Accounting: Ups and Downs

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