How to value a firm's future profits

A firm's profitability is a key factor in its investment appeal, says Phil Oakley. Here, he explains how to tell if a company is likely to maintain its profits when the going gets tough.

One of the first things any investor looks at when valuing a company is its profitability. If you know what a firm is making now, and what it should make in the future, you can work out how much you'd be willing to pay for those earnings today. But what profit figure do you use? This year's profits could be unusually high due to one-off cost-cutting, or because the economic cycle is peaking. And trying to predict what will happen in five years' time is a mug's game.

Enter the concept of 'sustainable profits' a level of profitability that can be maintained through thick and thin. This can be traced back to legendary value investor Benjamin Graham, who reckoned that if you can buy a firm more cheaply than its sustainable profits imply that it's worth, you'll have a 'margin of safety' and a good chance of decent returns.

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Phil spent 13 years as an investment analyst for both stockbroking and fund management companies.

 

After graduating with a MSc in International Banking, Economics & Finance from Liverpool Business School in 1996, Phil went to work for BWD Rensburg, a Liverpool based investment manager. In 2001, he joined ABN AMRO as a transport analyst. After a brief spell as a food retail analyst, he spent five years with ABN's very successful UK Smaller Companies team where he covered engineering, transport and support services stocks.

 

In 2007, Phil joined Halbis Capital Management as a European equities analyst. He began writing for MoneyWeek in 2010.