What are 'Earnings'
Earnings typically refer to after-tax net income. Earnings are the main determinant of share price, because earnings and the circumstances relating to them can indicate whether the business will be profitable and successful in the long run. Earnings are perhaps the single most studied number in a company's financial statements, because they show a company's profitability compared to analyst estimates and company guidance.
BREAKING DOWN 'Earnings'
Earnings are the amount of profit that a company produces during a specific period, which is usually defined as a quarter (three calendar months) or a year. Every quarter, analysts wait for the earnings of the companies they follow to be released. Earnings are studied because they represent a direct link to company performance. A company that beats estimates is outperforming its peers; thus, the CEO will be praised and the Board will pat itself on the back. A company that misses earnings is under-performing its peers; so the CEO will be blamed and the Board may elect a new CEO.
Measures and Uses of Earnings
There are many different measures and uses of earnings. Some analysts like to calculate earnings before taxes. This is referred to as pre-tax income, earnings before taxes, or EBT. Some analysts like to see earnings before interest and taxes. This is referred to as earnings before interest and taxes, or EBIT. Still other analysts, mainly in industries with a high level of fixed assets, prefer to see earnings before interest, taxes, depreciation and amortization, also known as EBITDA. All three measures provide varying degrees of profitability.
Earnings Per Share
Earnings per share is a commonly cited ratio used to show the company's profitability on a per-share basis. It is also commonly used in relative valuation measures such as the price-to-earnings ratio. The price-to-earnings ratio, calculated as price divided by earnings per share, is primarily used to find relative values for the earnings of companies in the same industry. A company with a high price compared to the earnings it makes is considered overvalued. Likewise, a company with a low price compared to the earnings it makes is undervalued.
While earnings may appear to be the holy grail of performance measures, they can still be manipulated. Some companies intentionally manipulate earnings higher. These companies are said to have a poor or weak quality of earnings. Earnings per share can also be manipulated higher, even when earnings are down, with share buybacks. Companies do this by repurchasing shares with retained earnings or debt.