The Importance of Company Earnings in Stock Valuation

By Stock Research Pro • November 17th, 2008

Company earnings are the profits it generates. If you subtract the company’s costs from the revenue it generated over a specified period of time, you have its earnings. Stock evaluation should always include the examination of company earnings. Earnings are viewed as a significant component in analyzing the health of a given company and the future earnings expectations of the company play a major role in the market’s setting the price of the stock.

The Value of Strong Earnings

Earnings enable companies to expand and implement growth strategies. Earnings performance will also indicate whether the company will have the resources to pay dividends. For many investors the most attractive thing about a particular stock is its dividend and that income is derived from earnings.

Generally speaking, companies with strong earnings will outperform the market while those with poor earning will not fare nearly as well. The essence of the stock market is really in investors looking for companies with earnings that meet or exceed expectations.

Small companies or start-ups may operate with negative earnings for a long period and still carry high stock prices. This happens whenever the market as a whole believes the company will be profitable and successful in the future.

Translating Earnings to Earnings Per Share

The earnings per share (EPS) is used to compare the earnings of different companies. Dividing earnings by the number of shares outstanding leaves you with the EPS. This measure is generally considered to be the most important variable in determining the price of a stock and often serves as a comparison tool when evaluating stock investments within the same industry.

EPS, however, does not tell you what the market thinks of the stock as an investment, but the price to earnings ratio (P/E) does. By dividing the current stock price by the EPS, the P/E can help you understand how much investors are currently willing to pay for these earning. In general, a higher P/E ratio indicates more investor optimism about the stock’s future.

More information on company earnings and stock price


The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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