A buddy at work didn’t understand why corporations needed to try to make, what he called  “huge profits“, so I thought I’d share my thoughts on the topic.

Have you ever been to a soccer (or basketball or football) game where the opposing team looked like they were standing still, and the game was a huge mismatch?

Well, that is exactly what would happen if the companies don’t try to make a healthy profit.  Nobody invests in the company, and there is no motivation for the company employees to try. In fact, company can have a better product and still fail to an inferior product from a competing company because of the lack of profits!  The failure of a superior product to an inferior one is why profits and the abilities of the management team (CEO, etc) to achieve them are so important.

Why wouldn’t the company employees try, you might be wondering?
Well if your company isn’t profitable, your company isn’t going to give bonuses and may not even give raises (this is obvious given the past few years).  We go to work to feed our families and make money so we can use the cash to buy stuff to make our lives better.  Without the hope of future raises and bonus, we start to look for other places to get ahead in life! (Note, this doesn’t apply directly to government workers, but indirectly it does.  If companies and their employees don’t make money, governments don’t get taxes, and eventually government workers are affected too).

I think my friend didn’t really understand what happens to the profits after they are declared.  First, the profits that the companies make don’t just disappear…  They are distributed as dividends to the shareholders, used to buyback outstanding company shares or saved and used for future company growth.

Even if the money is just held in cash, that money still belong to the shareholders of the company!  Occasionally, you’ll see a company like Microsoft give a huge cash dividend.  This is because they have enough money in retained earnings to cover their future needs, so the excess is given back to the risk takers (stock owners like us) that invested money in the stock.  Actually dividends are a good wealth distributor and benefit all of us in one way or another, vs private companies like Fidelity. Private companies don’t even have to report their profits publically!

So given the choice been a company that is very profitable and one that doesn’t really care about money and isn’t expected nor even tries to earn a profit, I’m going to pick the one to invest in that cares about a profit!  And I’m betting so would you if you want to be a successful investor!

I’m writing this article today, because sometimes we don’t see all the pieces of a business process.  Just because those pieces are not in the media or communicated out doesn’t mean that they aren’t critical for a given company, and in the end society as a whole!  So yes profits are necessary…

What is your take on company profits?  Do you understand why the are necessary?

MR