If you don’t understand the returns, you can’t do much in the stock market. From CEOs to research analysts, everyone is fascinated by this frequently quoted number. But what does the revenue represent? Why do they cause so much attention? We will answer these and more questions in this income primer.
- The company’s income refers to the net income or profit after tax in a particular quarter or fiscal year.
- When evaluating a company’s profitability, profitability is of the utmost importance, and it is also a major factor in determining the company’s stock price.
- Earnings per share (EPS) is the company’s net income (or earnings) divided by the number of common shares outstanding.
- EPS shows the company’s earnings per share. A higher EPS indicates that the stock has a higher value than other stocks in the same industry.
- Companies need to report quarterly results, but earnings per share are often the most concerned by investors, especially when earnings per share exceed, match, or fall short of stock analysts’ forecasts.
What is the benefit?
The income of a company is simply its profit. Take the sales income of a company and subtract all the costs of producing the product, and voila, you have income! Of course, the details of accounting are much more complicated, but revenue always refers to how much money the company makes minus costs. Many of its synonyms have caused some confusion related to income. The terms profit, net income, bottom line, and earnings all refer to the same thing.
Whether you call it revenue, net income, profit, or bottom line, you are still looking at the same metric-the company’s revenue minus costs.
Earnings per share
To compare the earnings of different companies, investors and analysts often use earnings per share (EPS) ratios. To calculate earnings per share, divide the remaining shareholder earnings by the number of outstanding shares. You can think of earnings per share as a per capita way of describing earnings. Because each company has a different number of public shares, just comparing the company’s earnings data does not indicate how much money each company makes per stock, so we need earnings per share to make an effective comparison.
For example, consider two companies: ABC Corp. and XYZ Corp.. Their earnings are both US$1 million, but ABC Corp. has 1 million shares outstanding, while XYZ Corp. has only 100,000 shares outstanding. ABC Corp.’s earnings per share are US$1 (US$1 million per 1 million shares), while XYZ’s earnings per share are US$10 (US$1 million per 100,000 shares).
The earnings season is equivalent to the school transcript of Wall Street. It occurs four times a year; US law requires listed companies to report their financial performance every quarter. Most companies report according to the calendar year, but they can also choose to report according to their own accounting calendar.
Although it is important to remember that investors look at all financial results, you may have guessed that earnings (or earnings per share) are the most important numbers released during the earnings season, attracting the most attention and media coverage. Before the earnings report comes out, stock analysts publish earnings forecasts (estimates of the numbers they think the earnings will reach). The research company then compiles these forecasts into “consensus earnings estimates.”
When a company exceeds this expectation, it is called an earnings surprise, and stocks usually go higher. If a company releases earnings lower than these expectations, it is said to be disappointing, and prices usually fall. All of this makes it difficult for us to guess the trend of a stock in the earnings season: everything is related to expectations.
Why should you care about benefits?
Investors care about returns because they will eventually drive stock prices. Strong earnings usually cause stock prices to rise (and vice versa). Sometimes a company whose stock price has soared may not make much money, but a stock price increase means that investors hope that the company will be profitable in the future. Of course, there is no guarantee that the company will meet the current expectations of investors.
The boom and bust of Internet companies is a perfect example of companies whose earnings are far lower than investors imagined. When the boom began, everyone was excited about the prospects of any company that ventured into the Internet, and stock prices soared. Over time, it is clear that Internet companies will not make as much money as many people have predicted. The market simply cannot support the high valuations of these companies without any gains; as a result, the stock prices of these companies plummeted.
When a company makes money, it has two options. First, it can improve its products and develop new products. Second, it can transfer funds to shareholders in the form of dividends or stock repurchases. In the first case, you believe that management will reinvest profits in order to make more profits. In the second case, you can get the money immediately. Typically, smaller companies try to create shareholder value by reinvesting profits, while more mature companies pay dividends. Both of these methods are not necessarily better, but both rely on the same idea: in the long run, earnings provide returns for shareholders’ investments.
Earnings are ultimately a measure of the company’s profitability, and are usually evaluated in terms of earnings per share (EPS), which is the most important indicator of the company’s financial status. Earnings reports are published four times a year, and Wall Street will pay close attention to them. Finally, growing earnings is a good sign that the company is on the right path to provide investors with substantial returns.