Show pageOld revisionsBacklinksBack to top This page is read only. You can view the source, but not change it. Ask your administrator if you think this is wrong. ======Net Earnings====== Net Earnings (also known as [[Net Income]] or, more colloquially, the 'Bottom Line') is the grand finale of a company's performance report. Think of it like your personal take-home pay. Your salary is your [[revenue]], but you don't get to keep all of it. The government takes its share ([[taxes]]), you pay for your living costs, and maybe you have a loan payment ([[interest]]). What's left in your bank account at the end of the month is your personal 'net earnings.' For a company, it's the profit remaining after every single expense—from raw materials and employee salaries to interest on [[debt]] and taxes—has been subtracted from its total revenue. This single number, found at the very bottom of the [[income statement]], tells you whether a business is truly profitable. For a value investor, it's not just a number; it's the starting point for understanding a company's true worth and its potential to create wealth for its shareholders. ===== The Journey to the Bottom Line ===== Calculating Net Earnings is like following a trail of breadcrumbs through a company's finances. While the official formula can look intimidating, the logic is straightforward. You start at the top with a company's total sales, or revenue. - **Step 1:** Subtract the direct costs of producing the goods or services sold, known as the [[Cost of Goods Sold (COGS)]]. What's left is the [[gross profit]]. This tells you how profitable the core product itself is. - **Step 2:** From gross profit, subtract all the other costs of running the business—marketing, research & development (R&D), administrative salaries, and rent. These are the [[Operating Expenses]]. Now you have the [[operating income]], which shows the profitability of the company's main business operations. - **Step 3:** Finally, you account for non-operational items. Subtract any interest paid on loans and then subtract the all-important corporate taxes. Voila! The number you're left with is Net Earnings. It’s the clean, final profit figure that belongs to the company's owners: the shareholders. ===== Why the Bottom Line is a Top Priority ===== For a value investor, Net Earnings isn't just an accounting figure; it's the lifeblood of a business. It's the engine that powers growth, rewards shareholders, and ultimately determines a company's long-term value. ==== The Ultimate Test of Profitability ==== A company can boast about soaring revenues, but if it's not turning those sales into actual profit, it's just running on a hamster wheel. Net Earnings cuts through the hype. It answers the most fundamental question: After all the bills are paid, is this business actually making money? A consistent and growing stream of net earnings is the hallmark of a high-quality, durable business. ==== The Fuel for Future Value ==== A profitable company has four main choices for what to do with its Net Earnings, and these choices directly impact shareholder value: * **Reinvest in the Business:** The company can keep the profits as [[retained earnings]] to fund expansion, develop new products, or improve efficiency. This is how great companies compound their value over time. * **Pay Down Debt:** Using earnings to reduce debt strengthens the company's [[balance sheet]], lowers future interest payments, and reduces risk. * **Pay Dividends:** The company can distribute a portion of the profits directly to shareholders as cash payments, called [[dividends]]. This is a direct return on your investment. * **Buy Back Stock:** A company can use its earnings to purchase its own shares from the open market. These [[share buybacks]] reduce the total number of shares outstanding, making each remaining share more valuable. ==== The Foundation of Valuation ==== Net Earnings is the 'E' in many of the most crucial valuation metrics. Without it, you can't properly assess if a stock is cheap or expensive. - **The P/E Ratio:** The famous [[Price-to-Earnings (P/E) Ratio]] is calculated by dividing a company's share price by its [[Earnings Per Share (EPS)]]. (EPS is simply the total Net Earnings divided by the number of shares). This metric gives you a quick idea of how much you are paying for each dollar of a company's profit. - **Return on Equity (ROE):** The [[Return on Equity (ROE)]] metric (`Net Earnings / Shareholder's Equity`) shows how effectively a company is using the shareholders' money to generate profits. A consistently high ROE is often a sign of a superior business. ===== Buyer Beware: What Net Earnings Doesn't Tell You ===== While essential, relying on Net Earnings alone can be misleading. A smart investor always digs a little deeper. ==== Accounting Gimmicks and One-Offs ==== Net Earnings is an [[accounting]] figure, not a cash figure, which means it can be influenced by management's choices. Aggressive accounting practices can make earnings look better than they really are. Furthermore, be wary of 'one-off' gains, like the sale of a factory or a division. This can create a huge, temporary spike in Net Earnings that doesn't reflect the underlying health of the core business. Always look for a consistent track record of earnings from primary operations, not financial engineering. ==== Earnings vs. Cash: The Great Divide ==== Here's a crucial secret: **Profit is an opinion, cash is a fact.** A company can report a healthy profit but be bleeding cash. How? Non-cash expenses like [[depreciation]] (the accounting charge for the wear-and-tear of assets) reduce Net Earnings but don't actually involve a cash outlay. Conversely, a company might be spending a lot of cash on inventory or new equipment ([[working capital]] and capital expenditures) which doesn't immediately hit the Net Earnings figure. //Always// cross-reference Net Earnings with the [[Statement of Cash Flows]]. Specifically, compare it to [[Free Cash Flow (FCF)]]. If a company consistently reports profits but isn't generating cash, it's a major red flag.