A stock’s earnings are the profits or net income a company generates from its operations. Earnings can be found in a company’s statements, specifically its income statements. Company earnings must be reported every quarter in 10-Q financial statements and annually through 10-K financial statements.
By definition, the value of any stock is the present discounted value of all future profits. But stock prices could be more or less than this number depending on the market value investors are willing to pay for it. Over a longer horizon, however, the price of a stock will usually show its underlying value.
Earnings and Valuations
When an investor buys a share of stock at the market price, they are purchasing equity in the company and a share in the future profits. Investors use financial statements to estimate the profit potential of a stock. Another common measures of a stock’s valuation price is the price-to-earnings (P/E) ratio. The P/E ratio is calculated by dividing the stock price by its most recent annual earnings. If this ratio is less than others in its industry, it may indicate that the stock price is undervalued. Though, investors should mainly use P/E ratios to compare stocks that are similar in nature.
Earnings and Wall Street Expectations
There are many factors that affect a stock’s price, and company’s earnings report is one that can have a significant influence on the direction of a company’s share prices. Earnings reports are comparable to a quarterly and annual report card for a company. Wall Street analysts and investors set their own expectations on a company’s performance. Company’s can also issue performance guidance to set their own expectations and projections. Whether or not the company disappoints, meets or even exceeds these estimates can have a huge impact on the movement of its stock price.
Analyzing Earnings of a Stock
The ability to read and analyze financial statements of companies and competitors in the same industry is important for investors. Shareholders can look at the company’s profit margin–which is the amount of profits a company makes relative to its revenues–and net income growth to gauge the potential of a stock. A company’s profit margin can tell investors how efficient a company is in turning its sales into profits. The company’s earnings growth rate–comparing the change in profits or losses from one year to the next–is also essential.