When I am looking to invest in a stock, one major thing that I really like to focus on is the spending that the company has. To effectively evaluate the spending that the company has, you need to be able to compare CAPEX vs. OPEX. I know that might sound tricky, and that’s why I’m here to give you the 101!
First, let’s start off the same way that I begin many of my blog posts – laying the foundation. If you dive into the meat and bones of anything without first understanding the basics, you’re going to be lost and never truly going to be able to build on the things that you have learned.
CAPEX is short for Capital Expenditures while OPEX is short for Operating Expenditures. Sure, that means the difference is that one is capital and one is operating, but what does that really, truly mean?
Investopedia defines the two by saying, “Capital expenditures (CAPEX) are major purchases a company makes that are designed to be used over the long term. Operating expenses (OPEX) are the day-to-day expenses a company incurs to keep its business operational.”
Some examples of CAPEX are going to be major physical assets that a company needs to run a business while the OPEX are going to be things like rent, property taxes, the actual cost of goods sold, etc.
One of the major benefits of OPEX is that it can be deducted from that organization’s annual income, therefore reducing the tax burden of the company. Because of this, a lot of companies will lease hardware instead of buying it outright because when it’s purchased outright it is counted as CAPEX.
eFinanceManagement.com has a nice infographic that compares CAPEX and OPEX from one another, as shown below:
Starting to feel like you have a pretty decent foundational base with CAPEX vs. OPEX? While that’s great, we’re not here just to understand the way that these financial terms work in the business world, but we want to apply them to our own investments!
So, how do we do that?
I like to go to SEC.gov to find the 10k and then you can type in the stock ticker for the company that you want to look at. Since we are talking about heavy company spending, I want to look at a company that’s going to likely need to spend a lot of money to maintain their infrastructure – Norfolk Southern (NSC).
NSC is a major railroad company in the U.S. and should give us a good breakdown on their 10K. After I locate the NSC 10K, I will search for some of the key terms that I want to find such as “operating expenses” for OPEX and “Property” or “Equipment” for CAPEX. CAPEX a lot of times will be identified in the 10K as PP&E, or Property, Plant and Equipment, so searching some of those terms can be helpful as well as looking at “capital”.
When I search for “operating expenses”, I can find a chart showing the last few years of performance for NSC. As you can see below the Operating Expenses decreased significantly from 2019, down from $7,307 million to $6,787 million, a decrease of over 7%, and a total decrease of 9.5% from 2018 – a significant drop!
Ok, so let’s move on to look at the CAPEX now. You can see below that the total CAPEX decreased in 2020 as well, down from $2,019 million to $1,494 million, a decrease of 26%!
Typically, if you see a decrease in CAPEX then you’re going to see an increase in OPEX, and vice versa. These two typically will flow together with one another unless something drastic is going on with the company.
Right now, my personal “sirens” are going off because both expenses decreased drastically, so why would this be occurring? Is there something fundamental changing about the business? This is where I would recommend that you really need to dive in and look further into the 10K and make sure you understand exactly what happened in 2020.
Given that 2020 was the WOAT (Worst of All Time) year, you likely know that the cause of this is due to COVID-19, and you would be right. While package shipping was at all-time highs, a lot of railroad demand is focused on shipping raw materials like oil and coal, both are commodities that dropped off a cliff when the U.S. shutdowns were first really getting started in March.
Because of this, NSC saw their demand drop-off rapidly as well and to decrease their spending, they reduced their CAPEX and OPEX as much as they could, within reason.
It’s important to note that there isn’t always going to be a reason like COVID-19 that you can point to when trying to understand things in the 10K, which is really why you need to read them thoroughly and make sure you understand what is going on in the business.
I also would highly recommend that you compare CAPEX vs. OPEX among the peers of the company rather than just looking at it in a vacuum. A railroad company is going to have an entirely different model than a cloud computing company and it’s imperative that you’re looking at apples-to-apples when you’re investing.
Another potential pitfall to be aware of is if you start to see a company with lower CAPEX than its peers, you need to understand why. That might mean that they’re simply more savvy with their money and using it as needed, but it also could be a sign that they’re underinvesting in their assets and potentially could see a much higher spend in the future.
It also could mean that they’re trying to beef up their balance sheet and increase income to try to be acquired.
Sure, are a lot of things to consider, right? Well, that’s called investing. There is no right, guaranteed process that’s going to get you to have 100% surefire investments.
My advice is two things:
1 – Read the 10K
I think this is the third time that I’ve said it so please take note! There is no better way for you to truly understand what is going on in a business and be fully prepared to weather the storm when things get tough. If you don’t know what you’re investing in, I guarantee you’ll panic sell as soon as you hit turbulence!
2 – Consume as much information as humanly possible.
My advice is to check out the Investing for Beginners Podcast and the Sather Research eLetter, especially if you’re just getting started. Andrew and Dave put out amazing information each week and the Sather Research eLetter provides a monthly stock pick with very thorough breakdowns of the company/industry, as well as access to all previous editions and current stock recommendations.
Not a bad move for a new investor that’s trying to learn from a seasoned vet like the DRIP KING!