Friday, April 28, 2006

Deciphering Company's Profit/Loss

It always feel exhilarating to see an increase in a company's profit and demoralising to see a decrease or a loss. However, before you make any decision to purchase or sell the share of the
company, it is important to take a closer look at the details that attribute to their profit/loss.

1) Before we even look at Profit/Loss meaningfully, one should always exclude any extraordinary gain or loss.

For example, a divestment of the company's asset will definitely increased its profit. In fact, you might even downgrade the company if the asset is one of the revenue churning asset in its core business. One recent example is the Ascott group where it divest its properties to its REIT.
Likewise, acquisition will significantly reduced a company's earning or might even cause them to go into the reds. Similarly we should exclude them, adding the amount from acquisitions back into Profit/Loss Statement. Strategic acquisitons lead to growth and will increase a company's future earnings.

2) Seasonal effect on Profit/Loss.

Sometimes it is just normal for a company to achieve marginal profit or even be in the red for certain seasons. There appears to be a drop in earnings from the previous quarter, but it might be a rise in profit compare to the same quarter last year. One example for this is Brookstone where it has first 3 quarters of loss and last quarter of profit that is more than sum of its losses. As it deals with lifestyle products and partly because of Americans expenditure pattern, The Americans only buy these products for their loved ones during festive seasons, mainly Christmas.

3) Profit due to cost cutting

It will be a very good news if the increased in profit due largely to the company ability to cut production/operating cost. Improved cost effectiveness will always stay with the company even if during the bad times. They will have a competitive advantage over its peer and sometimes be able to whether a storm when its peers struggles and ultimately fades out of the competition - a bonus: getting bigger market share without doing a thing.

4) Profit increase at the expense of decreasing profit margin.

A company might be able to increase its market share by decreasing the retail price of its products and hence lowering its profit margin. The question is can they sustain this advantage? What if there is a sudden surge in the cost price of its raw material and was caught off guard? For example, the company has went into a contractual agreement with its customer to supply the products at a better-than-market price by sacrificing its profit margin. The company's profit margin might become negative if there is an unexpected surge in its raw material price during this period.

Of course, there are much more cases not consider. So the main point is to take a closer look at Profit/Loss Statement and not take them as they are present to you.


At 5:40 AM, Blogger Jason said...

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At 1:28 AM, Blogger tradingdiary said...

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