To illustrate:

Revenues = Total income from sales and services

Earnings = Revenues - Expenses - Taxes - Other liabilities = Net income

Think of it like this: Revenues are the total amount of money coming in, while Earnings are the actual profit made after accounting for all expenses and liabilities.

Earnings: The Bottom Line

In simple terms, earnings refer to a company's profits. In the business world, other terms like "net income" and "bottom line" are also used to describe profit. Just as "net pay" or "take-home pay" represents an individual's income after deductions, earnings represent a company's "take-home pay" after accounting for all business expenses, such as salaries, raw materials, taxes, and loan interest.

Earnings are the ultimate measure of a company's growth and success. Analysts and investors closely watch earnings performance, seeking companies with consistently growing earnings. This is why quarterly earnings reports are highly anticipated events in the stock market, as they provide insight into a company's financial health and potential for future growth.

Revenues: The Top Line

Revenue represents the total amount of money a company receives from selling its goods and services, before deducting any expenses. In an income statement, revenues (or sales) are typically displayed on the left-hand side (in a horizontal format) or at the top (in a portrait format).

While revenue growth is crucial, it doesn't necessarily indicate whether a company is generating a profit. To determine profitability, expenses must be subtracted from revenues, resulting in earnings (or net income). In other words, revenue is the initial income, and earnings are the remaining profit after accounting for all expenses.

Think of it like this:

Revenue = Total income from sales and services (the top line)

Earnings = Revenue - Expenses = Net income (the bottom line)

Forms of Earnings: Understanding the Variations

As we know, earnings represent a company's profit, but it's essential to understand the different components that make up this number. You may come across various terms, including:

• Earnings Before Taxes (EBT)

• Earnings Before Interest and Taxes (EBIT)

• Earnings Before Depreciation, Interest, and Taxes (EBDIT)

• Earnings Before Interest, Taxes, Depreciation, and Amortization (EBDITA)

• Earnings After Taxes (EAT)

Each of these terms represents a specific aspect of a company's earnings, helping analysts and investors understand the profit margins and financial performance from different perspectives.

These variations in earnings calculations enable a more detailed analysis of a company's financial health, profitability, and growth potential.

Earnings Per Share (EPS): A Key Metric

Earnings Per Share (EPS) represents the portion of a company's profit allocated to each outstanding share. It's a vital indicator of a company's profitability and a crucial ratio for evaluating a stock's potential. EPS helps investors and analysts understand the profit generated by each share, providing valuable insights into a company's financial performance and potential for future growth.

Calculation: EPS = (Net Income / Total Number of Outstanding Shares)

EPS is a widely used metric for comparing the profitability of different companies, evaluating investment opportunities, and assessing a stock's value.

The formula for calculating Earnings Per Share (EPS) is:

EPS = (Net Income - Dividends on Preferred Stock) / Average Outstanding Shares

Where:

• Net Income is the company's total earnings or profit.

• Dividends on Preferred Stock are the dividends paid to preferred shareholders, which are subtracted from net income because they are not available to common shareholders.

• Average Outstanding Shares are the average number of shares outstanding during the reporting period, which takes into account any changes in the number of shares outstanding due to issuances, repurchases, or other events.

Using the average outstanding shares provides a more accurate representation of the EPS, as the number of shares outstanding can fluctuate during the period. By using the average, you get a better picture of the company's profitability on a per-share basis.

Why is EPS important? 

EPS is a crucial metric for investors and analysts, but it should not be relied upon as the sole indicator of a company's performance. Here's why:

1. Comparability issues: As you mentioned, EPS doesn't consider the amount of capital invested to generate profits. A company with higher capital expenditure may show similar EPS to another company with lower capital expenditure, but the former may be less efficient in utilizing its resources.

2. Accounting practices: EPS is susceptible to accounting manipulations, such as aggressive revenue recognition or expense management. This can lead to inflated EPS figures that don't accurately reflect a company's true performance.

3. Industry differences: EPS varies significantly across industries, making direct comparisons challenging. For example, a company in a high-growth industry may have a lower EPS than one in a mature industry, but its growth potential may be higher.

4. One-time items: EPS can be influenced by one-time events like asset sales, write-offs, or legal settlements, which may not reflect a company's recurring earnings power.

To get a comprehensive picture, it's essential to consider EPS in conjunction with other metrics, such as:

• Return on Equity (ROE)

• Return on Assets (ROA)

• Cash Flow per Share

• Price-to-Earnings Ratio (P/E Ratio)

• Dividend Yield

By analyzing these metrics together, you can gain a better understanding of a company's financial performance, efficiency, and growth potential.

When analyzing EPS, it's important to keep the following points in mind:

1. Consistency matters: Compare EPS growth with previous years/quarters to ensure consistent growth. A steady increase in EPS indicates genuine growth.

2. Quarterly growth: Current quarterly EPS should show a significant increase (at least 10-20%) to indicate strong performance.

3. Long-term perspective: Annual EPS should demonstrate decent growth over the previous five years, indicating a stable and growing trend.

4. Contextualize: Consider EPS with other metrics, such as revenue growth, profit margins, and return on equity (ROE), to gain a comprehensive understanding.

5. Industry comparison: Compare EPS with industry averages and competitors to evaluate relative performance.

6. Quality of earnings: Assess the quality of earnings by considering factors like cash flow, revenue recognition, and accounting practices.

By keeping these points in mind, you can gain a deeper understanding of a company's EPS and make more informed investment decisions.