Bottom line vs. top line

Doug Horn

The management of investments offers many statistics, ratios, indicators, hunches, and whispers that can be observed and followed if appropriate. Two of the most basic statistics refer to the change in the bottom line or the top line of the company.

When the economy is in a recovery mode from a recession, both of these statistics offer a great deal of insight into the health of the company, the industry and perhaps the economy. How to interpret these statistics comes with practice and not in a vacuum, but with the awareness of the overall conditions of the economy.

Bottom line refers to the profit or loss of a company. Prior to the start of a recession, the bottom line of many companies starts to change. The growth rate of the profit per share slows, or for many companies their profit per share actually starts to decline. Throughout the recovery, we are seeing the opposite happen per the earnings reports during each quarter. It is this increase in the bottom line of a company that will often drive up the value of their stock.

The change in the bottom line is not always a clear indicator things are going well for the company. As with this recession, tens of thousands of employees were laid off. While the impact for the individual worker was not pleasant, for the company this reduction translates into lower expenses. There are two ways to control the bottom line of a company. The first is to reduce costs. If a company has the same revenue but reduces its costs, its profit per share will improve and thus potentially drive up the value of each share. But as you might expect, there are only so much in cuts that can be made before quality, service, or deliverability will be impacted. When these factors are negatively impacted, the ability of the company to grow profits and perhaps remain profitable may become in question.

Thus, during a recession and the period following it watching the bottom line is critical, but not the sole solution. The company must respond to the economy around it and generally this means cuts. As such, the first signs of improvement will be the improving bottom line. However, this alone will make for a short recovery and a possible quick return into a recession. The expectation naturally turns to the top line. This is referring to revenue growth of a company. As businesses increase their revenues, it becomes easier to continue to grow the bottom line; and in fact, the bottom line may actually accelerate in its growth rate.

Once a company has returned to profitability, the current revenue level is covering their expenses. If they are able to continue to increase their revenue, a greater percent of each new revenue dollar will actually fall to the bottom line. It is this action that may speed the growth of profits. Understanding what impacts the bottom line and what may drive or reduce the top line will lead to improved portfolio performance.



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