Understand Company Earnings

(2 of 9)

Understand Company Earnings

The way in which a company conducts its business is important to understand when evaluating its earnings. Companies devoting significant resources to creating a new product may have relatively weak earnings now. But if that new product catches on—watch out. The earnings may begin to soar. Meanwhile, companies that have great earnings now, but are not investing any money to ensure that their business success will continue, may have significant problems in the future.

When evaluating corporate earnings, you should look not only at the income sources, but the expenses as well. They can reveal the company’s long-term strategy for making money, or uncover potential inefficiency or mismanagement.

Finding Company Earnings Information

Among the key research that investors do when they examine a company’s securities is learning about its earnings. Fortunately, there are several good sources for this important information.

Things To Know

  • The best place to learn about corporate earnings is the company annual report.

The best place to learn about corporate earnings is the company annual report. The annual report contains information on the company philosophy and its position in the marketplace. It also contains audited financial statements. These tell you all about the company’s financial operations. You can obtain an annual report directly from the company’s public relations department or on the Web by searching the Securities and Exchange Commission’s EDGAR database (www.sec.gov/edgar.shtml).

To find information about a company’s earnings, you should study its income statement and balance sheet. The income statement shows the sources of a company’s income, production costs, and other expenses. The balance sheet shows the company’s overall financial strength and potential for future growth.

Using Earnings Information for Investment Decisions

How corporate earnings affect your investment decisions depends upon your investment goals. If you are an income investor, you probably want to invest in a company that is paying dividends. If you are looking for long-term growth, dividends may not be as important to you. The "financials" will show you whether a company is oriented toward income, growth, or a bit of both. You can get all this information from the financials. But you must compare the financials for different companies in the same industry to see which has characteristics best suited to your investment goals.

A convenient way to compare companies is through earnings per share (EPS). EPS is the net profit divided by the number of outstanding shares of stock.

When comparing earnings per share of several companies that are candidates for your investment dollars, here are a few things for which to look.

Companies:

  • with higher earnings are stronger than companies with lower earnings.
  • that reinvest their earnings may pay low or no dividends but may be poised for growth.
  • with lower earnings, and higher research and development costs, may be on the brink of a breakthrough (or disaster).
  • with higher earnings, lower costs, and lower shareholder equity may be targets for mergers.

When comparing different companies’ earnings, you should ask yourself these questions:

  • Why are they different?
  • Do the differences make sense for these companies?

When considering which companies to invest in, compare their earnings to be sure you are investing in a company that is efficient and whose earnings and dividend policy match your investment goals.