The intelligent investor himself, Benjamin Graham, advised Warren Buffet that ‘price is what you pay; value is what you get. Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down’.
Stock market terms can get tricky and are sometimes hard to follow, but this piece of advice is thankfully quite straightforward. Invest in value, and know when it's most valuable. If you’re planning for your retirement, putting money aside for the kids or just saving up for your next big adventure, understanding the difference and relationship between a company’s revenue and profit is vital to invest in value accurately.
price is what you pay; value is what you get.
Investing for Beginners: Revenue vs. Profit
Revenue is all financials that come into a company. Revenue is described before expenses and taxes are subtracted from their total income, meaning that it is not necessarily an accurate representation of what a company might be worth. However, it is still a valuable metric to consider, which we’ll discuss soon.
Profit is different to revenue. Profit is described only after expenses and taxes are deducted from earnings, which means that is can be used to more accurately represent a company’s worth. However, it needs to be weighed against revenue in order to be analysed correctly.
This graphic above illustrates the comparison between revenue vs. profit gained in 1 minute and 6 seconds of trading on an average day across several companies and industries. The light blue indicates revenue, while the dark blue indicates profit.
What’s Valuable to the Intelligent Investor
As mentioned before, to the intelligent investor revenue might not be an accurate measure for what a company is worth, but it does have value. Revenue is the first measure of all the trading that a company does in a given time, which means it is a valuable metric to understand the scope of a company. Despite profit margins, a company with a small revenue stream means that it is only capturing a small market or is not being well accepted by a larger market. That’s an important consideration when deciding which companies will have a place in your portfolio, particularly if you’re a value investor and focused on the long game (which you well might be for retirement planning or college funds).
Profit on the other hand, is an indicator of a company’s financial health and future. If a company’s revenue stream is massive, but they only have a small profit margin (like Boeing and Airbus in the above graphic), then these companies are likely not financially strong. Why? Because this means that in order to increase the worth of the company, they need to push for an enormous market, as their percentage of profit is so low. This is a particularly worrying statistic to see in already established companies that have perhaps outgrown their early-to-market fast growth.
That’s why companies with fairly large revenue streams that still hold high profits are most often intelligent investing decisions. These companies are financially stable and have the scope to grow more.
Of course, this needs to be weighed against other information too. Apple might seem like a great investment, and we don’t necessarily disagree, but a confused market reaction to their iWatch, recent loss in revenue and a worrying drop in share price has made many investors jump ship. Learn more about our stance on Apple here.
If you’re only beginning to invest and looking for more information on how to invest in stocks, keep an eye out next Friday for a great offer from us. Or simply get hold of us to find out more.