What is 'Earning Potential'

Earning potential refers to the potential gains from dividend payments and capital appreciation shareholders might earn from holding a stock. In other words, it reflects largest possible profit that a corporation can make. It is often passed on to investors in the form of dividends. The possible growth in earnings that could be generated for each share outstanding of a particular stock. Earning potential can be measured on an earnings per share (EPS), return on assets (ROA) or return on equity (ROE) basis. Companies sometimes choose to pass this growth on to investors in the form of dividends.

BREAKING DOWN 'Earning Potential'

In addition to scrutinizing earnings growth potential, analysts, investors, portfolio managers and potential acquirers usually look at a stock or industry sector's earning potential in relation to other factors such as price, by calculating the price to earnings (P/E) ratio. Generally, the higher the ratio, the greater the earnings potential. The perception that a given stock has higher earning potential relative to other securities tends to drive up the price of that stock. Although earning growth potential can cause a stock's price to rise, this will not necessarily translate into higher current dividends as company management might choose to instead reinvest its earnings in the business. A company that comes out with an innovative new product may have higher earning potential in the future as a result, but the projected revenue may not translate into actual profit for some time. A company’s market value can and does fluctuate for reasons unrelated to its earning potential. For instance, during “risk-off” periods in markets when a change in risk perception makes investors reluctant to bet on any but the safest assets. The same dynamic can operate in reverse during times of bullish sentiment.

Analyzing Earning Potential

A lot of factors need to be taken into account when valuing a stock’s earning potential. The value of intangibles such as intellectual property and brand equity, share buyback plans, revenue forecasts and market share in addition to management acumen, regulatory risk and general investor sentiment all come into play when analyzing or deciding whether or not to invest in a stock or acquire a company. Earning potential varies by industry, so it’s important to consider where a stock trades relative to its industry peers’ by analyzing comps, or comparables. And comparing a company’s earning potential to its past performance can show you how its growth potential has changed over time.

RELATED TERMS
  1. Earnings

    Earnings typically refer to after-tax net income or a company's ...
  2. Value Stock

    A value stock is a stock that tends to trade at a lower price ...
  3. Capital Dividend

    A capital dividend is a type of payment a firm makes to its investors ...
  4. Stock Dividend

    A stock dividend, also known as a scrip dividend, is a dividend ...
  5. Total Return

    Total return is a performance measure that reflects the actual ...
  6. Property Dividend

    A property dividend is an alternative to cash or stock dividends. ...
Related Articles
  1. Investing

    Comparing P/E Ratio, EPS and Earnings Yield

    P/E ratios may be the established standard for valuation, but earnings yields are especially useful for comparing returns across different instruments.
  2. Investing

    Dividend facts you may not know

    Dividends are one way in which companies "share the wealth" generated from running the business. Discover the issues that complicate these payouts for investors.
  3. Investing

    Financial Ratios to Analyze Investment Banks

    The general rules of stock-picking apply but there are also some additional metrics with particular relevance for investment banks.
  4. Investing

    4 Ratios to Evaluate Dividend Stocks

    Discover details about fundamental analysis ratios that could help to evaluate dividend paying stocks, and learn how to calculate these ratios.
  5. Investing

    The 3 Biggest Misconceptions of Dividend Stocks

    Learn about three dividend stock misconceptions and how to avoid them for greater gains.
  6. Managing Wealth

    How to Use Earnings Season to Make Better Decisions

    Earnings season reflects the state of the stock market, but also demonstrates how the overall economy is performing.
  7. Investing

    3 Top Dividend Stocks for 2018

    These three dividend stocks offer long-term return potential with a steady stream of income.
  8. Investing

    Breaking Down Stock Buybacks

    Learn about stock buybacks and how they affect financial ratios and stock value.
RELATED FAQS
  1. Can a Company Declare a Dividend that Exceeds EPS?

    Many well-known Fortune 500 companies have paid dividends in years where they posted negative earnings per share. Read Answer >>
  2. What is the formula for calculating earnings per share?

    Learn how to calculate earnings per share and why it's an important gauge in determining a stock’s value and a company's ... Read Answer >>
  3. What causes dividends per share to increase?

    Learn what the major factors are that can lead to changes in a company's dividend payouts and drive increases in dividends ... Read Answer >>
  4. How do dividends affect the balance sheet?

    A company might issue a dividend to investors in the form of cash dividends or stock dividends. Each type impacts its balance ... Read Answer >>
Trading Center