Tracking a trend sounds easy enough. In fact, though, the methods investors and traders need to employ, and their assumptions, are easily misunderstood. It is easy to fall into the trap of expecting revenues and profits to keep rising at the same rate every year, for example
You want to make sure that the way you track trends is realistic. A company's history (and future trend) of revenue and net profits or level of debts should be subjected to a few practical rules. These include:
1. Don't expect growth to continue on the same curve every year. When you see that revenues have grown by 10% every year over the past three or four years, it might be a mistake to assume that the same growth curve will continue indefinitely into the future. All trends tend to flatten out over time, so when future growth declines below the recent trend, it is not always a negative sign. It's just part of the normal flattening out of the growth curve.
2. Some trends are not going to grow, but are more likely to stay the same. You expect to see the dollar value of revenues and net profits grow each year. However, net profits are most like to remain at about the same percentage of revenues year after year. You do not want to see a decline in this net return; but when a company maintains the level, especially when the dollar levels keep rising, that is a very positive outcome.
3. One year's negative outcome is not always the end of the road. Few trends continue relentlessly in the same direction. Profit and loss is a chaotic matter, so you might see a quarter or even a full year with disappointing results. Keep a realistic eye on the long-term trend and the company's financial health and competitive stance. Never assume that the latest quarter or year proves reversal of a longer-established trend.
4. When using averages, remove the non-recurring aberrations. In statistics, a rule of averaging is to eliminate the highest and lowest outcomes in the field. This applies in financial analysis as well. Look for the non-recurring spikes above or below the average and exclude these from the analysis. This is especially important when trying to identify a stock's volatility, in which prices have spiked once during the year and then returned to a previously set trading range.
5. The long-term trend is more revealing than the short-term trend. Finally, remember to view at least five years of results; if you can find 10 years of outcomes, that is even better. When reviewing revenues and profits, debt levels, or dividend yield, the longer periods reveal much more. You can spot the strength or weakness in the trend by seeing how it has worked over many years, and in different economic conditions.
Financial trends are the study of past movement, used to predict likely future movement. The more reliable and stable the trend, the easier this is. By following these guidelines, your ability to accurately interpret the numbers improves significantly.
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