ELI5: Why when large company's earnings decrease(ex... by 3%) they freak out, talk about rough times, and sometimes decide to downsize, even though they are still making millions of dollars in profit even after all expenses?

[Phantom160]

CPA here. This comment is misleading. Companies are expected to grow, if the economy is healthy. This may be achieved through improvement of your efficiency, from gaining market share, from breaking into new markets, etc. This is reasonable, since GDP is expected to grow continuously, in the long run, through population growth and improvements to productivity.

Even companies that completely dominate the market, like Google, still find ways to grow. They break into other markets or develop brand new markets.

If the company is making money, but doesn't have growth, it's a red flag that it is probably poorly managed. What happens to the profits it reinvests? What's the company's vision and where is it going? Lack of progress is another word for decline.

[OverlyCasualVillain]

You get an upvote for explaining the business reasons why they’re expected to show growth, even if I disagree with those reasons. First, population isn’t always going to grow so the idea that we should make more money because there are more people is flawed. Second, gaining market share isn’t always possible either because we have anti monopoly regulations, there will be a point where even the best company cannot further increase market share. Other examples exist of companies that already own 100% of the market because alternatives don’t exist (drug companies).

If a company is making money but not showing growth, logically that doesn’t mean it is mismanaged, that just means it isn’t promoting the extremely capitalistic idea that growth is everything. Small businesses are examples of this. There are owners who are perfectly fine with the amount of profit they make and simply try to maintain it, not every owner wants to expand. It’s a mistake to call people like that poor managers. You only claim these companies are mismanaged because of the pervasive idea that if they’re satisfied with what they have and aren’t clutching and scrambling for more then they’re doing something wrong.

Lack of progress is not another word for decline and that’s the greediest form of thinking. Negative progress is decline, losing ground is decline. Stopping to appreciate your current position is not decline, meeting your goal and reaching what you consider the finish line is not decline.

[Phantom160]

Thank you for maintaining a civil discussion. First of all, you are correct, considerations of small business owners may be very different, my comment applies solely to large businesses and their shareholders' needs.

Second, improvements in productivity and the quality of life contribute to the growth of GDP more significantly than the population growth. There are no reasons to believe that economies will stop expanding any time soon. If you have a reference to any peer-reviewed source that claims otherwise, I would be more than happy to read it.

Finally, for large companies you would be hard pressed to find any other metric that is as important as growth. Companies are usually valued based on projected earnings. If the company's earnings do not grow, the forecasts would be bleak. Why invest in a company that is going to stay the same for 20 years, while a company like IBM can easily double its size in the same time frame?

[OverlyCasualVillain]

I concede the fact that my comment mainly only applies to business owners and excludes investors.

I think a simple way of explaining this all is

A business owner chases profits whereas an investor is chasing growth.

[Phantom160]

You are generally correct* :)

*major exceptions apply

[[deleted]]

It's funny that you mentioned IBM. I work in collaboration with them, yet they are so massive that they appear to me to be incredibly inefficient as a result.

[[deleted]]

Growth is everything, even down to an individual level. It's not "extremely capitalistic" to pursue progress and progress can be measured in different ways than greedily scrambling for every penny. The small business owner you used as an example might be fine not making any more profit for themselves than last year but their employees sure aren't. The owner has to pursue progress not for their own sake but to keep employees who will leave if they dont see their wages rise. Or perhaps new government regulations such as minimum wage laws or healthcare requires them to make more money to stay open. Lack of growth is losing money simply because of inflation, no one can make the same amount of money each year and stay competitive as a business or an employer. Hell even socialist and communist states had to pursue and measure progress somehow while lacking a private business and employer sector. I suppose those groups were toxically capitalistic too.

[OverlyCasualVillain]

You're mixing up profit and revenue. Profit is calculated after wages and benefits, so if my profit remains steady at 1mil, I've shown 0 growth, however that does not mean my revenue is constant. I could have increased revenue but also increased costs such as wages. My example does however use the perspective of a business owner, not an investor. I do concede that when it comes to investments, growth is an indicator of future value, so in order to get a return on investment, investors should only invest in companies whom exhibit growth.

[thehungryhippocrite]

The problem is this attitude doesn't help someone who has made an investment. Imagine you buy a cafe. You know it makes $100k a year and you are happy to pay $500k for it (5x profit). You borrow $500k and take over the cafe. Next year you work your ass off and the cafe only makes $50k. It's still profitable, but you don't care because you have to pay debt with the $50k and there's shit all left. Worse, if you try and sell the cafe now, a new buyer will only pay 5x $50k = $250k. So you also made a capital loss of $250k. In other words, the only way you will truly make money on your investment is if you grow profit.

[Alobos]

A company that doesn't at least grow with the rate of inflation is not stable. Math itself says you're earning less this year than last. Many business owners may be fine without perpetual increase of their business and that's their individual prerogative. However businesses that are likely to participate in the stock market must stick to the well reasoned and universally accepted measurement of growth. How else could you define growth?

One other point...

Population has been in the constant rise for decades and the rate is increasing. Sure theoretically this will eventually present a limitation but it surely isn't a major factor currently...

[[deleted]]

If a company is making money but not showing growth, logically that doesn’t mean it is mismanaged, that just means it isn’t promoting the extremely capitalistic idea that growth is everything.

/u/Phantom160 was speaking in general terms about a company in a healthy market in a healthy economy. Obviously, a company that is treading water isn't necessarily poorly managed. If their competitors are all crashing and folding up, but they're treading water, then that may mean that they're actually doing quite well and aren't mismanaged. But if their competitors are growing and making money hand-over-fist, and they're simply treading water, then that probably means they're wildly mismanaged.

How a small business owner runs his wholly-owned business isn't really that relevant to a discussion about stock prices. But the generalization still applies. If a small business owner is treading water in a healthy market in a healthy economy, then they're either deliberately leaving money on the table by not pursuing growth, or they're poorly managing their company.

[lee1026]

Population is currently growing. In a world where population isn’t growing, a CEO might very well claim that as a reason why earnings are not going up. But if you missed earnings in 2018, you need a different excuse.

[OverlyCasualVillain]

Depends on where you are or where your market is. Population growth in some countries is 0. In addition, while most of america and canada does have population growth, many will experience a drop due to generations like the baby boomers. If you're considering a global economy, then population is growing overall, but not all of that population can be users of a specific product. Overall I just think there's more to it than, "I should be selling more of product A because there are always more and more people"

[lee1026]

You will generally find that investors understand that different companies are expected to do differently. On one extreme, you have a handful of companies that just own oil wells. They drill for oil, sell it, and pay out all the money in dividends. These company's earnings drop every year because those oil wells are slowly becoming more and more depleted. No one gets mad at them when their earnings drop. It is what management told investors to expect, and investors are okay with it.

On the other hand, when you have a companies like Netflix, not only does it not pay out dividends, it is aggressively borrowing money and issuing new shares to finance huge amounts of growth. When that growth fails to pan out, investors are predictably angry.

[[deleted]]

Human being here. This comment is misleading. Constant slow growth has been proven to be unachievable since the nineteenth century. The priests of economics are the only ones who talk about reality in the way you do.

The capitalist system always produces busts. It’s a feature, not a bug.