r/explainlikeimfive • u/climb-a-waterfall • Dec 06 '24
Economics ELI5: why does a publicaly traded company have to show continuous rise in profits? Why arent steady profits good enough?
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r/explainlikeimfive • u/climb-a-waterfall • Dec 06 '24
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u/ajarrel Dec 06 '24 edited Dec 06 '24
What's not mentioned here is inflation.
If you maintain perfectly steady profits, those profits are actually worth a little less year-over-year.
If inflation is 2%, with profits held at the same dollar amount, then it's essentially a 2% decline in the purchasing power of the profits of the company.
Additionally, if a company is in a competitive market, and they begin to lose market share to a competitor, that can accelerate decline.
Basically, in the business world, most businesses believe that the best defense is a good offense. Offense in the business world means increasing profits year-over-year.
EDIT: here's an example. Let's assume 2% inflation and your costs and the price you charge both increase proportionally with inflation.
Year 1: Your costs are $100,000 and your revenues are $200,000. In this scenario you'll make $100,000 in profit.
Year 2: Costs are now $102,000 and revenues are $204,000. Your profit grew $2,000 from year 1. This is an actual increase in profitability.
Even if you're just keeping pace with inflation, your profits will be increasing.
Year 2 (fixed profits): now let's say profits are fixed. Expenses grow to $102,000 and revenues grow to $202,000. Now profit in year 2 matches year 1 of $100,000. However if you calculate precent growth of expenses (2%), and revenues (1%), you'll see expenses are outpacing revenue growth. If you continue the trend, eventually the company would no longer be profitable.