Profits

Our economy is basically based on profiteering.

Lets be clear, there is nothing wrong with making a profit, it inspires enterprise which stimulates the economy and creates jobs.

However it depends a lot on how many are eating at the trough.

Profit related to value added is productive, but profit related to effectively nothing is a problem.

In one model you might have the producer, say the farmer, who could sell direct to a consumer resulting is a single profit.

That became less possible so we see them selling to middlemen who take the product from the farm to the city say.  A second profit.

Generally they then resell the product to retail outlets who sell to the consumers, a third profit.

This is true for almost all the things we buy with escalating profits.  Of course there is usually some real service provided.

In health care of course we have multiple streams.  There is the delivery of the medical service, the equipment used, and the cost of running the hospital.  We then add the profit stream of the insurance provider.

How to reduce the cost unrelated to the actual delivery of health care would go a long way to making health care more affordable.

We just don't want to.

Profits or Sales Growth?

In 2009 a fairly constant refrain heard as companies reported better than expected earnings was "but they are doing it on lower sales". Now as we kick off the first 2010 earnings season, Alcoa had higher sales but missed the profit estimate. This caused the market to have a small correction, although of course other factors were in play.

The objective of any business is to make money, otherwise it is a hobby. There have been many many cases of businesses that expanded so much on credit that ultimately they were forced into bankruptcy. Having more market share or sales without more profit is not a path to success.

Clearly the ideal company would grow both. The best way to do that of course is to make sure you have a secure business model and expand only when it is clearly justified. Some executives and companies start to think that bigger is better and do whatever they can to expand (including reducing margins). The strategy here is to become so large that competition becomes irrelevant and they can then increase margins. This strategy has a number of issues, and can lead to being over leveraged.

The contraction has left many companies smaller than they were. The ones that have adjusted to this and eliminated significant costs have profited and will continue to profit. Owning stock is owning a piece of a company, and if that company is making money, the share ultimately will reflect that. Profits are the goal.

Increased profitability

Companies that made money last quarter will make more money this quarter if the earnings were based on continuing operations. It is ridiculous when I hear people with significant business backgrounds talk about how cost cutting is a one time thing. When you reduce staff, reduce inventory or eliminate facilities it is ongoing, and those costs will not return until you hire people or open new facilities. In fact, normally the cost cuts get better over time as severance payments or costs related to closed facilities go away.

So, the companies that achieved profitability via better efficiency (a nicer word than cost cuts) have only to see revenues stay the same to have an increase in profitability. If there is revenue growth it will greatly increase profitability.

In fact, the next quarter is going to see a shortage of consumer goods develop since retailer's have lowered their expectations and stocked much less inventory. As hot items start to move off the shelves, we will see manufacturers filling rush replacement orders and putting on additional shifts to satisfy this short term demand. Now, this doesn't require great sales increases from last year, since if you are stocked up to a level that expects less sales and get the same sales, you will be short of product.

Businesses are prepared for the worst and they are going to get something better than that. That is going to drive significant earnings improvements similar to what happened during back to school shopping. You don't have to sell more than you did less year, you simply have to sell most of your current inventory.