Earnings Growth is the measure of how much a company's profits have increased over a specific period, typically expressed as a percentage. Think of it as the annual report card for a company's profitability. A company’s bottom line, or net income, is the ultimate source of value for its shareholders. When that number consistently gets bigger, it's a powerful signal that the business is healthy, expanding, and creating more value. While often seen as the holy grail for a strategy called growth investing, understanding the nature, quality, and price of earnings growth is a cornerstone of intelligent value investing. A company that can't grow its earnings is like a shark that stops swimming; eventually, it sinks. This growth is the fuel for future dividends, share buybacks, and, most importantly, a rising stock price over the long term.
Why do investors get so excited about earnings growth? Because, fundamentally, it's the engine of compounding. A company that grows its profits has more cash to work with. It can use this expanding pot of money to:
Over time, a company that can consistently grow its earnings at a healthy clip will almost certainly see its stock price follow suit. It is the single most important long-term driver of share price appreciation. A business that is stagnant is, in real terms, going backward due to inflation. Growth is a sign of life, innovation, and a management team that is successfully navigating its market.
Calculating the basic earnings growth rate is straightforward. The most common metric used is earnings per share (EPS), which divides the company's total net income by the number of outstanding shares. The formula is: ((Current Period EPS - Previous Period EPS) / Previous Period EPS) x 100 For example: Imagine a company, “Robo-Burger Inc.,” had an EPS of $2.00 last year. This year, it reported an EPS of $2.50.
Robo-Burger grew its earnings by a very healthy 25% year-over-year.
A single growth number can be misleading. Smart investors look for patterns and context.
The legendary investor Warren Buffett famously said, “Growth and value are joined at the hip.” For a value investor, the question isn't if a company is growing, but rather:
This leads to a philosophy often called Growth at a Reasonable Price (GARP). A value investor avoids chasing companies with dazzling growth stories that trade at insane valuations. Instead, they look for wonderful companies with durable, profitable growth and try to buy them at a fair price. Growth that comes from taking on massive debt or from accounting tricks is low-quality. Growth that comes from a powerful brand, a unique product, or a widening economic moat is high-quality and worth paying a fair—but not excessive—price for.
Not all growth is created equal. Be on the lookout for these common traps.
Some companies use financial tricks to make their earnings growth look better than it is. This is sometimes called creative accounting.
A great way to check for this is to compare net income growth with the growth of cash flow from operations. If earnings are soaring but cash flow is flat or falling, something is fishy.
This is the danger of overpaying. Wall Street often gets overly optimistic about high-growth companies, bidding their stock prices up to stratospheric levels. These stocks are priced for perfection. If growth merely slows down from an incredible 40% to a “disappointing” 20%, the stock can get cut in half. This is why a margin of safety is so critical. By refusing to overpay, you protect yourself from the inevitable bumps in a company's growth journey.
Earnings growth is a vital sign of a healthy, thriving business. However, it is just one piece of the investment puzzle. A smart investor never looks at growth in isolation. It must be weighed against the company's valuation (price-to-earnings ratio), its profitability (return on equity), its financial strength (debt-to-equity ratio), and the durability of its competitive advantages. A truly great investment is found at the intersection of quality, growth, and price. Your job as an investor is not just to find growth, but to find it at a price that makes sense.