Key questions: are earnings sustainable

I have sorting through my files, and came across this little gem on investing for 2011 on the Motley Fool boards.

In a thread entitled “MUBL – lessons from a value share gone wrong”, Chinga1 writes (http://is.gd/Ie8U3Z):

Looking back, I can see a number of reasons to have avoided this share:

1) It’s over-reliance on a single customer – Morrisons
2) The general decline of the CD/DVD industry
3) The fact that it is, effectively a distributor, neither making nor selling its products
4) It’s announcement of a strategic review of the business on 5th October
5) the issue of a profit warning on 7th October which said profits for the year to 31 March 2011 is expected to be materially behind market expectations.

Here’s a response by Paul Scott (http://is.gd/94wNtQ):

but a very wise old city warhorse leaned over whilst we were having lunch a few years ago, and gave me the best advide I’ve ever heard.

He said, before you invest in any company, ask youself one KEY quesion, and this was it;

ARE EARNINGS SUSTINABLE?

His view was that you cannot value any company until you have established whether their earnings are sustainable. And most companies earnings are actually not sustainable.

It’s good to see that I’m not the only one to make numerous typos.

There are numerous other good responses by CockneyRebel and others, so give the thread a good skim-read. I like this by odysseus2000:

If you’re in a situation where the market is on a low p/e so that lots of shares are at low p/e it is generally good to buy. If your in a situation where the market has moved up so that p/e are well of their lows and you find a share with a low p/e it is likely dangerous even if it looks attractive with other positives such as a good dividend. The value game of low p/e generally works well for large cap stocks were there are many ways to grow future earnings and where going bankrupt is unlikely. You may have to wait for value to out but in the by and by you will in general do well. With small caps there is far more danger that the company loses its earning stream and goes down hill.

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About mcturra2000

Computer programmer living in Scotland.
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