======Profits======
Profits (often used interchangeably with [[Earnings]] or [[Net Income]]) are the financial lifeblood of any business. In the simplest terms, profit is what's left over after a company subtracts all its costs from all its revenues. Think of it as the ultimate scorecard for a business: a positive number means it’s winning, creating more value than it consumes. For an investor, a company's ability to consistently generate profit is the primary source of shareholder returns and the fundamental driver of its long-term stock price. This crucial figure is found at the bottom of a company's [[income statement]], which is why it's famously nicknamed the "bottom line." Understanding not just the final number, but //how// that number is created, is one of the most essential skills for a [[value investing]] practitioner. It’s the difference between just looking at a price tag and truly understanding the quality of the item you’re buying.
===== The Many Faces of Profit =====
When you look at an income statement, you'll notice that "profit" isn't just a single number. It's revealed in stages, with each level telling you a different part of the company's story.
==== Gross Profit ====
This is the first and most basic level of profitability. It's calculated by subtracting the direct costs of producing and selling a product from the total sales.
  * **Formula:** [[Revenue]] - [[Cost of Goods Sold (COGS)]]
Gross Profit tells you how efficiently a company makes its products or delivers its services. A high and stable [[gross margin]] (Gross Profit / Revenue) is a fantastic sign. It often indicates the company has a strong brand, superior technology, or some other competitive advantage—what legendary investor [[Warren Buffett]] calls an [[economic moat]]—that allows it to charge a premium price without losing customers.
==== Operating Profit ====
Next up is Operating Profit (also known as [[Earnings Before Interest and Taxes (EBIT)]]). This figure shows you the profit a company makes from its core, day-to-day business operations, //before// accounting for the costs of its debt (interest) or its tax bill.
  * **Formula:** Gross Profit - [[Operating Expenses (OPEX)]]
Operating Expenses include costs not directly tied to production, such as marketing, research & development (R&D), and general administrative salaries. Operating Profit is an excellent metric for comparing the core operational efficiency of two different companies, as it strips away the effects of their unique financing decisions and tax situations.
==== Net Profit ====
This is it—the famous "bottom line." Net Profit is the final amount of profit remaining after //every single expense// has been deducted, including interest on debt and corporate taxes.
  * **Formula:** Operating Profit - Interest Expenses - Taxes
This is the profit that truly belongs to the company's owners, the shareholders. It's the source of future growth and investor returns. This final profit figure is used to calculate one of the most widely cited metrics in finance: [[Earnings Per Share (EPS)]], which tells you how much profit was generated for each outstanding share of stock.
===== Why Value Investors Obsess Over Profits =====
For value investors, profits aren't just an academic exercise; they are the tangible source of investment value.
==== Quality, Not Just Quantity ====
A single year of high profits can be a fluke. A true value investor looks for a long history—at least five to ten years—of consistent and preferably growing profits. This track record demonstrates a resilient and well-managed business that can thrive through different economic cycles. It's a sign of a high-quality company, not just a one-hit-wonder.
==== The Source of Value ====
A profitable company has wonderful options, all of which benefit shareholders. It can:
  * Reinvest profits back into the business to develop new products, expand into new markets, or improve efficiency, thereby generating even more profit in the future. This is the magic of compounding at work.
  * Pay out a portion of the profits directly to shareholders in the form of [[dividends]].
  * Use profits to repurchase its own stock ([[share buybacks]]), which reduces the number of shares in circulation and increases each remaining shareholder's ownership stake in the company.
Ultimately, the intrinsic value of a business is the sum of all the cash it can generate for its owners over its lifetime. While sophisticated investors often use [[free cash flow (FCF)]] for a more precise [[discounted cash flow (DCF)]] valuation, a deep understanding of sustainable profits is the foundational starting point.
===== Potential Pitfalls: Not All Profits Are Created Equal =====
A healthy dose of skepticism is a value investor's best friend. Always question the numbers before accepting them at face value.
==== Accounting Shenanigans ====
Remember that Net Profit is an [[accounting]] figure, and accounting rules can sometimes be flexible. A company can use various techniques to make its reported profits look better than its actual cash generation. **Pro Tip:** A major red flag is when a company consistently reports strong Net Profit but generates weak or negative Free Cash Flow. Cash, as they say, doesn't lie.
==== One-Off Gains ====
Always check //where// the profits came from. Was it from the company's fantastic core business, or was it inflated by a one-time event, like the sale of a factory or a large legal settlement? These one-off gains are not repeatable and can paint a misleadingly rosy picture of a company's ongoing health. Always focus on the profit generated from recurring, sustainable operations.