Corporate earnings—the monetary profits generated by private sector businesses—are an important component of financial markets and global economics. As one of the main leading indicators of consumer spending, economic production, and inflation, they are used by central banks to help guide interest rate decisions and other monetary policy interventions. They also provide insight into the state of the economy by highlighting trends in business investment, productivity, and pricing power.
Earnings reports can be a source of positive sentiment when companies exceed expectations, negative sentiment when they miss them, or indifference if the results are in-line with estimates. While the metrics that investors and traders focus on differ by individual strategy, revenue trends, earnings per share (EPS), and forward guidance are among the most commonly cited data points.
EPS measures how much profit is left after all expenses and taxes have been deducted from revenue. It is calculated on a diluted basis to account for shares outstanding. Since a company’s profitability is a key driver of its value, EPS is an important metric to track and compare across competitors. However, it is important to understand that EPS can be distorted, both intentionally and unintentionally, by one-time gains or losses. For example, if a company receives a windfall from the sale of a land parcel that it owned, this would be considered an extraordinary item and should be excluded from EPS calculations.
Other ways that EPS can be inflated include adding back in amortized costs and depreciated assets, using different methods for computing capital expenditures, and taking into account the effect of stock buybacks on the number of shares outstanding. Investors should be sure to look at adjusted EPS, which excludes these items, in addition to tracking EPS on a year-over-year (YoY) basis.
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