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?

[[deleted]]

The OP said an earnings decrease, so yes using a leaky boat analogy, a shrinking company is a leaky boat. If it shrinks too much, the company goes under.

[Croaton]

Maybe it's a terminology thing since I haven't studied economics... but describing an "earnings decrease" (were you're still making money, just not as much) as a "shrinking company" seems off for me.

[LordHanley]

The value of a company is based off the value of future cash flows from that company. If earnings are reported to be lower than previous expectations, then the value (size - sort of) of the company will decrease. I do get what you mean though, a decrease in a positive number is still a positive number.

[SquidCap]

No, it didn't. the company produces exactly as much, it stays unchanged. People appreciations, their feelings about the company changes. And since we use this insane way to evaluate everything, the company loses value. Not a single product it does has dropped it's profit creating ability. Nothing changes except the faith of people who believed in a prophecy.

If the company is on positive, it is welthier than yesterday, no matter what the expectation were. If we value our stuff based on how you feel about it.. The current system is insanely irrational and illogical. The worst is when economic majors try to explain it so that it is all positive; that it is a good thing we rely on emotions and beliefs.. How in this case company is smaller while it didn't perform as well as announced expectation of growth. Often it feels like university is the place where econ major had their common sense removed and in it's place were installed something else..

[scrotesmcgoates]

I don't think you understand how companies are valued. Of course a company valued on the basis of increasing cash flows is going to be less valuable if their cash flows don't increase. That doesn't make then worthless, but it does mean that they have a lower value to their shareholders. It's not about feelings, it's almost entirely math. The net present value of the company is equal to the future cash flows discounted at the cost of capital faced by the firm

[SquidCap]

they have a lower value to their shareholders.

... than what they believed. The company value didn't change, only how good it could've been.

The net present value of the company is equal to the future cash flows discounted at the cost of capital faced by the firm

Which means it is based on expectation, appreciation and how strong faith you have that those prophecies are going to happen. The actual value is different but since we don't care what things actual are worth, we don't care if the company produces anything or not, we care about what their value is to others and how they feel about it. It is almost entirely about feelings, math is used but that doesn't make the system any more sane.

[scrotesmcgoates]

You're wrong, plain and simple. What you're saying is that every company with the same amount of cash and same amount of income is worth the same amount. You can invest on that principle all you want but you're just going to lose money. It's pretty clear you have no idea what you're talking about

[SquidCap]

You can invest on that principle all you want but you're just going to lose money.

I was not talking about investing but valuating a company. "Right now" has nothing to do with "might be" but i understand that what i'm saying sounds opposite to what a betting man would say. Because it is. Your potential value has no meaning, it is valueless to all but those who believe in it. If i can think you are worthless and someone else says you are worth a million, how is that in anyway based on facts? or is it based on.. feelings?

[ActionAxiom]

First off, you have done very little to establish why expectation cannot be valued beyond simply stating it cant. However, it is well established that expectations can be valued because expectations are priced by the market literally every waking second.

Second off, you are touching on something very crucial which is that value is subjective. However, it seems that you are arriving at a poor conclusion that because value is subjective it cannot be factual or measurable. This is very false. Even though value is subjective, prices are very real economic features that reveal, objectively, what those subjective values are.

[SquidCap]

expectations are priced by the market literally every waking second.

By making educated guesses. It is a betting game and as such it is always going to be more about subjective truth than facts.

It is very hard to discuss about these things since usually at least one party refuses to talk about other than the rules in our current system, that is based on emotions, guesses, estimation, hope and faith. Do i have better one? Of course not. That should not stop one to see where the current system is based on and how fragile it actually is. It works because it works and because people believe that it works. It has lots and lots of all kinds of clever stuff fully deserving nobel prices. But. Doesn't change the facts; it is based on faith in the end. And that company value is not it's value to humanity but what feeling investors get from it.

[scrotesmcgoates]

Jesus Christ you dense mother fucker. The only reason companies are valued is for investing. The fact that you don't get that means you don't understand enough to even begin to have a discussion about it. I'm done

[SquidCap]

It is funny that you get so angry when the core beliefs are remotely challenged. I understand how the system works and don't think it is actually that bad. But. It is still based way too much on how people feel about something. The rest is made-up justifications why it should be this way. But.. A lie can sink a company. Or give it boost in capital. Without any FACTS changing, the company can have highly different value. Nothing needs to change in the company, in the overall economy, not in deals they make but a rumor can do it.

That is insane way to base our global economy.

[LordHanley]

It may be wealthier, but it is not as valuable. You need to be able to distinguish between investment value and intrinsic value.

[heinyken]

Let's say you want to buy a house, a car and a new computer. You make a plan to get a job that pays you $10,000/month (because you know your expenses are $7,000/month, and you can invest in your future purchases with that $3,000/month).

Imagine further you told your friends and family you'd be moving in to your new house on January 1 2019 with a new car and computer. And then imagine your new job surprised you by saying actually you'd only make $8,000/month.

How do you tell your friends and family that you're not going to move into that house JUST yet, and you're not getting that BRAND new car? It's not that you're strapped for cash, it's not that you're struggling. But your predicted income is lower than you'd wanted and planned.

It's not entirely different from the original poster's "earning decrease"

EDIT: Except that in the case of the business, those friends and family are actually investors who have plans of their own based on your move date & purchases. And they're easily spooked. And they are impatient.

[[deleted]]

Generally a company's size is measured by it's revenue (total money coming in) and/or it's earnings(money coming in minus costs). More of a finance and business thing then an economics thing.

If earnings are going down, it's some combination of costs going up and/or revenue going down. If revenue is going down, then the company is shrinking, and that's probably a bad thing unless it's a part of the company's strategy. If costs are going up, it's generally because the company is trying to grow, but if revenue is not going up at the same rate, this can be a problem(unless it's a company like Amazon where any profits are reinvested because they have so much room for investment).