A Primer in Understanding Company Earnings

A Primer in Understanding Company Earnings



The word "earnings" might make you think immediately of your paychecks or even the earnings of a company. But what exactly are earnings? First, let's define earnings as they relate to companies. Earnings are basically a measure of how profitable a company has been over a given period of time. Stock investors use earnings to determine whether an investment is worth making, or how much money to invest in it.

There are three main ways that a company can earn money. They include sales, expenses, and profits. Sales is when people buy products or services. Expenses are when you pay for things like rent, utilities, and employees. Finally, profits is the difference between the amount of sales revenue generated and the costs incurred.

What are Earnings?

Earnings represent a company's profits and are the result of its revenue minus its costs. Earnings are also referred to as net income or earnings per share (EPS). When a company announces its quarterly or annual earnings, it is called an earnings report.

Companies can be profitable, but that doesn't mean they're earning much money or generating a lot of profit.

The most common way for stock investors to track their investment is by looking at how companies perform over time. To do this well requires some understanding of what profitability means and how earnings can be measured and calculated in different ways.

When are Earnings Reports Released?


Earnings reports are usually released in the weeks following the end of a quarter. Investopedia writes, "the majority of public companies release their earnings in early to mid-January, April, July, and October. It is important to note that not all companies report during earnings season because the exact date of an earnings release depends on when the given company's quarter ends. As such, it is not uncommon to find companies reporting earnings between earnings seasons."

What Types of Information Are Included in Earnings Reports?

Earnings reports will include the following key data points:

  • Earnings per share (EPS) - The most important number of all is the EPS, or earnings per share. This is the amount of money a company made on each outstanding share in a given period. It's calculated by dividing net income by weighted average common stock outstanding, but keep in mind that this figure only tells you what happened to profits at one point in time and doesn't take into account changes from year-to-year.
  • Earnings per share growth - Stock investors use this information to get a more comprehensive picture of how stocks perform over time; their aim is to look for companies with high earnings growth rates. If there are no estimates available for next quarter or next year yet (which would be unusual), the focus would look at current results to gauge if there are opportunities or dangers going forward.


How Do You Find Earnings Information for a Company You're Considering Investing In?

Stock investors use earnings reports to determine whether to invest in a company or not. Investors get this information from:

  • The company's website
  • The investor relations section of the company's website
  • The annual report (if it doesn't exist online)
  • Quarterly earnings reports and presentations, which are available from financial news sites such as Yahoo Finance or Google Finance. Companies usually post these reports within 24 hours of releasing them to investors. You can also look for transcripts of quarterly earnings conference calls on their websites or on SEC filings.

What Are the Different Ways Companies Announce Their Results?

When a company announces its earnings, they do so on an ongoing basis. Companies will announce their results every three months, and these announcements are usually made after the close of the market.

Knowing when, how and where to look for earnings information is key to understanding company performance.

Return on equity tells you whether a company is generating enough profit to cover its costs. Investors will look for the price to earnings numbers (P/E) in the hopes of finding overvalued or undervalued stocks. Typically, a low P/E ratio indicates that the company is worth more than the current price. Low P/E stocks are considered value stocks. It’s important to know when companies release earnings and how to read the reports.

Stock investors will use the latest news on the companies they research because they are hoping to make smart investment decisions that will increase their return.

Understanding Earnings and Prudent Investing

Even though earnings can give you financial insight into a specific company, the reality is that it is difficult to build a prudent, broadly diversified portfolio with a small number of specific stocks. As we mentioned in our previous post (See article here), individual stock risk is significantly more volatile in comparison to a diversified market portfolio.  It bears repeating that Individual Stocks risk can be diversified away when investing in an asset class fund that contains all the stocks in an entire asset class or index rather than the individual stock itself. The reason? There can be permanent loss in an individual stock since many individual companies go to zero.

The danger for individual investors who use earnings reports to determine how to invest is that it is an attempt to find undervalued stocks in the hopes of beating the market. This type of strategy is the strategy employed by active managers who often claim they can find mispriced securities and use this information to “beat the market.”

As famed author and investment academic Larry Swedroe states, “[...] active stock picking is based on a false notion — that the market is somehow mispricing stocks. The evidence is that the market is highly, though not perfectly, efficient — available information is digested rapidly and reflected in market prices. Stock pickers can’t identify underpriced stocks with any regularity.



Earnings may be an interesting exercise in understanding a company’s performance but this information doesn’t really give you a “leg up” in regards to building a prudent, diversified portfolio. As researchers and academics David Sherman and S. David Young point out in the Harvard Business Journal:

“In a perfect world, investors, board members, and executives would have full confidence in companies’ financial statements. They could rely on the numbers to make intelligent estimates of the magnitude, timing, and uncertainty of future cash flows and to judge whether the resulting estimate of value was fairly represented in the current stock price. And they could make wise decisions about whether to invest in or acquire a company, thus promoting the efficient allocation of capital. Unfortunately, that’s not what happens in the real world, for several reasons.

First, corporate financial statements necessarily depend on estimates and judgment calls that can be widely off the mark, even when made in good faith. Second, standard financial metrics intended to enable comparisons between companies may not be the most accurate way to judge the value of any particular company—this is especially the case for innovative firms in fast-moving economies—giving rise to unofficial measures that come with their own problems. Finally, managers and executives routinely encounter strong incentives to deliberately inject error into financial statements.”

Trying to find winning stocks is not unlike finding a needle in a haystack. The winning investment strategy is just to invest in the haystack.

If you want to know more about building a diversified portfolio that gives you the highest probability of success, contact us at [link here]

To read the full article by Sherman and Young, click here.