A Guide to Earnings

A hand drawing an arrow to earnings
October 4, 2021

Earnings are an important determinant of a company’s share price. This is because earnings can indicate the profitability and success of the company in the long run. Earnings are usually reported on a quarterly and annualized basis. These reports are compared to analysts’ expectations. Analysts make predictions for a company’s earnings report based on various financial factors. If a company’s earnings report deviates from the analysts’ expectations, the stock generally reflects that deviation (positively or negatively).

A company that beats analysts’ expectations shows that it is more profitable than previously believed, which will positively impact its stock price. If a company reports lower-than-expected earnings, the stock price will most likely reflect that news by declining.

There are three main earnings measurements:

EBT: Earnings Before Taxes
EBIT: Earnings Before Interest and Taxes
EBITDA: Earnings Before Interest, Tax Depreciation, and Amortization

Along with these three measurements, multiple calculations use a company’s earnings. One calculation is the Earnings Per Share ratio. This ratio is commonly used to show a company’s profitability. It is calculated by dividing a company’s total earnings by the number of shares outstanding.

Another commonly used ratio is the Price to Earnings Ratio. The Price to Earnings Ratio, also referred to as the P/E Ratio, is relative to the earnings per share ratio. The P/E Ratio is calculated by dividing a company’s share price by its Earnings per Share. This is primarily used to find relative values for the earnings of companies in the same industry.

For example, if the technology sector has an industry-wide P/E Ratio of 20, and a company within the tech sector has a P/E Ratio of 75, then an investor could view that company’s stock price as overvalued.

These ratios are most commonly used among dividend-paying stocks and value stocks. These companies are more established and have more history within reporting earnings. These ratios are not as popular among high-growth companies because these companies tend to have very high P/E Ratios and are not as helpful when evaluating a company’s stock price.

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