Why the Dow Is Falling Behind This Morning

Usually, major market benchmarks trade roughly in tandem, as the same factors that affect one industry tend to affect them all to a greater or lesser extent. Today, though, you can see the disconnect among the most popular stock indexes as different industries post different levels of performance. Overall, the broad market is slightly weaker, with a rise in jobless claims offsetting strong gains in durable-goods orders and capital-goods purchasing activity. But while the Nasdaq has climbed 0.27% due largely to the 25% spike in Facebook shares, the Dow Jones Industrials (DJINDICES: ^DJI  ) lags behind, falling a more substantial 0.37% points by 11 a.m. EDT.

Many of the stocks contributing the most to the Dow's losses are the same stocks that have struggled for a while now. Caterpillar (NYSE: CAT  ) has fallen more than 2%, showing a complete lack of confidence among investors that the morning's economic data marks a turnaround in the foreseeable future. Following its earnings disappointment yesterday, a Wall Street analyst added insult to injury by downgrading the stock. Strength in the U.S. economy will help Caterpillar, but it really needs global expansion to resume in order to make the most of its profit opportunities.

Microsoft (NASDAQ: MSFT  ) has also posted a decline, falling 1.8%. In restructuring its corporate structure, Microsoft clearly hopes to come out with products and services that will be better integrated with each other and take maximum advantage of technological advances it makes. Yet Facebook's strong results underscore the speed at which up-and-coming companies have challenged the business models of big tech stalwarts like Microsoft, further upping the pressure for Microsoft to become more efficient in capitalizing on opportunities in promising areas like the mobile space.

Despite the Dow's overall losses, though, a few Dow stocks have posted gains. Travelers (NYSE: TRV  ) is rising after a report from Fitch Ratings noted favorable trends in earnings throughout the property and casualty insurance sector. With past-year catastrophic events having helped companies boost premiums while loss experiences more recently have become favorable, Travelers and its industry peers have seen loss ratios plunge, boosting profits. The insurance industry tends to run in cycles like this, so investors shouldn't expect Travelers to stay this profitable forever. But after a tough couple of years for the industry, it's good for insurance company investors to see conditions finally improving.

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Some Numbers at Graham that Make Your Stock Look Good

There's no foolproof way to know the future for Graham (AMEX: GHM) or any other company. However, certain clues may help you see potential stumbles before they happen -- and before your stock craters as a result.

A cloudy crystal ball
In this series, we use accounts receivable and days sales outstanding to judge a company's current health and future prospects. It's an important step in separating the pretenders from the market's best stocks. Alone, AR -- the amount of money owed the company -- and DSO -- the number of days' worth of sales owed to the company -- don't tell you much. However, by considering the trends in AR and DSO, you can sometimes get a window onto the future.

Sometimes, problems with AR or DSO simply indicate a change in the business (like an acquisition), or lax collections. However, AR that grows more quickly than revenue, or ballooning DSO, can, at times, suggest a desperate company that's trying to boost sales by giving its customers overly generous payment terms. Alternately, it can indicate that the company sprinted to book a load of sales at the end of the quarter, like used-car dealers on the 29th of the month. (Sometimes, companies do both.)

Why might an upstanding firm like Graham do this? For the same reason any other company might: to make the numbers. Investors don't like revenue shortfalls, and employees don't like reporting them to their superiors.

Is Graham sending any potential warning signs? Take a look at the chart below, which plots revenue growth against AR growth, and DSO:

Source: S&P Capital IQ. Data is current as of last fully reported fiscal quarter. FQ = fiscal quarter.

The standard way to calculate DSO uses average accounts receivable. I prefer to look at end-of-quarter receivables, but I've plotted both above.

Watching the trends
When that red line (AR growth) crosses above the green line (revenue growth), I know I need to consult the filings. Similarly, a spike in the blue bars indicates a trend worth worrying about. Graham's latest average DSO stands at 60.6 days, and the end-of-quarter figure is 65.7 days. Differences in business models can generate variations in DSO, and business needs can require occasional fluctuations, but all things being equal, I like to see this figure stay steady. So, let's get back to our original question: Based on DSO and sales, does Graham look like it might miss its numbers in the next quarter or two?

I don't think so. AR and DSO look healthy. For the last fully reported fiscal quarter, Graham's year-over-year revenue grew 52.6%, and its AR dropped 7.0%. That looks OK. End-of-quarter DSO decreased 39.8% from the prior-year quarter. It was down 3.9% versus the prior quarter. Still, I'm no fortuneteller, and these are just numbers. Investors putting their money on the line always need to dig into the filings for the root causes and draw their own conclusions.

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