The Importance of Earnings

Business and economic activity are undertaken with the idea of generating a profit.

Profit is simply the gross revenue of an enterprise, minus the cost of producing that income, over a defined period of time. For businesses, it's important to measure the profit and allocate capital resources in such a way as to maximise it.

It is the earnings that make the world go round.

So much is made of earnings and earnings reports. Do you hear much about a company's cash balance, accumulated depreciation, or owner's equity during CNBC and other financial shows?

Does everyone salivate four times a year for "asset season?"

No, but there's a definite "earnings season" at the end of each calendar quarter, giving financial analysts, journalists, and pundits plenty to talk about.

On an ongoing basis, earnings are the driving force and "macro" indicator of a company's success.

• If earnings are growing, the financial press doesn't worry much about the other stuff.
• Conversely, serve up a couple of double faults on the earnings front, and everybody is all over asset impairment, write-offs, debt, weak cash positions, and the other similar "disasters."

In the purest sense, long-term stock price appreciation is based on the growth of a company's asset base and owner's equity in that base. Ultimately, that comes from earnings.

If a company is earning money, and particularly if it earns it at a growing rate, that's a good thing. As Warren Buffett says, "If the business does well, the stock always follows."

Earnings tell us how well a business manages its operations, while the balance sheet tells us how well it manages its resources.