Accounting: Ups and Downs
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just earnings profits But many companies go through periods of
time where they're not profitable at all That is there's
a product revolution or their international markets that need to
be built and expanded and they consume cash and earnings
and opportunity Regulatory and other global events also take their
toll And suddenly a company that earned a dollar eighty
five share last year well this year loses a nickel
a share It's so if a company with a billion
dollars of revenue that for decades passed had produced fifteen
percent per year net profit margins suddenly had negative profit
margins for in two or three years Well how would
Wall Street value this company when historically it's always traded
at sixteen times earnings Only now there's no earnings is
the company that I earned a dollar eighty five last
year today worth zero after it lost a Nicholas Share
would you have valued General Electric at zero in two
thousand ten when it had lost money and its earnings
line Because more or less numbers adjusted That is what
happened And no you could not have bought the entire
General Electric Corporation for less than the price of a
lot But Wall Street looked past current earnings and found
another metric upon which to value the company Investors used
evaluation technique called multiple of revenues Yeah remember that one
will It's that valuation metric that many Wall Street people
attribute to companies in order to value them That is
if you'll hear phrases like the paper and pulp industries
a lousy industry for margins It's going through a transition
But it should only trade at one times revenue when
it eventually finds a way for robots to produce paper
and actually shows a profit again Without unions and other
venues Silicon Valley will produce the next IT girl software
applications for company's growing revenues at well over one hundred
percent a year in having no profits So the lazy
person's attribution might be a phrase like this company should
trade it ten times forward revenues Will the key point
here is that the amount of revenues a company has
is a very good proxy for what earnings power it
may have in the future A company with one hundred
million dollars in revenues in a comparably profitable industry might
have a harder time earning eighty million dollars versus a
company in the same industry with a billion dollars of
revenue Okay so let's go through the mouth of the
billion dollar revenue fifteen percent net margin company that's growing
revenues and say six percent about its historical rate which
happens to be in about three hundred fifty basis points
more than GDP usually grows So the billion dollar company
with fifteen percent margins produces by definition one hundred fifty
million bucks in profits if that company historically has traded
at sixteen times its net income line or sixteen times
earnings well then if you apply those metrics here it
would trade today for evaluation of about two point four
billion Well assuming all else was equal I either wasn't
something funky going on with dead or cash or dividend
payments or lawsuits or other shenanigans based on these margins
and multiples While this theoretical company should trade for about
two point four times revenues we did there the two
point four billion units a billion dollars revenues should point
for that So that's the big magic in the revenue
Multiple you'll hear about from lazy Wall Street people take 00:03:23.855 --> [endTime] it all with many grains of ah garlic salt