A company’s earnings are the money it makes from its operations. Publicly-traded companies must report their financial results on a quarterly basis (four times per year) and this is known as “earnings season.” It’s an important time for investors because these numbers are used to calculate EPS, the portion of a company’s net profit allocated to each outstanding share, providing insight into per-share profitability. In addition, some companies provide revenue and earnings guidance for future quarters which can also influence market sentiment.
Earnings are important because when a company is making more money, it can either return that money to shareholders in the form of dividends or use it to expand and improve its operations. In turn, this expansion and improvement can lead to economic gains which are shared by all stakeholders. The Bureau of Economic Analysis estimates corporate profits so that investors, Congress, policymakers and businesses can make informed decisions about the economy.
But those numbers can be distorted by accounting rules that can shave off the true value of assets and distort long-term earnings prospects. For example, some companies report earnings based on a rule called historical cost accounting that translates into a higher valuation of assets than is appropriate. And some firms try to reduce their tax bill by understating income or overstating deductions. Those distortions can alter how we think about economic trends, stock prices and long-term investing. Ultimately, the goal of this article is to provide a road map for assessing these important earnings reports.
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