Translate Foreign Revenue Carefully

The three-volume Principia Mathematica, written by Bertrand Russell and Alfred North Whitehead between 1910 and 1913, is regarded as one of the most influential works on logic ever. Influential, yes; good beach reading, no: It took them well into the second volume to develop the logic needed to state "1+1=2."

Needless to say, this would not go over big in a business in which we have to reduce everything to simple buy-or-sell decisions and need quick and plausible justifications therefore. But Russell and Whitehead were on to something: Questions that are apparently simple on their face can be astonishingly vexing to answer. Consider the following question posed by a RealMoney reader for this site's "Ask Our Pros" section:

When looking at a company's annual report, what percent of a company's sales/revenue should be from sources outside the U.S. for the company to benefit from a falling dollar?

An Unanswerable Question

As an old saying goes, when you're a hammer, all problems look like nails. Each of us has a different skill set and predisposition we bring to this business. My preferred vantage point is to look at things from 30,000 feet as an economist, not from 3 feet as a financial analyst. So when I first read this question, I thought, "Here's an opportunity to learn a thing or two by poking around a few income statements just like an anthropologist observing the local customs."

But then I got to thinking about what I had to find. It is not so much the percentage of foreign revenue, but the source of that revenue. For example, an American firm such as Kellogg(K Quote - Cramer on K - Stock Picks), which has done considerable business in Latin America over the decades, has earned Mexican pesos or Brazilian reals. Neither currency has appreciated against the dollar in the long run, despite some recent strength in the Brazilian real.

Prior to hedging gains or losses, the earnings in either of these two currencies would not translate into more dollars if repatriated, but rather fewer. More important, the local subsidiary's dollar costs would increase in local currency, and we can glean nothing from a financial statement about the operating risks, such as taxes, regulations and the purchasing power of the local citizenry. At the end of this exercise, the key number for valuing the firm's operations in that locality, the currency and risk-adjusted expected net operating profit, cannot be deduced with any accuracy. A repetition of this exercise across a group of countries, many of which have currencies moving in different directions from both each other and from the dollar, would be similarly inconclusive.

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