You don’t have to be an investor or follow business news very closely to know that corporate earnings are hugely important. Everyone from the media to investors and central banks alike rely on these numbers when making decisions and setting economic policy. Yet, while many are aware that companies report earnings on a quarterly basis and the results are a huge driver of stock prices, most have little understanding of what these numbers really mean or how they’re calculated.
Earnings are the sum total of all a company’s profits during a given period. They’re calculated by subtracting a company’s costs from its revenue, with the result being a figure that’s reported on a quarterly basis. Earnings are important to the economy because they’re an indicator of how successful businesses are at turning their assets into cash.
The main metrics investors and analysts focus on are EPS, net income, and margins. Companies will also often provide forward guidance, a projection of their future financial performance that shapes expectations and drives immediate market reactions.
It’s important to understand what each of these metrics means in order to make informed investment decisions. For example, focusing on only EPS growth without considering one-time gains or losses can lead you to believe that a company is growing faster than it actually is. Similarly, not considering share buybacks can distort the true picture of a company’s profitability. It’s important to be aware of these issues in order to avoid overreacting to earnings reports.