Income Statement: Profit Information for Stock Investors - dummies

Income Statement: Profit Information for Stock Investors

By Paul Mladjenovic

Earnings or profit is the single most important item on the income statement for you to consider as a potential stock investor. It’s also the one that receives the most attention in the financial media. When a company makes a profit, it’s usually reported as earnings per share (EPS).

If you hear that XYZ Corporation beat last quarter’s earnings by a penny, here’s what that means. Suppose that the company made $1 per share this quarter and 99 cents per share last quarter. If that company had 100 million shares of stock outstanding, its profit this quarter is $100 million (the EPS times the number of shares outstanding), which is $1 million more than it made last quarter.

Don’t simply look at current earnings as an isolated figure. Always compare current earnings to earnings in past periods (usually a year). For example, if you’re looking at a retailer’s fourth-quarter results, don’t compare them with the retailer’s third-quarter outcome. What if the company usually does well during the December holidays but poorly in the fall? In that case, you don’t get a fair comparison.

A strong company should show consistent earnings growth from the period before (such as the prior year or the same quarter from the prior year), and you should check the period before that, too, so that you can determine whether earnings are consistently rising over time. Earnings growth is an important barometer of the company’s potential growth and bodes well for the stock price.

When you look at earnings, here are some things to consider:

  • Total earnings: This item is the most watched. Total earnings should grow year to year by at least 10 percent.

  • Operational earnings: Break down the total earnings and look at a key subset — that portion of earnings derived from the company’s core activity. Is the company continuing to make money from its primary goods and services?

  • Nonrecurring items: Are earnings higher (or lower) than usual or than expected, and if so, why? Frequently, the difference results from items such as the sale of an asset or a large depreciation write-off.

Keep percentages as simple as possible. Ten percent is a good number because it’s easy to calculate and it’s a good benchmark. However, 5 percent isn’t unacceptable if you’re talking about tough times, such as a recession. Obviously, if sales, earnings, and/or net worth are hitting or surpassing 15 percent, that’s great.