Regardless of its size, every business or company’s main objective is to profit from its primary activity. When a company has public participation through its shares in the stock markets, investors are attentive to the results. Company earnings are one of the most anticipated results by analysts and investors. These occur public periodically through earnings reports. The results obtained by a company are decisive in the price of the shares in the stock market. We will analyze the concept of company profits and the different mechanisms of establishing them in-depth.
What are company profits?
As the time to present the earnings report approaches, expectations are growing. Investors hope that, from the results, the shares in their possession will benefit. Besides, analysts want to see their projections confirmed. Company earnings constitute one of the most anticipated information on the stock markets.
However, what exactly are corporate profits? These are the results obtained by a company in a certain period. Commonly, companies report them every three months. Others consider the fiscal year to release their information.
Earnings, for analysis purposes, become considered before or after deduction of taxes. This way, net earnings reports include the deduction already.
The profits of the companies are decisive when analyzing the profitability of each one of them. The information announced will have an impact on the listing price of its shares on the stock market.
In general, companies disaggregate the results according to each business unit. This allows investors to know which are the most profitable areas and, based on that, determine the outlook.
The importance of earnings information
If we consider that any company’s objective is to make a profit, talking about the importance of this report seems like a truism. However, the profits of the companies must be analyzed carefully, beyond the technical result.
Before the release of the earnings reports, analysts have made their estimates. On the other hand, each company establishes its projections for the next quarter or year.
Once the reports became published, the stock markets give their verdict. If the company’s earnings were in line with analyst projections, there would be the peace of mind among investors. Here, it also matters the predictions that the company has made during the presentation of the report. If the projections are optimistic, there may be a rise in the price of the shares. On the contrary, if there is a weakness in the predictions, the shares could go down.
If the company’s earnings report was below analyst estimates, investors could divest part of the stock. This means that stocks could go down in the stock market.
When company earnings exceed projections, investors consider buying stocks. This moves the price of the stock higher in the market.
Exceptions to the rule
When it comes to analyzing company earnings, it is important to delve into how it is composed. In some cases, companies have a weak earnings report. But, that result is the product of heavy investments in new businesses. When this happens, regardless of the result, investors’ expectations remain intact.
For several quarters, Amazon reported limited earnings in early 2000. But this was because it was undergoing an investment process. Investors decided to hold onto the shares in anticipation of future profitability potential.
How to measure the profits of companies?
For analysts, there are different ways to calculate and measure company profits. Some of them calculate earnings before tax (EBT). Others take total earnings before interest and taxes (EBIT). For companies with a significant number of fixed assets, earnings before, interest, taxes, depreciation, and amortization (EBITDA) are used.
From these calculation methodologies, it is possible to obtain different ways of measuring a company’s profitability.
Earnings per share (EPS): This indicator is the most common that analysts work with. Its calculation is simple and consists of dividing the total earnings by the number of shares in circulation.
Price-Earnings Ratio (P/E) : This relationship arises from dividing the share price(P) by the earnings per share(E). This indicator can give us a status of the shares’ valuation. A high ratio concerning other companies could indicate an overvaluation of the shares.
Earnings performance: Analysts consider this metric to measure earnings. The earnings per share of the last 12 months are taken and divided by the current market price.
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