The Strong Dollar Impact on Earnings Shows Up in Guidance

“Revenue grew 2% as reported and 5% in constant currency.” Lines like that turn up after a strong year for the dollar. Most readers skip the second number. They shouldn’t. The gap between those two figures is money the company earned abroad and then lost in translation, and the same exchange rates will sit inside next quarter’s guidance, where they decide whether the stock has a bar it can clear.

How translation takes dollars away

A US company keeps its books in dollars. Euro sales are converted at the period’s rate. When the dollar strengthens, each euro converts into fewer dollars. The customers can buy exactly as much as last year. Reported revenue still falls.

Take a hypothetical company with $1,000,000,000 of annual revenue, EUR 370,000,000 of it from European customers, and hold those euro sales perfectly flat while the exchange rate moves from 1.08 dollars per euro to 1.00.

That 3.0% can turn modest growth into a decline. It also runs down the income statement, and if the costs of serving those European customers are paid in dollars, most of the $29.6 million comes straight out of operating profit, which on a business with thin margins can be a far bigger share of earnings than of sales.

The hit repeats, too. As long as the rate stays at 1.00, each quarter is compared with a year-earlier quarter booked near 1.08, and the headwind shows up in every report until the comparison period catches up with the new rate.

Where to find it in the release

Two numbers carry the story. The first is reported growth. The second is constant-currency growth. It restates the quarter at last year’s rates. Many companies with large foreign sales publish both. Subtract one from the other. That’s the currency effect, sized by the company itself. In the release line at the top, 5% constant-currency growth against 2% reported means currency took about 3 points off the quarter.

The guidance section matters more. Companies that give an outlook often state the exchange rates they assumed, or say how many points of currency headwind the range includes. It’s the dollar’s effect on next quarter, stated before a single sale is booked.

The objection: currency is noise that washes out

The strongest case against paying attention goes like this. Exchange rates move in both directions, the effect is outside management’s control, and a headwind this year can become a tailwind next year, so a patient holder should look through it and judge the business on constant-currency growth alone.

There’s something to that for a long-term view of the business. It’s weaker for the stock over the next quarter or two. The $29.6 million is real money in the reported quarter. It doesn’t come back unless the rate reverses, and nobody knows when that happens. Estimates are built in dollars. When the rate moves, analysts rebuild their models on the new rates, the consensus for the next quarter comes down, and a company that guides below the old consensus can see its stock fall even when constant-currency growth looks healthy.

Watch that sequence. A guidance cut blamed on currency still resets expectations. The market’s reaction to a company cutting guidance rarely waits to ask why. Some companies send the warning early, in an earnings pre-announcement, which is the currency sum arriving before the calendar says it should.

Where the effect is smaller than the sum suggests

The translation sum above assumes every euro of revenue is matched by dollar costs. Plenty of companies don’t work that way.

A company that makes and sells in Europe has a natural hedge. Revenue and costs both shrink when converted, so the profit in euros survives and only the translated size of that profit falls, which is a much smaller hit than the revenue line suggests. Others hedge. Forward contracts lock in rates for some months ahead, which softens the effect and pushes it into later quarters, so a company can report a mild currency hit this year and a heavier one next year when the old contracts roll off at the new, less favorable rates. The annual report usually describes the program and roughly how far ahead it covers.

There’s also the other side of the trade. A strong dollar lowers the dollar cost of anything bought abroad. An importer that sells at home can come out ahead.

So the sum is a starting point for a question. How much of the foreign revenue has foreign costs against it, and how much is hedged? The answers decide whether the 3.0% hit to revenue is also a 3.0% hit to earnings, something far smaller, or larger once operating leverage is counted.

Read the guidance before the headline beat

When the dollar has strengthened, estimate the translation loss on a company’s foreign sales before it reports, then go straight to the outlook and its stated rates when the release lands, because that is where the currency effect turns into next quarter’s expectations. The case fails for companies whose foreign sales carry matching costs or solid hedges. For the wider picture, see the macro course for stock pickers and the earnings hub.