In our Masterclass we look at Earnings and what you need to know. A company’s earnings are its profits, or other names are net income, bottom line and how much is made. Take a company’s total sales or revenue then subtract all the costs to produce that product, then take away the expenses/overheads and we have earnings.
Earnings to Compare Companies
To compare the earnings of different companies, we often use the ratio of earnings per share (EPS). To calculate EPS you take the earnings / profit and divide by the number of shares outstanding. But note – because every company has a different number of shares owned by the public, just comparing only companies’ earnings figures does not indicate how much money each company made for each of its shares, so we need EPS to make valid comparisons.
For example, two companies that both have earnings of $1 million but one has 1 million shares outstanding while the other has only has 100,000 shares outstanding. The first has EPS of $1 per share ($1 million/1 million shares) while the second has EPS of $10 per share ($1 million/100,000 shares). But which has a better profit margin? Which has more manageable debt? Which has a better return on assets, return on equity etc?
Earnings season is the regular time of year that publicly-traded companies publish their financials – twice a year in Australia, in the U.S. quarterly. Most companies follow the calendar year for reporting, but they do have the option of reporting based on their own fiscal calendars.
Earnings (or EPS) is the most important number released during reporting/earnings season, and before earnings reports come out, stock analysts issue earnings estimates – what they think earnings will come in at. These forecasts are then compiled by research firms into the “consensus earnings estimate”.
When a company beats this estimate it’s called an earnings upside or surprise, and the stock usually moves higher.
If the earnings are below these estimates it is said to disappoint, and the price typically moves lower.
This makes it hard to try to guess how a stock will move during earnings season: It’s really all about expectations.
What is the Importance of Earnings?
Investors care about earnings because they ultimately drive stock prices. Strong earnings generally result in the stock price moving up (and vice versa). Sometimes a company with a rising stock price might not be making much money, but the rising price means that investors are hoping that the company will be profitable in the future .
When a company is making money it has two options. First, it can invest back in the company – improve its products and develop new ones and make more profit. Or second, it can pass the money onto shareholders in the form of a dividend or a share buyback.
In all, growing earnings are a good indication that a company is on the right path to providing a solid return for investors.
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