Corporate earnings are a key piece of information for market participants, whether they’re investors, consumers, or interested in how the economy is performing. While there are many different metrics that can be considered in analyzing earnings reports, the most important are a company’s net income, revenue trends, and earnings per share (EPS).
The difference between revenues and expenses is a company’s net income. Revenues are the amount of money that a company receives for services rendered or sales of products. A company’s costs include things like the cost of goods sold, operating expenses, and taxes. Generally, a company’s net income will include one-time gains or losses that can temporarily inflate or deflate reported earnings. To avoid overreacting to these fluctuations, it’s often best to look at adjusted earnings, which exclude such items.
Companies can choose to reinvest their net income or pass it on to shareholders in the form of dividends and share buybacks. The latter option can have the effect of reducing the number of outstanding shares in a company, which can boost EPS growth. However, it’s important to understand that this type of “earnings engineering” doesn’t necessarily mean fraud or manipulation. In some cases, the way that companies account for the wear and tear on their assets (called depreciation) may end up understating real expenses over time, which can make a company appear more profitable than it really is.
In addition to revealing financial results, earnings reports also provide a glimpse into future expectations. This can give investors a sense of whether a company’s growth potential is sustainable or not. During earnings season, companies frequently release forward guidance and other special announcements that can drive immediate market reactions.