Factor Forex Into Investment Decisions

Lack of revenue growth, even as the stock markets have rebounded, has been catching the attention of the financial media lately. What could be behind this phenomenon?

One oft-overlooked yet potentially significant factor in revenue declines is foreign exchange, particularly in the current market environment.

Most of the largest companies in the U.S. and many of the smaller ones also conduct business outside of the country. We refer to these companies as multinational corporations. When operating outside of the U.S., companies generate revenue in foreign (sometimes referred to as local) currencies, incur expenses in those foreign currencies and may issue debt in them. As far as earnings are concerned, foreign currency revenues and expenses are translated into U.S. dollars.

Here is how it works. Let's use McDonald's(MCD) as an example. Assume that McDonald's generated $5 million in revenue in the U.S. and 500 million Japaense yen in Japan during a quarter when the JPY/USD foreign exchange, or forex, was 100 (100 yen buy $1). The 500 million yen equate to $5 million of revenue for that quarter, so in U.S. dollars, the company generated $10 million in total revenue.

Now skip ahead to the same quarter in the following year. Assume that McDonald's sales were unchanged in each geographic region: $5 million in the U.S. and 500 million yen in Japan. Also assume that McDonald's did not open any new stores. But the yen-dollar foreign exchange (forex) rose to 108. The dollar has appreciated relative to the yen vs. the prior year, and now every dollar buys 108 yen, equating this time to about $4.63 million. Total U.S. GAAP-based revenue for McDonald's would be $9.63 million.