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OklaBoston (61.21)

Earnings growth vs. revenue growth.



November 06, 2009 – Comments (3)

When a company's management is writing off the things it should write off, or paying off debt before it comes due, it is going to make earnings appear to be growing more slowly than they really are, isn't it?

 If that is true, doesn't it mean that in a really healthy company revenues should grow FASTER than earnings? Doesn't that, in turn, mean that when management claims earnings are growing faster than revenues, one should be suspicious of it's honesty or competence? 

 These are honest questions from someone trying to improve his understanding of fundamentals. They are not, in any sense, "trick" questions. 

 Thanks in advance to anyone who gives honest answers to these questions. 

3 Comments – Post Your Own

#1) On November 07, 2009 at 12:29 AM, Imperial1964 (95.59) wrote:

I'd have to investigate further if either earnings or revenue are growing without the other.

Earnings growing while revenue is not is usually indicative of cost-cutting measures or perhaps lower input costs (i.e. cheaper materials).  It could also be a  failure to reinvest in the business.

Revenue growing while earnings are not is (mathematically) indicative of slimmer profit margins.  It could be a price war, rising input costs, moving into lower-margin products, etc.  I don't think I would really welcome rising revenues without rising earnings.

I guess what I'm getting at is you need to understand why the numbers are moving the way they are.  Knowing the numbers is the first step.  Understanding why is the second.


On a somewhat related note I tend to pay a little more attention to cash flow than earnings.  Cash isn't subject to accounting tricks or booking profits before the prodict is made or paid for.  


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#2) On November 07, 2009 at 1:27 AM, BravoBevo (99.96) wrote:

Imperial1964 is correct to focus on cash flow.

If a business is "paying off debt before it comes due" as OklaBoston suggests, the amounts used to reduce the outstanding principal balance of the debt comes from cash flow after profits are determined. Interest accrued on a loan is a business expense, and it affects the profit/loss statement. Principal payments, whether scheduled or not, are neither an income nor an expense item.

Thus, a quicker debt reduction does not directly affect profit.  It would indirectly suggest whether more or less interest accrues (and thereby cutting into profits or exacerbating losses).  If earnings (i.e. profits and losses) are not in line with changes in revenue, then the most obvious suspects are changes (build ups or drawdowns) in accounts receivable and inventory.

I hope that this helps.

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#3) On November 07, 2009 at 5:27 AM, Schwab711 (98.92) wrote:

balance sheet

cash flow

income sheet

in that order everytime... 

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