Investors and financial planners alike can make one rather tragic mistake if they simply look at earnings to understand whether a company is looking good or set to fall into the dumpster. Why is that? Because many people look only at quarterly earnings reports and let it go at that. A financial planner worth his or her salt will look at any number of measuring tools to gauge a company's real worth. Here are some of them:
This is operating income divided by sales. It shows up as a percentage that indicates how much money a company is making from its sales staff. But just looking at one company isn’t enough. You have to compare that company's margin to those of others also in the same industry.
Operation's Cash Flow
This reflects cash that is received. Keep in mind that a company could sell product on credit and then include the sale in its book and even the money in its net income. The problem is it really doesn't have the cash on hand. Admittedly, cash flow from operations shouldn't be considered a measure of earnings but it certainly can point you in the right direction as to that company's financial health. This reflects cash that is received. Keep in mind that a company could sell product on credit and then include the sale in its book and even the money in its net income. The problem is it really doesn't have the cash on hand. Admittedly, cash flow from operations shouldn't be considered a measure of earnings but it certainly can point you in the right direction as to that company's financial health.
Operating Cash Flow Per Share
It is usually referred to as OPS and it represents the cash flow from operations divided by outstanding shares. It will uncover if a particular company has generated any real cash from its earnings.
Aha, here is the traditional baby. This reflects the net operating revenue after excluding what are called extraordinary items which are one time costs such as income, gains, or losses from discontinued operations. Unfortunately, there is no set standard for what should be included, or even excluded, as an extraordinary or nonrecurring item.
Actually, this was created recently by S&P and is similar to operating earnings except that the calculation requires companies to treat employee stock options as expenses and also to exclude gains (and losses) not only from pension plans but also from the sales of assets that are not deemed a part of the company's basic business. S&P suggests that you might want to review the spread between the numbers; in other words between the operating earnings and the core earnings. If the operating earnings are high and the core low, then earnings may not be of the highest quality. What's a good sign? When you see the spread narrow.
Earnings Before Interest, Depreciation, Taxes, and Amortization are another earnings measure but caution here. Use it occasionally and always with other measures. It is most relevant, say the experts, when it is applied to companies with a high debt level and a lot of hard assets. EBIDTA gives a look at a company's finances without certain financial burdens, but by the same token, it is vital that you scrutinize earnings after accounting for interest, depreciation, taxes, and amortization. Why? Because they could show a different side of the company.
The bottom line is that to really understand a company's true performance, you need to look at a number of different measurements That'll be invaluable to determine what a company may or may not do.
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