You can’t get far in the stock market without understanding earnings. Everybody from CEOs to research analysts is infatuated with this often-quoted number. But what exactly do earnings represent? Why do they attract so much attention? In this article, we will look at everything about earnings and what to look for it.
What are earnings?
A company’s earnings are, quite basically, its profits. Take a company’s revenue from selling something, subtract all the costs to produce that product, and, voila, you have earnings. Of course, the details of accounting get a lot more complicated, but underneath all the financial jargon, what is really being measured is how much money a company makes.
Earnings per share
To compare the earnings of different companies, investors and analysts often use the ratio earnings per share (EPS). To calculate EPS you take the earnings left over for shareholders and divide by the number of shares outstanding. You can think of EPS as a per-capita way of describing earnings
For example, take two companies: ABC Corp. and XYZ Corp. They both have earnings of $1 million, but the ABC Corp has 1 million shares outstanding while XYZ Corp. only has 100,000 shares outstanding. ABC Corp. has a EPS of $1 per share ($1 million/1 million shares) while XYZ Corp. has a EPS of $10 per share ($1 million/100,000 shares).
Earnings season is Wall Street’s equivalent of a school report card. It happens four times per year; publicly traded companies in the U.S. are required by law to report their financial results on a
quarterly basis. Most companies follow the calendar year for reporting, but they do have the option of reporting based on their own fiscal calendars.
Why Do Investors Care About 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 – of course, there are no guarantees that the company will fulfill investors’ current expectations.
What To Look For In An Earnings Report?
This may be even more important than the numbers. Most CEO’s will give an appraisal of where they see their markets and businesses headed. If they revise their earlier estimates for revenues and profits downward, the stock will immediately reflect that. If it’s upward, investors like that and will usually bid up the stock.
While earnings are the driver for stocks, what is almost as important for investors is revenues. They will be going up or down. Good stocks always have a way of seeing revenues increase.
As indicated, these don’t happen every quarter, like other expenses. They’re extraordinary. That means if a company has a rare occurrence, such as a tornado knocked out a plant, it’s not likely it will happen again. Most analysts overlook these events and factor back into their calculations the earnings that the event damaged.
Earnings mean profit; it’s the money a company makes. It is often evaluated in terms of earnings per share (EPS) – this is the most important indicator of a company’s financial health. Earnings reports are released four times per year and are followed very closely by Wall Street. In the end, 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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