Why Conversion Rates Matterwhen Reading Annual Company Reports

By Author: Milton Nichols
Total Articles: 1
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Individual investors tend to underestimate the impact conversion rates have on earnings and overall financial results of listed companies. Today's financial markets are easy accessible via a personal computer connected to Internet and there are a growing number of people around the world who try to gain profits on the foreign currency exchange and stock markets.

The Forex market deals with world currencies while the stock market is the place where the companies list their shares, which are then freely traded. But while Forex traders are obliged to understand the nature of currency fluctuations and all fundamental factors behind the currency mover, many stock market investors underestimate the power of conversion rates that leads to loses on profits reported by companies listed on the stock exchanges worldwide.

Most listed companies are multi-national, hence, currency conversion rates play an important role in their earnings. One of the major U.S. stock exchange indices, S&P 500, comprises 500 of the largest ...
... American corporations that generate half of their sales outside the United States. Thus, their earnings are heavily influenced by foreign currency exchange fluctuations that often determine whether the company will increase its profit or will incur losses.

A U.S.-based company that generates major part of its revenue abroad can experience drop in earnings in a strong dollar scenario because its abroad revenue will buy less U.S. dollars and lower U.S. dollar-denominated profit will be reported. In contrast, the same company will report better results generating revenues abroad when the U.S. dollar is weak because its foreign currency-denominated revenue will buy more U.S. dollars that will result in higher profits.

Many multi-national companies try to avoid these complex calculations of conversion rates by posting financial results in constant currencies. Using this method, corporations report their performance without the effect of currency fluctuations by translating results for the current year at the last year's average exchange rate. However, every stock market investor should try to translate these figures into face value in order to calculate the real company's results and decide accordingly on his share trading strategy.

Some corporations hide their inability to deal with the currency risk by using constant conversion rates in their reports. This is not a bad practice if the company introduced measures to hedge against currency risks associated with its core business activity. However, such types of company statements can mislead investors that are not accustomed to translate these figures into face value.

If you have decided to invest your hard earned money in shares of a multi-national company you should make decisions on buying and selling shares not only on the company's performance in constant currencies but try to work out what is the impact of currency conversion rates on its performance. This can be a hard task to perform for a novice but you can always ask your broker for advice. Professional brokers are familiar with techniques to calculate the company's earnings using the applicable correction for currency conversion rates.