Mark Suster writes on Both Sides of the Table about the healthy tension between profits and growth. Most companies — even tech start-ups — should be very profit-focused, he maintains, noting, “being profitable allows you degrees of freedom you don’t have when you rely upon other people’s money.”
To simplify: Revenue – Cost of Goods Sold (COGS) = Gross Profit (also called Gross Margin or sometimes “Net Revenue”) – Operating Costs = Profit. When Suster examines an income (or profit and loss) statement, he starts with the revenue line. “If you had two companies each with $100 million in ‘earnings,’ or profits, they might have vastly different prospects for the future,” he points out. “One company might be growing its revenue at 50% per year and the other might be growing at 5% per year. Assuming they both had the same net profit margins (profit/revenue) then the former company would be much better off at the end of the year. So while the simplest way that people often evaluate stocks is by P/E ratios (price-to-earnings), one also needs to look at other metrics such as the PEG (price-to-earnings-growth).”
When Suster evaluates companies that already have revenue, he seeks to understand the revenue line in greater detail. “What makes up revenue?” he asks. “Is it one product line or multiple? Do 20% of the customers make 80% of the revenue or do the top three customers represent 80% of the revenue?” Suster also tries to understand how the company prices its product, how its competitors price, and what its pricing expectations are for the future. “Fast early growth in a market is often eroded when competition gets fierce and prices are forced down due to competition,” he points out.
Source: Both Sides of the Table