Traditionally, investors looked forward to their dividend checks as a reward for having invested in their preferred companies.
Today, the dividend returns are quite dismal. And capital growth substitutes for that. However the question beckons “How important are Profits”?
a. Can we measure a company’s success by the way it reports its profits and by their magnitude?
b. Can we rely on the company providing us continuous profits each year?
c. Can we say that because a company has reported profits for over 10 years we can assume it’s a safe company to invest in?
For each of the questions asked, the answer is NO.
Warren Buffet of Berkshire Hathaway stated in this year’s letter to shareholders, “never trust the financial statements of companies, and don’t just focus on profit figures….research and focus on broader financial figures”, as reported by The Daily Telegraph March 7, 2011, Vol.1, No 2274.
You must first ask, what is profit? Profit is only derived after taking into account “allowable expenses” as determined by the country’s taxation system in order to purely determine taxable income, ie Profits.
The main aim of the game is to ascertain what portion of the company’s effort is to be given to the Tax Dept for the liberty of doing business in that country/state.
For question a; can we measure a company’s success by the way it reports its profits? Just by analyzing the paragraphs above I think you may have some idea that its not totally correct or a reliable indicator.
It would be difficult to assess a company’s success if we are merely to rely on profits, since now we know how profits come about.
In reality, when you look at profits, all you should see is a manipulation of figures to give a residual figure that the tax man is looking for or an amount the company is willing to set aside towards the payment of taxes.
A situation did occur in the recent banking crisis where the profits stopped and its follow through effects to all industries in all corners of the world. And this should also answer question b.
An Investment Analysis researched many years ago, showed that most banks were in financial distress, despite reporting profits each year.
The success and or viability of the company rests elsewhere, in most parts.
To be really “profitable” or viable, you need to have, adequate systems in place, assets in the right place doing the right things, investments producing proper results…these are a few of the main drivers of the business.
It is the nuts and bolts of the company that need to be addressed and analyzed.
For whatever change that may happen in the financial market, it is only the companies that have the base fundamentals together that will survive from any changes and/or to any external threat that is beyond their control.
Investment Analyst firms devote their time assessing companies in a manner that is more in tune with what inner management of companies do, so that investors can invest wisely.
The managers of companies are reluctant to impart this information due to competitive concerns.
Being profitable or reporting profits does not mean the company is a “safe” company even if its being doing that for over 10 years or even 100 years.
Sometimes the backers of the businesses have too much to lose than let a company go its own way.
History has shown us this even back to the days of the British Empire. (This should answer c. above).
As Investors we need to know whatever information a company does provide us, it is limited, and is also limited due to competitive conditions.
Analyzing other areas apart from base line profits, will show us more about the company’s prospects and its ability to withstand financial shocks and still continue to be viable.
As Investors, we need to know – Is it Safe? Is it Stable? Is it Viable? And not just Profitable.
Checking Investment Analysts Firms such as RP Maths Pty Ltd will provide a broader view of your Investments.