41 lines
2.0 KiB
Plaintext
41 lines
2.0 KiB
Plaintext
102 • The Intelligent Option Investor
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Another case in which the normal profit range of a company may
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change is through improvements in productivity. And although improve-
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ments to productivity can take a long time to play out, they can be ex-
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tremely important. The reason for this is that even if a company is in a
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stage in which revenues do not grow very quickly, if profit margins are in-
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creasing, profit that can flow to the owner(s) will grow at a faster rate than
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revenues. Y ou can see this very clearly in the following table:
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Year 0 1 2 3 4 5 6 7 8 9 10
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Revenues
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($)
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1,234 1,271 1,309 1,348 1,389 1,431 1,473 1,518 1,563 1,610 1,658
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Revenue
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growth (%)
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— 3 3 3 3 3 3 3 3 3 3
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OCP ($)
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4 432 445 497 485 514 544 560 637 625 708 746
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OCP
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margin (%)
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35 35 38 36 37 38 38 42 40 44 45
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OCP
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growth
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rate (%)
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— 3 12 –2 6 6 3 14 –2 13 5
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Even though revenues grew by a constant 3 percent per year over this
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time, OCP margin (owner’s cash profit/revenues) increased from 35 to
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45 percent, and the compound annual growth in OCP was nearly twice
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that of revenue growth—at 6 percent.
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Thinking back to the earlier discussion of the life cycle of a company,
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recall that the rate at which a company’s cash flows grew was a very important
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determinant of the value of the firm. The dynamic of a company with a rela-
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tively slow-growing revenue line and an increasing profit margin is common.
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A typical scenario is that a company whose revenues have been increasing
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quickly may be more focused on meeting demand by any means possible rath-
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er than in the most efficient way. As revenue growth slows, attention starts to
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turn to increasing the efficiency of the production processes. As that efficiency
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increases, so does the profit margin. As the profit margin increases, as long as
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the revenue line has some positive growth, profit growth will be even faster.
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This dynamic is worth keeping in mind when analyzing companies
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and in the next section, where I discuss the next driver of company value—
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investment level and efficacy. |