. That means that, in Japan, the price of that phone would be 100,000 Yen (1,000 x 100). Then let’s say that USD/JPY moves to 150 as the Dollar gains strength. One dollar before bought 100 Yen, but now it buys 150, so each Dollar is worth more. That, however, hurts Apple as an American company in one of two ways. Either they leave the price of the iPhone in Japan at 100,000 Yen and earn only $667 on each unit sold, or they increase the price to 150,000 Yen to keep profit per unit at $1,000, but making the iPhone uncompetitive and probably losing sales as a result.
A company like Walmart (WMT), on the other hand, that imports things to retail, finds that when the dollar is strong, each dollar they spend buys more goods. Using the above numbers, something that they bought from Japan for 100 Yen when USD/JPY was at 100 would cost them $1. With USD/JPY at 150, the same item bought for 100 Yen would only cost them $0.67. They could then sell it for the same amount in America and make more money per item, or they could reduce the price in an effort to sell more.
It seems that when we hear about foreign exchange in an earnings context, we typically only hear about the downside. Companies hurt by a move and/or a sustained period of relative weakness or strength will tell us all about it, while those that benefit will usually not mention it as a factor in their success. Putting that somewhat cynical observation aside though, currency fluctuations can be a reason for an earnings miss, as the Apple example above shows.
That, however, doesn’t make them an excuse.
There are ways for companies to protect against currency fluctuations. They can hedge in the forex or currency futures markets, for example, or negotiate with foreign counterparts only in USD, thus shifting the currency risk to another party. The extent to which they do those and other things to protect themselves, or don’t in some cases, is entirely their decision. They all have a cost if things don’t go as anticipated, though, and many CEOs and CFOs will take the bird in the hand of greater profit now rather than spend money protecting against something that might not happen in the future.
So, when a company tells you that they have been negatively impacted by foreign exchange, what they are saying is that they made a miscalculation or were hurt by their short-term greed. Or, more charitably, they have decided to let the average exchange rate over time work in their favor.
A company giving you their results in “constant currency”, while somewhat deceptive in some ways, is not unhelpful. All markets tend to revert to the mean over time, and forex is no exception, so it is fair to assume that adverse conditions will recede and may even transition to favorable ones at some point. On average, therefore, constant currency is probably a better way to look at a company’s long term performance and prospects than the distorted view offered at times when currency markets are volatile.
Still, next time you hear that a company had a good quarter in “constant currency” or “ex currency impact,” know that it is like a commentator saying that a pass to the end zone would have been a touchdown if it were caught by a member of the quarterback’s team. It is true, but irrelevant. It didn’t happen that way. The pass was intercepted or fell to the ground and the company lost money or made less than they would have if things had been done just a little differently. History will show only that and the final score or the price reflect that, regardless of any excuse. So, while a constant currency look at a quarter can be useful from an analysis perspective, that won’t be much consolation to a stockholder watching a stock drop after a currency impact driven miss of expectations.
