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Technology Stocks : Lucent Technologies (LU)

LU 2.415

+1.9%

Nov 21 9:30 AM EST

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To: Bindusagar Reddy who wrote (8978)	8/3/1999 11:58:00 AM
From: Chuzzlewit	Read Replies (2) of 21876

Bindusager, you are the one who doesn't understand. COS is a variable cost. The point of discussion was sustainable growth, not a one time spurt in eps growth. In your scenario, after a growth spurt of 40% due to a combination of sales growth and decrease in COS earnings growth will revert to the growth in the top line The general simplified equation for calculating profit is: Profit = SALES * (1-VC) - FC There is a linear relationship between sales and profit. That means that regardless of the profit margin, profits are dependant on the rate of increase of sales. For example, if you have variable costs of 75% and sales of 100 you will have a gross profit of 25. Doubling sales will yield a gross profit of 50. This relationship is true irrespective of the gross profit margin. Gross margin is constrained by costs, competition and mathematics (it cannot exceed 100%) and so it cannot continuously improve. That is not the case with sales. While you may get a one time jump in earnings growth by substantially decreasing COS, that growth rate cannot be sustained. Under your assumptions, after the decrease in COS sustainable earnings growth cannot exceed the 20- 25% top line growth you forecast. The situation is complicated by two additional factors: First, fixed costs are not really fixed. They are generally semivariable (displaying a stair-step pattern) because as capacity is constrained new capital expenditures are required. Second, expressing profit as eps depends on the capital structure of the company which is malleable. New shares may be issued or stock may be repurchased. I suggest that you consider very carefully before offering gratuitous advice on investing. TTFN, CTC

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