Monday, July 27, 2009

Revenues Down, Profits Up

Interesting that he came to this conclusion when there are so many other things at play... profits can't continue to be disassociated with revenues for long. 

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About 75% of all companies reporting second quarter earnings have exceeded market expectations, even as revenues declined year-over-year.  Bulls focus on the higher profits, while bears key off the lower revenues.  While both are important, especially in the long-term, it is the rise in profits that is most significant at this stage of the business cycle.  A decline in revenues is hardly a surprise given the recession, especially since these comparisons are made against the second quarter 2008, before the economy weakened sharply.  Sales growth should resume in the third quarter compared to the second quarter, as GDP turns up.  It is the rise in profits that foreshadows an improving ability of firms to finance investment and hiring, which supports a rise in GDP in the near future.

In contrast, the improvement in profitability is significant, because it demonstrates quite clearly that businesses have been very successful in lowering costs, mostly by laying off workers, to reduce operating expenses and adjust the size of their operations to the lower level of demand in the recession.  The very fact that profits rose, despite the fall in sales, suggests that firms have gotten ahead of the recession and may have fired too many workers.  If demand now increases at all, firms may need to resume hiring. 

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