Growth and profitability
One of the most common methods of valuing a company or stock is to use its past performance as a guide. By analysing the revenue and profits of the company over time, we can get a sense of how well the business is doing and what are its future prospects. Revenue is the amount of money that the company earns from selling its products or services. Profits are the amount of money that the company keeps after paying all its expenses and taxes.
Revenue and profits can tell us a lot about the condition and strategy of the company. For example, if the revenue is increasing, it may mean that the company is gaining more customers, offering more products or services, or expanding into new markets. If the revenue is decreasing, it may mean that the company is losing customers, facing more competition, or withdrawing from some markets. Revenue growth is usually a positive sign for investors, as it indicates that the company has a strong demand for its products or services and a potential to increase its market share.
However, revenue alone is not enough to measure the performance of the company. We also need to look at the profit margin, which is the percentage of revenue that the company keeps as profit. Profit margin can show us how efficient and effective the company is at managing its costs and generating income. For example, if the profit margin is increasing, it may mean that the company is reducing its expenses, increasing its prices, or improving its quality or productivity. If the profit margin is decreasing, it may mean that the company is facing higher costs, lower prices, or lower quality or productivity. Profit margin can also reflect the overall strategy of the company, which can be further investigated by looking at its financial statements and reports. For instance, a high profit margin may indicate that the company has a competitive advantage or a niche market, while a low profit margin may indicate that the company is pursuing a high-volume or low-cost strategy.
A sudden change in profit margin can also signal an important development in the core business of the company, which may warrant further analysis. For example, a sharp increase in profit margin may result from a one-time gain, such as selling an asset or receiving a tax benefit. A sharp decrease in profit margin may result from a one-time loss, such as paying a lawsuit settlement or writing off an impairment. These events may not reflect the long-term profitability of the company and should be adjusted for when valuing the stock.
Another way to use past profits to value a company or stock is to project its future earnings based on its current and past financial statements. This method assumes that the company will continue to grow at a similar rate as it did in the past and that its profit margin will remain stable. By applying a growth rate and a discount rate to the past earnings, we can estimate the present value of the future earnings, which represents the intrinsic value of the stock. This method is also known as the discounted cash flow (DCF) method and is widely used by analysts and investors.
However, this method also has some limitations and challenges. For one thing, it relies on historical data, which may not be accurate or reliable. For another thing, it requires making assumptions about future growth and discount rates, which may be difficult or subjective to estimate. Moreover, it does not account for changes in market conditions, customer preferences, competitive forces, or other factors that may affect the future performance of the company. Therefore, this method should be used with caution and complemented with other methods of valuation.