Current earnings

Over and over again I hear analysts say that the recent good (relatively speaking) earnings were due to cost cutting and that there is only so much cost cutting you can do.

The implication of this is that earnings related to cost cutting are temporary and unless top line revenue grows, the earnings will disappear. Now, I can't imagine that is what the analysts are actually saying, but, over and over again I hear that comment and I'm beginning to wonder if they can really believe it.

If you have a company with sales of say $1 billion dollars and make a profit of 10% or 10 million dollars and then find that because of an economic contraction you are losing sales, you either reduce cost or lose money. Now, getting rid of excess inventory, reducing staff and closing facilities can be painful, but suppose sales have shrunk to 850 mil from the billion. If you have reduce costs enough to generate the same 10% profit, you will have earnings of $8.5 million.

Now, that constitutes reverse growth of a sort, but the savings and earnings will not go away unless sales continue to decline or costs are reintroduced. Since I believe the economic contraction has ended, the reasonable expectation is that sales will increase or at least stay stable.

Now, if you are thinking about investing in this company, the stock price should be lower than what it was when earning were higher. Mostly they are. I would argue, you need to analyse the company based on what is going to happen, not on what used to be.

Does the new company have growth potential from where it is? The fact that a company that is now only 85% of what it was is simply an interesting tidbit. Does it have good growth potential? Does it pay stable dividends?

Lots of analysts came up during a period when constant growth was the goal and they seem unable to adjust to the fact that we have reversed about 10 years of growth in the current economy. Businesses seem to have adjusted and have set themselves up to be profitable. The analysts seem to be a lagging indicator.