Investors' Obsession With Profitability And Why It Matters

Oct 04, 2022 By Susan Kelly

Perhaps the most essential and simple is a company's earnings. Still, many other variables can impact a stock's price, such as the company's growth potential, changes in leadership, the general mood of the market, hype, rumors, and a few dozen others.

Reviewing the company's financial records is a crucial step before investing in an already-established company since they reveal a wealth of information about the operation. The profit margin, operating expenses, and total revenue for the past year should all be included. All shareholders in a public company are interested in the same things.

How Do Earnings Reports Work?

The Securities and Exchange Commission (SEC) requires publicly listed corporations in the United States to file quarterly earnings reports. A quarterly earnings report will include a company's income, expenses, and net profit for the quarter. The annual earnings report is another means through which companies must disclose their financial performance for the year.

What Exactly Are Earnings?

The term "profits" is commonly used to refer to the money a business makes. Earnings are what's left after deducting the cost of goods produced from a company's income. Earnings are the money a firm makes after deducting its expenses.

This seems simple, but the accounting specifics may grow rather sophisticated. Earnings might be confusing because of all the words that mean the same thing. Earnings, Bottom Line, Net Profit, and Profitability all mean the same thing.

Average Earnings Per Share

Earnings per share is a common metric utilized by financial experts and investors alike (EPS). EPS is determined by dividing the net profit after tax by the total number of outstanding shares. EPS is a measure of a company's profitability that is calculated on a per-share basis. Earnings per share (EPS) is necessary for accurate comparisons across firms because the number of publicly held shares varies from company to company.

Earnings-to-Price Ratio

The price-to-earnings (P/E) ratio is another crucial financial indicator extracted from a company's quarterly or yearly report. Stocks in the same industry can be compared with one another using the price-earnings ratio (P/E).

A stock's relative price history may also be used to determine if the current price is high or low. The price-to-earnings ratio (P/E) is a useful indicator of whether the stock market as a whole or in a specific industry is high or low relative to historical norms.

EBITDA

Earnings Before Interest, Taxes, Depreciation, and Amortization, abbreviated as EBITDA, is another key indicator used in firm earnings reports and earnings calls. For a company to be doing well financially, EBITDA has to be high.

The fact that it doesn't take into account things like interest on debt, capital expenditures, and non-cash expenses is one of the ratio's major flaws. Therefore, it does not give an accurate depiction of the company's financial situation.

Season of Earnings

A report card for the stock market, the earnings season is a major holiday for students. Publicly traded corporations in the United States are obligated by law to declare their financial results quarterly.

Reporting periods for most businesses are based on the calendar year, but organizations are free to use any fiscal year they like. You would imagine that earnings (or EPS) are the most important statistic disclosed during earnings season, receiving the most attention and media coverage, but remember that investors look at all financial results.

Why Do Earnings Matter?

Earnings are important to investors since they are the primary factor in determining stock values. When earnings are solid, stock prices tend to rise. Even though a company's stock price is skyrocketing, it may not be producing a lot of money at the moment. However, investors are betting that this won't always be the case.

However, there is no assurance that the firm will be successful in meeting the hopes of its investors. The dot-com bubble and its bursting is a classic case of a company's earnings falling well short of the expectations of its investors. When the boom began, investors became optimistic about the future of any firm that dealt with the Internet, driving up stock prices.

When Financial Results Can Be Deceiving

There are occasions when businesses present a more optimistic financial image than they have. Companies may get into difficulty if they inflate their financial figures and deceive investors. Enron, the then-seventh largest U.S. firm, is often cited as an example of a company that inflated its assets and revenues through questionable accounting procedures.

The corporation and its stock price fell apart after a series of unfortunate occurrences in 2001. After the SEC began looking into Enron's accounting methods, the company revised its financial statements for the preceding four years. During that time, it had a drop in profits of $591 million and an increase in debt of $658 million.

More Articles
blownions
Copyright 2019 - 2023