Two pet peeves in business journalism

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Sorry, have to vent:

1. “So and so grew the value of the business from $100MM in 1985 to $500MM today”.

That sounds really impressive, but it’s only a roughly 5.9% annual growth rate with compounding. Any time a journalist quotes two numbers divided by a period of time, s/he should automatically give you the compound annual growth rate. This would allow you to very easily distinguish between a truly remarkable result (of the type Warren Buffet created at Berkshire) from someone who was just buying t-bills or something.

2. “Target’s profits dropped 46% as a result of the hacking scandal over the holidays”

Obviously, a 46% percent decline in profits is a bad result. But retailers have very high fixed costs (they pay lots of rent and salary) and work at very low margins. So, relatively small declines in revenue have major impacts on their bottom lines.

For example: Say you’re a retailer with $100MM in revenue and $90MM in costs, implying $10MM in net profits at a 10% margin (that’s actually high for retail). Of your costs, assume $50MM fixed  (rent, salaries, etc.), and $40MM variable (cost of goods sold), implying a gross profit of $60MM on $100MM of revenue, or 60% (again, not that unusual). Now, assume your sales drops by 5%. Revenue is now $95MM, gross profit is $57MM, and net profit is $7MM.

Your net profit just declined from $10MM to $7MM, a decline of 30%! But that was off a decline in sales of just 5%, which is pretty small and easily explained by changes in the weather, economy, etc. So, business journalists ought to be required to put in some kind of a disclaimer about how high-fixed cost, low net margin businesses can experience large swings in profitability on relatively small changes in sales.

/Rant over.

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