INVESTIGATING RED FLAGS
in Section 2A of the SSG
Cincinnati Investment Model Club
The trend in Section 2 A is down.
Don’t ignore the problem.
Do find out what has happened
• Section 2A tells us how good
management is at making
The Problem -
The Percents in Section 2A are going down
There are 3 components to
Section 2A. These components
are Sales, Cost of Goods Sold
and Overhead. Cost of Goods Cost of goods
Sold and Overhead are often sold
referred to as expenses.
We expect the Cost of Goods Overhead Pre-tax
Sold and the Overhead to grow at Profit
about the same rate as the sales.
This is a sign of a well managed
Reasons the numbers in Section
2A could go down
1. Sales are decreasing and the company has not
2 Cost of Goods Sold is growing faster than the sales
3. Overhead is growing faster than the sales
You must look at each of these to determine what is the
problem and then decide if it is a short term problem or a
long term problem.
If it is a long term problem, then you do not want to buy the
company. If you already own the company consider selling
if it is a long term problem.
The sales are decreasing
• This is easy to check out. Look at the graph
on Side one of the SSG.
• in the case of Dollar Tree this is not the
Comparing the Sales to the Cost
of Goods Sold and Overhead
• In order to compare the Sales with the Cost
of Goods Sold and the Overhead we will
have to convert the numbers into
• The numbers we need are found on the
Income Statements for Dollar Tree.
To convert the numbers to a
percentage we will use this
• Take this years amount and subtract last
years amount from it. Then divide that
answer by last years amount.
Chart comparing Sales to Cost of
Sales and Overhead
In 1999 the Cost of Sales grew faster than the sales but that was
offset by a big reduction in the Overhead.
In 2000 the Overhead grew significantly faster than the sales.
In 2001 both the Cost of Sales and Overhead grew faster than the
Now we know the problem. In the
past two years the Cost of Goods
Sold and/or the Overhead have
been growing faster than then
We turn to the Management
Discussion and Analysis in the 10K
or Annual Report to find out why.
What we learn in the MD & A
• Dollar Tree is opening more of the larger
stores. These stores have lower sales per
square foot than the smaller stores, but
customers shop longer and buy more.
• Dollar Tree is adding a “higher proportion
of consumable merchandise, which
typically carries a lower gross profit
Their Expectations for the Future
From the M D & A
Regarding Cost of Goods Sold
“We will continue to experience pressure on our gross
profit margins in future years as we refine our
merchandise mix to include a higher proportion of
consumable merchandise, which typically carries a lower
gross profit margin, open larger stores and continue to
absorb higher costs.”
The goal is to maintain a gross profit margin between 36
and 37%. (Gross Profit is the amount after Cost of Goods
Sold is subtracted from sales but before Overhead is
What they plan to do
From the M D & A section
1. They built two new distribution centers in 2001 to
partially offset the above factors with improved
domestic freight costs.
2. Vary the mix among the consumable merchandise
and variety categories to impact the gross margin.
Consumable merchandise sells more quickly than their
other merchandise resulting in increased sales
3. Installed a new scanner register and inventory
management system to better track the inventory and
move it to where it sells. They tailor the merchandise to
the demographics of the store.
Additional Cost of Goods Sold
Listed in the M D & A
• A “troubled distribution facility in
Philadelphia.” That has been closed and a
new one opened but there were added
Overhead (or Operating)Expenses
• There was a loss of leverage in payroll-
related costs and store operating
• Operating leverage is the extent to which a
company’s costs of operating are fixed
(rent, insurance, management salaries) as
opposed to variable (salaries of sales
The Solution- (from the MD & A Section)
Quote from the M D & A
• “We must control our merchandise costs,
inventory levels and our general and
administrative expenses. Increases in
expenses could negatively impact our
operating results because we cannot pass
on increased expenses to our customers by
increasing our merchandise price above
the $1.00 price point”
What we must decide?
• 1. Are the problems short term or long
• 2. Will the solutions fix the problems?
THE ANSWERS ARE JUDGMENT